Fourth Quarter 2017

Financial Market Update

The global stock market rose 24.0% in 2017, making it a terrific year for investors.  Both emerging market and foreign developed stocks, which were up 37.3% and 25.0% respectively, outperformed their U.S. counterparts for the first time in many years.  Even commodities, which spent most of the year in negative territory, ended the year positive after prices rose during the fourth quarter.

For U.S. stocks, 2017 marked the 9th straight calendar year with a positive returns on the S&P 500.  Since World War II, this has occurred only once before, during the technology rally of 1991 – 1999.  While there is no magic to the number nine, and U.S. stocks may continue to rise in the years to come, now may be a good time to consider adding money to other asset classes that may be more attractively valued.

Major Asset Class Returns

Q4 2017
Core Bonds – Taxable (BBGBARC U.S. Agg) 0.4% 3.5%
Core Bonds – Municipal (BBGBARC Int. Muni) -0.7% 3.1%
Global Stocks (as a whole) (MSCI AC World) 5.7% 24.0%
U.S. Large Stocks (S&P 500) 6.6% 21.8%
U.S. Mid Stocks (S&P Midcap) 6.3% 16.2%
U.S. Small Stocks (S&P Smallcap) 4.0% 13.2%
Foreign Developed Stocks (MSCI EAFE) 4.2% 25.0%
Emerging Market Stocks (MSCI EM) 7.4% 37.3%
Commodities (Bloomberg Comm) 4.7% 1.7%
Real Estate (DJ Global Select REIT) 3.6% 6.9%

Volatility

For U.S. stocks, both the occurrence of large price swings and expectation for future large price swings were virtually non-existent in 2017.  In fact, measures of volatility, such as the CBOE Volatility Index, spent the year at extraordinarily low levels.  Despite current readings, investors must remember that more normalized levels of fear and uncertainty will cause volatility to return at some point for U.S. stocks.  At that time, diversified investors will be happy that they did not put all of their eggs in one basket.

The Unemployment Rate Reaches 4.1%

The official unemployment rate at year end was 4.1%, a level not seen in over 15 years.  Broader measures, which include involuntary part-time workers and discouraged workers, fell 1% for the year while job openings increased to 5.9 million.  With such a strong labor market it is likely that wages will continue to strengthen in 2018.

Components of Stock Performance

Since 1960, the average annual return for U.S. large company stocks has been 10.0%.  That return was comprised of three main components: dividends of 3.3%, inflation of 3.7%, and the after inflation price growth of 3.0%.  With today’s dividend yield of 1.9%, inflation at roughly 2.0%, and economic growth averaging less than 3.0%, it is difficult to see how U.S. large company stocks can appreciate anywhere near the historic average over the next few years.  When we factor in the elevated valuations of U.S. stocks, foreign stocks (both developed and emerging) become quite appealing compared to their U.S. counterparts.

The Federal Reserve & Interest Rates

The Federal Reserve increased short term interest rates three times during 2017, bringing the yield on short term conservative investments above 1.0% for the first time in nearly 10 years. In addition, the Federal Reserve began reducing the size of its balance sheet in October by $10 billion per month.  When combined, the two actions are designed to help both short and long term interest rates gradually return to more normalized levels.  This did not occur in 2017, as short term interest rates rose while longer term interest rates actually fell.  As a result, investors are not being properly compensated for tying up their money for longer periods of time.

Tax Cuts and Jobs Act of 2017

The Tax Cuts and Jobs Act of 2017, which was recently passed by congress and signed by the president, significantly changes the landscape for individuals and businesses starting January 1, 2018.  The bill is a significant win for corporations that will see their income taxed at a new 21.0% flat tax rate, and also has many benefits for individual taxpayers.  Unfortunately, the bill is far from perfect and will negatively affect some, especially high earners living in high tax states such as New York, New Jersey, and California.

Federal Government Finances

Even before the Tax Cuts and Jobs Act of 2017 was passed, the federal government was projected to continue running budget deficits over the next 10 years.  The act merely adds another $1.77 trillion of debt over 10 years to the already projected $10.11 trillion of overspending.  As such, it is now estimated that future generations will be responsible for over $32 trillion (that is 12 zeros for those counting) in 2027.

 

John S. Gullo, CFA, CFP®, CIMA®
Chief Investment Officer
Chief Operating Officer

 

This publication contains general information that is not suitable for everyone. All material presented is compiled from sources believed to be reliable. Accuracy, however, cannot be guaranteed. Further, the information contained herein should not be construed as personalized investment advice. There is no guarantee that the views and opinions expressed in this publication will come to pass. Past performance may not be indicative of future results. All investments contain risk and may lose value.  ©January 2018

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