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Will the bulls keep running stocks higher and higher in 2018?

Five things that could tank the market

The coming year may be a time of reckoning for investors if this long-running bull market ever slows down or even tumbles after 105 months of almost nothing but up, up, up. Of course, there've been predictions galore about the death of this advance, which is just three months shy of its ninth year -- a milestone only one bull market has reached since World War II. But the naysayers were proved wrong the past eight-plus years as the bulls rarely looked back from the occasional 10 percent to 15 percent dips.  

"It's been said that bull markets don't die of old age, they die of fright -- and what they are most afraid of is recession," said Sam Stovall, chief investment strategist at CFRA. Here's the potential bad news: "Unfortunately, all of the Republican presidents since Teddy Roosevelt endured a recession in their first term in office," Stovall noted, "with nine of them witnessing the recession's start with the first two years in office."

Of course, it could be different under Republican President Donald Trump. Investors seem ecstatic about the stock market's enduring ebullience, with equity prices and valuations running at record highs as interest rates and inflation remain near historic lows. And both the U.S. and global economy are stable, which is highly positive for stock markets here and abroad. 

"Our baseline forecast assumes modest GDP growth and mid-single-digit stock price appreciation, based on the continued recovery from 2016's earnings recession combined with the effects of the expected tax cut [in 2018]," Stovall said. "if we are wrong, we are most likely underestimating the year's potential growth in GDP, profits and stock price appreciation as a result of favorable global economic growth, U.S. tax cuts and foreign earning repatriation combined with a possible increase in U.S. infrastructure spending."

What Stovall's forecast does not take into account, however, is the unpredictability of Donald Trump. Some skittish senior investment strategists say a serious misfire from the president on economic or foreign policy could shatter the bullish scenario. "Prepare for the possibility of [President] Trump putting the U.S. on a ramped-up war footing to distract Americans from his Robert Meuller woes," warned George Brooks, who publishes the influential daily blog Investorsfirstread.com. 

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Even on the market's fundamentals alone, Brooks at this point sees problems ahead. "I see volatility increasing dramatically after a 25 percent rise in the S&P 500 in 2017, driven by institutions betting on a massive tax cut -- and right they were," Brooks said. "The current S&P 500 price/earnings ratio is 22.5 times trailing earnings, well above the 10-year average of 14.1. ... [Yet] I see forecasts for the S&P ranging from 2,800 (up 4.3 percent) to 3,100 (up 15.5 percent) for 2018." 

That contrasts with the S&P 500 at 666 on March 10, 2009, a day when most everyone was bearish -- and "the day when Investorsfirstread.com issued a 'buy' recommendation," Brooks recalled

Some analysts predict that the market will surge in the first month of next year. Brooks warns that an upswing in early January is likely to "run into selling by investors opting to put [2017] profits into 2018." The selling could start even in the first week of January, he said.

Brooks sees two major corrections in 2018, ranging from a 10 percent to 15 percent pullback. The first could occur, as just noted, in January, and the next could occur around midyear. "The risk is real," he said, citing May 2010, when the market fell 17 percent; May 2011, when it fell 17 percent; August 2015, down 12 percent; and January 2016, down 14 percent  

Brooks believes the "odds of a bull market top in 2018 is 50-50, assuming one more speculative surge."  

Otherwise, "expect volatility in the face of results from the Meuller probe and military action in North Korea," he said. 

Whatever policies the Trump administration will proclaim next year could surely cast a friendly light -- as much as a shadow -- on market projections. The U.S. equity market has demonstrated it can stay above the din and distractions, as it did during the first year of the untested new administration.

So it looks like, at best, an uncertain market -- or a market of uncertainties -- lies ahead for investors. With that in mind, some analysts suggest adopt a three-step strategy:

  • Prepare to take profits at the end of this year or early in 2018 from stocks in your portfolio that have already provided good returns of 5 percent or more for the year
  • Keep those profits handy as cash for the market's next big fall, when you can buy your favorite stocks at lower prices -- in effect pursuing the ever-popular "buy on the dips" strategy. 
  • When buying new names, stick to the mightiest large-cap stocks because they would be less likely to be crushed to smithereens when the market turns south, such as during the disasters of 2008 and 2009.

The sectors that many astute analysts see as attractive in this type of market of uncertainties are:

Technology: Apple (APPL), Facebook (FB) and Microsoft (MSFT)

Financials: JPMorgan (JPM) and Bank of America (BAC)

Health care: CVS (CVS) and United Health Group (UNH)

Consumer and retail services: Amazon (AMZN) and Walmart (WMT)

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