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Index Month / Year to Date

Dow Jones +1.98%/+25.34%
S&P 500 +1.92%/+20.15%
NASDAQ +3.17%/+29.85%
10-yr Treasury 10-Yr Treasury yield was 2.41% at the end of November and 2.41% at the end of December
Source: marketwatch.com & macrotrends.com

Markets:

Throughout 2017, the stock market was driven mainly by hope and optimism over the Republican tax plan. The plan was finally signed into law in December, which reasonably should have given the market its biggest monthly boost of the year. Yet, each of the major indexes finished with smaller gains than in November. In fact, on the very day the Senate finally approved the tax bill, the market experienced a slight pullback, which was probably an acknowledgment that the tax plan’s value has already been priced into the market.1

With Wall Street counting on the tax plan to deliver the kind of growth Donald Trump had promised, it was a banner year for the stock market. The Dow gained over 25 percent, the S&P 500 added about 20 percent, and the Nasdaq gained nearly 30 percent.2 That sounds impressive, but now, the tax plan almost has to deliver 4 percent or greater GDP growth in order for the economy to catch up with overinflated stock prices. If that scenario doesn’t pan out, there might only be one other way for the markets to make fundamental sense again: a double-digit pullback.

This 2018 year could be in the double-digit for the markets, which could lead to either that major pullback mentioned earlier or another year of double-digit gains due to sheer momentum—but probably nothing in between. Even if the economy only continues to improve at its current pace, emotion may go on building up the “froth” that already characterizes this market. In fact, the momentum will most likely continue in the beginning of the year. Whether it continues throughout the entire year is another question.

Of course, the more important question is this: Is it worth the risk when a double-digit drop is equally possible based on economic realities? Consider that with long-term interest rates still almost where they were two years ago, and inflation still struggling to stay above 2 percent, the Fed’s plan for raising short-term interest rates continues to threaten the yield curve.3 A flat yield curve is just the kind of thing that can stall an economy completely and finally force the stock market to make fundamental sense again with a major pullback!

1. “Stock Market News for Dec 21, 2017,” Nasdaq.com, last modified December 21, 2017
2. Danielle Wiener-Bronner and Matt Egan, “Dow poised for best year since 2013,” CNN Money, last modified December 24, 2017
3. ycharts.com