The stock market continued to hit new highs through the third quarter, confounding those who
focused on the rapidly changing headlines in the U.S. and throughout the world. We believe there still are a
number of key issues that investors should watch as we enter the final quarter of 2017. We also have updated
our views on several key stock sectors. We believe there are opportunities in companies that continue to
demonstrate strong fundamentals — despite the occasional distractions of the global news cycle.
Tax reform leads the agenda
Since President Donald Trump’s election in 2016, there have
been varying expectations for a change in U.S. tax policy.
A broad tax framework with the goal to make American
companies more competitive recently was released by the
“Big Six”: Speaker of the House Paul Ryan, Senate Majority
Leader Mitch McConnell, House Ways and Means Chairman
Kevin Brady, Senate Finance Committee Chairman Orrin
Hatch, Treasury Secretary Steve Mnuchin and National
Economic Council Director Gary Cohn. That group
represents a wide swath of both the legislative and executive
branches of the federal government.
Overall, we believe this plan is a positive move. It consists of
a reduction in both individual and corporate tax rates and
eliminates many deductions. Under the proposal, the
corporate tax rate would be reduced to 20% versus the
current federal rate of 35% and an average of 22.5% for
other industrialized countries.
The proposed tax plan also calls for an incentive to increase
capital spending. Republicans plan to pass this legislation
under rules allowing a simple majority in the Senate,
meaning no support from Democrats would be needed. We
are cautiously optimistic that some version of tax reform will
be signed into law.
Trump has continued to seek improvements in infrastructure
across the U.S., as he did during his presidential campaign.
We believe the focus of his administration will turn to
infrastructure only after tax reform is completed. The
discussion, however, is likely to focus on how to pay for
infrastructure projects. We don’t think there will be broad
support for large deficit-financed infrastructure spending.
We think a more likely solution will come via a focus on
Trump also has been active since his election in pushing for
deregulation as a way to support U.S. businesses. We believe
this will continue to be a focus of the administration and think
it will provide a positive impetus for business confidence and
Changing tone of monetary policy
Global monetary policy continues to diverge. Even so, it
is clear that more central banks are moving away from
their crisis-induced policies that were prompted by the
global financial crisis that began in 2008. We believe this
divergence should be watched carefully as different parts of
the world begin to exit extremely easy monetary policies.
The U.S. Federal Reserve (Fed) has hiked interest rates four
times since late 2015. We think the Fed will raise rates again
in December and two more times in 2018.
The Fed also has announced that it would begin to reduce its
balance sheet starting Oct. 1 by allowing maturing Treasury
and mortgage-backed securities to roll off. The drawdown will
initially be capped at $10 billion per month and will increase
by $10 billion each quarter until it reaches $50 billion per
month. We think most financial markets already are pricing
the drawdown into their projections and do not expect major
volatility as a result of the Fed’s actions.
The European Central Bank (ECB) continues to purchase 60
billion euros per month in securities. We expect the purchase
amount to wind down throughout 2018 until it reaches zero,
with interest rates remaining at current levels.
We think the Bank of England probably will increase interest
rates in November, but the pace of further rate hikes will be slow
in 2018 because of a weaker economy in the U.K. and continued
uncertainty in the Brexit negotiations between the U.K. and
European Union (EU).
The Bank of Canada is likely to continue hiking rates slowly
in 2018 and we think the Reserve Bank of Australia will begin
increasing rates next year. However, the Bank of Japan still is
likely to lag the rest of the world in removing its accommodative
monetary policy and we expect little action on rates.
Geopolitics still deserve attention
The 19th National Congress of the Communist Party of China
will be held in Beijing in late October. During this meeting,
the leadership body of China — the Politburo Standing
Committee — will be reshuffled and President Xi Jinping
has the opportunity to reshape the committee with his own
supporters. We will be closely watching China’s action following
the party congress to see if it begins to address its structural
issues. We believe that President Xi will continue to gradually
push through reforms, slow the pace of debt accumulation and
focus on improving the environment while working to prevent
the economy from slowing much.
In Europe, the results of elections so far have not caused
much concern. France and the Netherlands avoided anti-euro
governments. Germany saw the ruling party win its lowest vote
share in decades. Even so, it looks to form a coalition with two
smaller parties. This coalition could cause issues with long-term
integration in the EU, but we believe the short-term political
outlook will be little changed.
Going forward, it will be important to watch elections in Italy,
which must be held by May 21, 2018. The anti-establishment
5-Star Movement now is neck-and-neck with the ruling
Democratic Party. If 5-Star candidates win the elections, they
wouldn’t have enough seats to form a government but could
form a coalition with other parties. Such a government led by
5-Star would likely be unwelcome by the markets.
Recent turmoil in Spain in response to the Catalonia region’s
push for independence also is cause for concern. Spanish
Prime Minister Mariano Rajoy’s response to the crisis has
brought into question the viability of his government and the
possibility of snap elections. At the very least, the outlook is
unclear. Catalonia’s action is a reminder, too, of other regional
independence movements across Europe, including in Venice,
the Basque Country, Scotland and Wallonia. While we do not
anticipate that the vote in Catalonia will spur other areas to act,
they do remain a potentially troubling undercurrent in what
otherwise is a unified Europe.
In the U.K., Prime Minister Theresa May had hoped to
strengthen her position with a speech at the Conservative
Party conference in early October. Instead, her speech was
disrupted by a prankster, she struggled with a cough and
ultimately she was panned by critics. Even her supporters
were underwhelmed. Several large publications in the U.K. are
calling for her to step down. While we see no signs that she will
do so, a change in prime minister could affect the negotiations
and timing of the U.K.’s exit from the EU. May repeatedly has
said she firmly plans to have the U.K. entirely out in early 2019.
What direction for inflation and wages?
Up to this point, inflation has been below the central bank
targets in most countries. Wage growth has been sluggish.
We would highlight that labor markets are fairly tight in the
U.S., U.K., Germany and Japan, to name just a few. While no
one knows the precise level of unemployment at which wage
growth will accelerate, we do believe the bias for wage growth
is to the upside.
Even so, we don’t think this will push inflation significantly
higher. Instead, we think the move higher in inflation is likely
to be gradual. However, in an environment where markets
are accustomed to very low inflation rates, any surprise move
toward higher inflation would be disruptive.
Key sectors to watch now
Technology retained its place as the stock market’s best performing sector through the third quarter, with the S&P
Information Technology Index returning 8.3% for the year to date. While technology remains a top performer, the Ivy
Investments team sees a number of opportunities, and risks, as we look ahead. Here are our thoughts on key sectors
to watch as we head toward 2018.
The sector has been the driver of upward market activity this
year, led by large-cap names – namely the FAANG stocks
(Facebook, Apple, Amazon, Netflix and Google-parent
Alphabet). Unlike the dot-com bubble era, these companies are
highly profitable with a lot of cash on hand. Growing confidence
in the economy and optimism within many companies’
management teams is likely to drive further corporate
investment and may lead to renewed revenue growth.
We have seen secular growth across the sector, and we think it
remains attractive as a defensive investment amid uncertainty.
Stocks across the sector have performed relatively well
despite concerns about pricing pressure and policy questions
arising from ongoing debate in Washington. Even with the
concerns around drug pricing, we believe biotechnology and
pharmaceutical companies that bring economic value to the
market (fewer hospitalizations, better patient productivity, etc.)
have the opportunity for appreciating stock prices.
These stocks generally rose toward the end of the third quarter
as oil prices stabilized around $50 per barrel, though the sector
overall has been disappointing over the course of 2017. But we
believe low valuations mean there is opportunity for active stock
pickers. The Ivy team still believes that shortfalls in oil supply are
likely within two years. Among global producers, the U.S. is the
only area where oil production is growing and that growth is not
likely to compensate for increasing global demand and declining
rates from existing wells.
We believe a healthy global economy, within a rising rate
environment, is positive for this sector. Several financial
company stocks turned higher in September. The lingering
perception of a less-intense regulatory environment also has
boosted prospects of financial stocks, though specifics remain
mired in political debate. We see opportunity as bank profits
stand to improve if the Fed follows through on the plan to
gradually increase interest rates over the next 12 months.
More broadly, growth stocks, especially technology and health
care, have outperformed value stocks, such as financials
and energy, so far this year. We believe this trend has been
supported by the prolonged low-growth, low-interest-rate
environment that has pervaded since the financial crisis.
Essentially, any growth has looked attractive, so investors
have been willing to pay for it.
However, as the economy continues to show steady improvement,
with interest rates likely to rise gradually, that dynamic could
change. It’s an area we’re watching closely, one that we believe
could provide opportunity for active managers over the next
Past performance is not a guarantee of future results. Investment return and principal value will fluctuate, and it is possible to lose money by investing. International investing involves additional risks, including currency fluctuations, political or economic conditions affecting the foreign country, and differences in accounting standards and foreign regulations. These risks are magnified in emerging markets. Investing in the energy sector can be riskier than other types of investment activities because of a range of factors, including price fluctuation caused by real and perceived inflationary trends and political developments, and the cost assumed by energy companies in complying with environmental safety regulations. These and other risks are more fully described in a Fund’s prospectus.
The opinions expressed are those of Ivy Investment Management Company and are not meant as investment advice or to predict or project the future performance of any investment product. The opinions are current through October 2017, are subject to change at any time based on market and other current conditions, and no forecasts can be guaranteed. This commentary is being provided as a general source of information and is not intended as a recommendation to purchase, sell, or hold any specific security or to engage in any investment strategy. Investment decisions should always be made based on an investor’s specific objectives, financial needs, risk tolerance and time horizon.