3 big questions for investors in 2018

It sure feels like maybe, just maybe, stocks will never go down again as Wall Street enjoys a rip-roaring start to 2018. 

The dynamics are familiar: The U.S. economy is strong and about to enjoy a boost from the implementation of the GOP's new tax cuts, inflation remains tepid, the Federal Reserve's rate hike campaign is proceeding cautiously and corporate earnings growth has been solid. 

But a number of new dynamics loom in 2018. Here are three questions investors need to ponder:

Are we headed for a "melt-up"?

With the S&P 500's gain on Monday, stocks have risen 2.8 percent for the new year, risng in every session so far. According to Jeff Hirsch at the Almanac Trader, this performance -- along with the solid run to end 2017 -- suggests 2018 will be great for investors. Over the last 39 years, when stocks performed this well, the rest of the year showed gains 87 percent of the time, with an average rise of 14 percent.

Even long-time market skeptics like GMO's Jeremy Grantham said markets could be headed for a "near-term melt-up" scenario. In a letter to investors, he wondered if stocks are entering the final, most ebullient phase of this long bull move. 

Jason Geopfert at SentimenTrader noted that the gains are part of a globally synchronized market displaying "extreme momentum." The weekly Relative Strength Index across six major worldwide stock indexes is now at the highest level in history. Such extreme readings have in the past been associated with further gains -- the type of melt-up move Grantham warns of. 

Why a warning? Because such a move means "we are probably down to the last few months" of the bull market, according to Grantham.

Will the "Fed put" finally end? 

In a recent note to clients, Bank of America Merrill Lynch (BAC) analysts noted that in 2017, for the first time, Federal Reserve policymakers stuck to their guns and tightened interest rates in three quarter-point increments -- a much more rapid pace than what bond traders expected at the start of the year. 

Previously, the Fed always lowered its tightening plans to match market expectations in fear of repeating 2013's "taper tantrum" episode during which long-term interest rates rose rapidly. That has changed now as the Fed's velvet glove treatment has resulted in financial conditions -- when measured broadly -- being easier now than when the central bank's tightening campaign started in 2015. 

This deferral to the market is widely known as the "Fed put" -- the idea that maintaining market calm overrides monetary policy desires. But it could be ending.  

Fed officials have penciled in another trio of quarter-point hikes for 2018. But the futures market assigns only 30 percent odds for that outcome. According to traders, the more likely outcome -- at 60 percent odds -- is that the Fed is forced to back down and raises rates no more than twice. 

However, Goldman Sachs (GS) is far more aggressive, warning clients that it expects four quarter-point rate hikes in 2018 as inflation heats up. 

Will the U.S. dollar continue to weaken? 

The good old greenback hasn't been faring so well lately. It has fallen 4 percent from its early November high and is down 12 percent from December 2016. Watch for a possible decline to lows not seen since 2014 as the dollar gets battered by a combination of higher oil prices, rising inflation and a creeping sense the Fed has been too slow in its policy normalization. 

Also factoring in is the excitement in cryptocurrencies like bitcoin and ripple, which are widely seen as private-market alternatives -- safe havens, even -- from government-backed fiat currencies. 

The problem, however, is that a rapidly weakening dollar would undermine the "Goldilocks" conditions that have allowed the Fed to take it slow by pushing inflation higher, via everything from higher import prices to a tailwind behind commodity prices like crude oil. 

  • Anthony Mirhaydari

    Anthony Mirhaydari is founder of the Edge , an investment advisory newsletter, and Edge Pro, options newsletter. Previously, he was a markets columnist for MSN Money; a senior research analyst with Markman Capital Insight, a money management firm; and an analyst with Moss Adams focusing on the financial services industry.