Positioning For Possibilities

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We continue to see near-term positive momentum in both the economy and the capital markets, though uncertainties loom. Here are five questions we’re pondering as we position for 2018.

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  • How Will Tax Reform Impact the Markets?
    In our view, corporate tax cuts could modestly benefit stocks, as higher after-tax profits and repatriated foreign cash will likely lead to more buybacks and some increase in capital expenditures. However, lower taxes could prompt some corporations to spend more on research and development, price promotions, and advertising and therefore provide less benefit to near-term earnings. That’s why we’re focused on companies capable of generating high returns on capital from organic growth—not just on those expected to benefit from lower tax rates.
  • Which Types of Stocks Appear Most Attractive?
    We expect stock selection, rather than broad themes, to drive performance in the period ahead. A few trends remain visible. For example, we continue to expect a slight advantage to non-US stocks. And in terms of style, there has been some recent rotation away from 2017’s significant outperformance of growth stocks. However, rather than making bets on style or factor rotations, we see individual stock selection as critical—especially as companies adapt to new technologies and changing consumer behaviors.
  • What if Rates Rise More Rapidly Than Expected?
    We continue to expect a gradual increase in interest rates though we now expect the Fed to raise short-term rates four times in 2018. Veering from expectations could create volatility in both stock and bond markets. That’s why our equities are diversified by both geography and factors—including quality, momentum, growth, and value. For bond-heavy allocations, we recommend diversification with assets that protect against interest rate risk, such as portfolios of floating rate loans to middle market companies.
  • Will Inflation Stay Low Forever?
    Economists have been surprised by stubbornly low inflation even as the global economy and employment have improved in recent years. But inflation’s noticeable absence is unlikely to persist. For portfolios that support necessary spending, we have long recommended protection against rising inflation, such as inflation-sensitive bonds, real estate-related securities, and commodities.
  • Why Should I Worry About Volatility?
    Markets have been unusually tranquil because the global economy has been calm, and because central bank actions have been very accommodating. That will change at some point. Our goal is to withstand unexpected market stress by including assets that have low correlation to stocks and bonds, such as hedge funds and securities with floating interest rates.

While markets are difficult to forecast in the short term, we remain positive on the outlook for equities. We don’t expect 2018 to replicate the strong market returns of 2017, but see opportunities to diversify by asset class and geography while positioning for possibilities.

The views expressed herein do not constitute research, investment advice, or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams.

Article by Kathleen M. Fisher, Alliance Bernstein

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