The 4th quarter of 2017 was one of the best quarters for stocks in years, as broad gains were driven by anticipation and passage of the Tax Cut and Reform Bill, acceleration in economic activity, and rising corporate earnings.
Looking back on the 4th quarter, one of the most important takeaways for investors is to appreciate that while tax cuts dominated headlines, stock gains in the 4th quarter (and most of 2017) were really supported by an accelerating economy and rising corporate earnings. That’s an important distinction to keep in mind as we start 2018 because, while risks remain (as always), this rise in the market has also been driven by strong economic data and strong earnings.
The markets continued to climb the proverbial “Wall of Worry” in the 4th quarter, as they did for all of 2017. Specifically, geo-political concerns in North Korea and Iran weighed on sentiment. In a similar way, there was some trepidation regarding Fed policy with the Federal Reserve continuing it’s historic task of “unwinding” the Federal balance sheet by executing another quarter-point rate hike in December. But none of these situation were enough to offset improving US corporate fundamentals.
For the year, US stocks were buoyed by strong economic data, rising corporate earnings, deregulation, the perceived safety of US assets, a rebound in oil prices, historically low interest rates, and low inflation. Underscoring the resiliency of the markets in 2017, the S&P 500 rose every month of the year, which is the first time that’s happened in history
Outside the US, the story was the same. Actually, the performance was better! Looking at the MSCI ACWI Index which is composed of 47 developed and emerging market countries, including the US, 32 countries posted higher returns than the US in 2017. In total, 44 of 46 foreign countries recorded gains in 2017 (the only two with negative returns were Pakistan and Qatar).
As a group, international stocks have outperformed domestic stocks over the last year, as gains were driven by strong growth in emerging markets. To start 2018, the outlook for international markets remains positive. Not only do foreign equity markets have momentum, they are also cheaper than US stocks based on multiple valuation metrics. Also lending a helping hand, the International Money Fund recently raised 2017 and 2018 global growth projections.
Almost all major bond categories inched higher in the 4th quarter, and even with the Fed rate hikes, fixed income returns were, for the large part, satisfactory during the full year. The Bloomberg Barclays US Aggregate Bond Index, the leading benchmark for bonds comprised of investment grade government bonds, corporate bonds, and mortgage-related bonds, was up 3.54% in 2017.
The market and economy stride into 2018 with a tailwind from the biggest tax overhaul in 30 years. While some of the benefits are arguably baked into current market prices, the aftermath will likely result in US corporations keeping more of the money they make. And, that extra cash can potentially be deployed in numerous stock positive ways: Increased capital expenditures, new growth initiatives, research and development, mergers and acquisitions, dividend increases, and stock buybacks are all on table for corporate America as we start 2018. This along with other positives, such as the continuation of robust corporate earnings, improving economic growth, unemployment near record lows, positive momentum for leading economic indicators, and high consumer confidence levels (based on low household debt interest and highest household net worth), make the outlook favorable for economy as we start the new year.
Our primary concern lies in the fact that the stock market starts the year over-valued by about 20% based on historic P/E ratios. In addition a terrorist attack or the Fed raising interest rates 3 times or more in 2018 could derail the level of optimism currently built into the stock market. Other concerns include geo-political tensions with North Korea, disappointing NAFTA renegotiations, or the possible re-introduction of sanctions against Iran. Any one of these could increase market volatility in 2018.
There’s always the chance of a market correction and that’s no different this year. We all know that emotion and surprise can easily spook an over-valued market. If we learned anything in the later stages of the bull market from 1995 to 1999 and the bubble preceding the great recession of 2008, it is prudent to take profits when you get them. So, we have been steadily re-balancing portfolios to capture our gains from 2017 and to use hedged equity strategies to reduce risk in your portfolio.
At Simmons Capital Group, we remain optimistic, but are guarded. While the general market set up remains positive, we are cognizant of the fact that markets are due for, at least, a short-term pullback and, the unnatural tranquility could change at a moment’s notice. We continue to believe investors should embrace broad diversification within various asset classes to position for further growth, while defending against uncertainty and risk. We will continue to take a diversified and disciplined approach with a clear focus on your longer-term goals and in delivering competitive risk adjusted returns. Bull markets traditionally end with economic recessions and inverted yield curves, neither of which are present or seem imminent right now.
Thank you for your ongoing confidence and trust. Please feel free to contact us with any questions, comments, or to schedule a portfolio review.
Donald E. Simmons, CFP Darren J. Leader, CFA Audra K. Higgins