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Record Run Defies Skeptics -- WSJ

30 Dec 2017 7:32 am
By Corrie Driebusch 

This article is being republished as part of our daily reproduction of WSJ.com articles that also appeared in the U.S. print edition of The Wall Street Journal (December 30, 2017).

The Dow Jones Industrial Average posted its second-biggest yearly gain of the past decade in 2017, rising a surprising 25%.

The market notched the most closing highs for the index in a single calendar year. Volatility swooned to historic lows and many global stock markets finished the year at or near records or multiyear highs.

It's a sharp change from what many money managers and analysts anticipated at the start of 2017. At the time, many expected what they called a "sideways market," where the overall levels of major indexes would remain little changed at year-end. Instead, the S&P 500 posted its best yearly gain since 2013.

Some of them acknowledge they were surprised by a confluence of market-supporting trends. They didn't expect corporate earnings and revenues to grow at such a fast clip. They didn't anticipate the economies of all 45 countries tracked by the Organization for Economic Cooperation and Development to be on pace to expand, an uncommon synchronicity. They certainly didn't predict the Dow would rise for nine consecutive months, its longest streak of monthly gains since 1959, even in the face of geopolitical turmoil in Washington and around the world.

"There was no knocking the market off its perch," said JJ Kinahan, chief market strategist at TD Ameritrade. "A couple times it wobbled, but we never saw a wild rush of sales in the market. Every dip was marked with big buyers."

Heading into 2017, many analysts and investors expected moderate gains for the S&P 500. Goldman Sachs Group Inc. forecast in a January 2017 report that the index would rise to 2400 in the first quarter before fading to 2300 by year-end. Credit Suisse also estimated in early January that the index would close out 2017 at 2300. The S&P 500 closed at 2673.61 Friday.

Underpinning the index's 19% climb in 2017 has been corporate-earnings growth, which is on pace to post its largest increase since 2011, as measured by earnings per share. At the end of the first quarter, analysts polled by FactSet were expecting companies in the S&P 500 to post 9.1% earnings growth in that period. Instead, companies grew their earnings by 14%, FactSet data show. That expansion has continued, albeit at a slower pace: In the second quarter, earnings for companies in the S&P 500 rose 10% from the year prior, and in the third quarter that growth was 6.4%.

"We're seeing a peak rate of growth," said Bob Doll, senior portfolio manager and chief equity strategist at Nuveen Asset Management. However, that doesn't mean investors should rush to sell stocks, he said -- even if growth slows in the next year or two, there is still upside potential, he said.

Mr. Doll, who said his own predictions for the S&P 500's 2017 rise fell short, also attributed the outsize gains to the synchronous economic expansion around the globe. The U.S. recovered from the financial crisis more quickly than other countries, but that changed in 2017 as others caught up. The result is global stock indexes near records or multiyear highs, from Japan's Nikkei Stock Average to the U.K.'s FTSE 100. The MSCI All Country World Index is also near a record.

The steep gains of 2017 have some analysts worried that the rally could wane in 2018, particularly if volatility, which hit historic lows this year, ticks up as many predict. Stocks are trading at above-average multiples of their past 12 months of earnings and government bonds have been sending cautionary signals about the U.S. economy's prospects, something that could end up jolting indexes in 2018.

The yield on the benchmark 10-year Treasury note, often seen as a gauge of investors' sentiment about the economy, closed at 2.409% on Friday, down slightly from 2.446% at the end of 2016 in defiance of analysts' predictions that it would soar in 2017 with a surge in growth and inflation. Its premium relative to the two-year note yield has been cut by more than half over the past year.

Though analysts have debated its significance, a shrinking gap between short and long-term Treasury yields, known on Wall Street as a flattening yield curve, has often been a warning sign for investors. Five of the past six times the two-year yield surpassed the 10-year yield, known as an inverted yield curve, the economy subsequently entered a recession, according to data from the St. Louis Fed.

With few other signs of recession, however, many investors say there are reasons to doubt the yield curve's signals, which some argue have been distorted by easy-money policies from central banks in Europe and Japan pushing yield-seeking investors into U.S. government bonds, driving down the yields on longer-term debt.

Still, many investors and analysts expect the curve to continue its flattening in 2018, given signs that the Federal Reserve will keep raising interest rates even if inflation remains stuck below its 2% annual target. That could push up the two-year yield, which is more sensitive to expectations for central-bank policy.

That, plus a potential deceleration in economic growth, could set up 2018 to be a tougher year. A bright spot some analysts point to is corporate tax cuts, which could boost earnings growth and stock prices. Yet, some analysts say they are worried the potential benefits from the tax bill are already priced into company shares, limiting upside in 2018.

"We've gotten used to things being very good," said Brad McMillan, chief investment officer for Commonwealth Financial Network, who added that he doesn't expect either big declines or big gains in 2018. "We don't need the tailwinds to turn into headwinds, we just need a couple to go away to find ourselves in a very different market environment."

--Sam Goldfarb contributed to this article.

Write to Corrie Driebusch at corrie.driebusch@wsj.com

(END) Dow Jones Newswires

December 30, 2017 02:32 ET (07:32 GMT)

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