Expectations for 2018

How to prepare for potential lower returns.

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Rebecca Katz: Why don’t we just jump into what has been on the headlines all day. The equity markets set new records today. We have a question from John in Fairfield, Connecticut, who just says, “What’s your outlook for equity investments in 2018? Will this party end?” So, Greg, as our chief investment officer, that’s yours.

Greg Davis: Sure. So, I mean, we typically don’t think about the equity market and investing in equities on a one-year basis. It’s very difficult to predict what’s going to happen in the short-run.

When we think about longer-term equity market returns on a global basis, we’re expecting somewhere in the neighborhood of 4.5% to 6.5% global equity market returns over a 10-year time horizon on an annualized basis. If we’re to look at the domestic market, we’re thinking in a 3% to 5% type of range just because starting valuations are a bit elevated relative to where they’ve been historically. So, if you take that into consideration, plus where we are in terms of the economic cycle, we’re expecting lower equity market returns relative to the historical average.

Rebecca Katz: Yes, that seems like that would feel a lot different. What have we been averaging, about 8%?

Greg Davis: North of 10%, right. And then, you know, in terms of when the party will end, I mean no one knows when the party will end. What we would say is that we should be on the lookout for certain things. Things such as are we starting to see a big pickup in terms of inflation, and will that cause the Federal Reserve and the global central banks to start taking away some of their accommodation when it comes to monetary policy? That would be a warning sign that the party could be coming to an end. And then other things like China. If we start to see things in China start to flare up again about concerns about growth in China, that would be another one of those factors that could cause pressure in the equity markets globally.

Rebecca Katz: Okay. Well we do have, I’m sure, a lot of questions around how to time the markets, when to get in, when to get out; things like that. So, Steve in Tupper Lake, New York, for example, said, “If there’s going to be a major adjustment in the market,” which you didn’t mention, but if there was one and we were going to expect it, “should we move out of stocks in early 2018?” So, I guess, two questions. Do we expect an actual big correction, and how do you avoid that?

Tim Buckley: Well, I guess my lesson for Steve would be in 26 years I’ve learned that market timing is a fool’s errand. Greg made a great case for why, look, equites are stretched in their valuations, and, you know, a rational person would think, hey, they’re stretched, there’s likely to be a pullback, I should get out now.

You also have to remember that markets and investors can remain irrational for long periods of time. And the other thing is you don’t necessarily have to have a pullback to get valuations back in place. We actually can have markets with low returns. If we have low returns and decent earnings growth by companies, that would get price/earnings (PE) multiples back in line over time, so you don’t necessarily have to have a pullback.

But let’s say Steve got it right, and he said, “I’m going to go into cash.” And he pulled back and he pulled into cash and the market went down 20%. The next thing Steve has to do is know when to get back in the market. And markets are fairly punchy. They get all the return on a couple of days, and so you have to know when to get back in. So now is the tough part. You don’t know, do I get back in right after or is there another turn coming? It’s too hard. It is just too hard to get that timing right and I’ve yet to meet the investor who actually can time it perfectly. And that’s why we talk about diversification, and you hear us say it time and again, “diversification.”

You have diversification for just these times. Right, Greg? If we knew that you weren’t going to get a pullback in the markets, we’d tell you 100% equities, right? If you’re going to have a nice equity market, why be diversified? But we never know when those pullbacks are coming in the stock market, so you stay diversified and then when a pullback comes to the market, be ready, be courageous—it takes a little bit of courage to say, “I’m going to sell some of my bonds and actually buy into those equities.” And that’s the best thing you can do.

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