Market Insights - January 2018
For our clients, 2017 proved to be a year of strong investment returns, against a backdrop of the calmest markets in decades. We can’t even imagine more favorable circumstances. Global balanced portfolios benefited from interest rate stability, a weaker dollar, great corporate earnings, and the powerful recovery of international markets.
US stock markets rallied in anticipation of a corporate tax cut, a business-friendly administration, and surprisingly good corporate results; with companies posting earnings gains of 9.8% year over year in the third quarter, a three-year high. Those comparisons are likely to continue into 2018.
The backdrop to the stock market's rally has been consistent improvement in the broader economy; Unemployment has been steadily dropping for more than five years, to a rate not seen in the last sixteen years, and consumer confidence reached a 17 year high in December. The Dow posted 71 new closing records in 2017, gaining more than 5,000 points. The weaker dollar not only boosted returns for U.S. based multinationals, but also magnified returns for already strong developed and developing economies. Bond markets remained stable despite an historic shift in Federal Reserve policy, three hikes to the Fed Funds
Asset Class returns
Emerging markets posted the strongest gains in 2107, adding 37.8% in us dollars, while developed markets rose 25.6%. U.S. large cap stocks, measured, by the Dow gained 28.1%, while the broader S&P 500 added 21.8%. Small cap stocks gained 14.6%, while the real estate investment trust sector added 8.7%. Even gold bugs got a treat as the precious metal was up 12.5%. Despite three rate hikes in 2017 bonds posted acceptable returns; aggregate investment grade bonds added 3.5%, while economic optimism boosted high yield bond prices over 10%.
A new Fed Chairman and a new tax code
In January, the first major tax revision in 30 years takes effect, and in February we will have a new Fed chairman, Jerome Powell. Over time he will most certainly put his own stamp on the direction and mandate of the Fed, but is likely to continue the current policy in the near term. We anticipate three or four rate increases in 2018, as well as the continuation of the fed balance sheet normalization, which began in October, with purchases of $20 billion per month in the first quarter, and rising incrementally to $50 billion per month. GDP growth should accelerate into the 3% range for most of 2018, before slowing down in 2019, as we reach full employment. Bonds reacted quite favorable to the Fed strategy in 2017; the ten-year Treasury began the year with a yield of 2.45% and ended the year at 2.40%. Credit markets continue to price in moderate inflation, but with strong economic growth we believe there will be some pressure on long term rates, and expect the ten- year US government bond to touch 3% by year end. Our fixed income concerns focus on credit, rather than duration risk.
US stock markets are priced at 18.2 times earnings; above their long-term average of around 16, but not so dear that valuation would weigh heavily on future returns. Global equities present a compelling opportunity, with high unemployment rates falling in the Eurozone, and a trade surplus (vs. a US trade deficit). Our concerns would include rising tension on the Korean peninsula, the pace of economic development in China, fallout from Brexit, a toxic political environment in the US, the effect of cryptocurrency speculation, and too rapid expansion leading to rate hikes greater in number or degree than anticipated. The debt levels remain an overarching concern; the new tax cuts are reckoned by the Congressional Budget Office to push the deficit to over 97% of GDP before the individual tax cuts expire.
Great disruption equals opportunity (and volatility)
The next five years holds out a heady mix that has the potential to create exceptional returns, but at a pace that can seem overwhelming, and with volatility that may test our resolve. We are experiencing a period of cross industry disruption and innovation that promises to upend the economy as we know it over a very short period. In the automobile and transport industry, we are already seeing the impact of new financing and purchase/use methods, electrification, and self-driving and automation. Is Tesla an auto company, an energy company, or a space exploration enterprise, or do we lack the vocabulary for a new economic reality? Some other areas where the impact of disruption will be felt include artificial intelligence across all industries, particularly healthcare,
block chain technology and disintermediation of the existing banking and payment systems, the rise of alternative currencies, major reworking of the food supplychain, and the complete reordering of the retail spending and goods delivery model as we know it. This will be accompanied by rapid and unpredictable shifts of global economic power. That the next five years will be more volatile than we have become accustomed to seems certain; it also seems certain that the economy will need to slow down and retrench at some point, and that will be painful, especially for those with a short-term perspective. We continue to believe that a balanced global portfolio with emphasis on credit quality, shorter duration on the fixed income area, and meaningful diversification to small and medium sized companies, will prove to be an effective strategy for the risk-averse investor going forward.
We are very pleased to announce that Gene Balerna, Jr., CIMA®, has joined The Bedminster Group as Director, Investment Research. Gene is a graduate of the University of Massachusetts, as well as completing his Master of Finance degree at Bentley University. His designations include the CIMA® certification administered by Investment Management Consultants Association and taught in conjunction with The Wharton School, University of Pennsylvania, Philadelphia, PA. He has been awarded the Applied Behavioral Finance Certificate Conferred by IMCA® and completed Chartered Financial Analyst (CFA) Level I, CFA Institute His ability to assess portfolio risk exposures and develop investment strategies/policy and in-depth knowledge of economic and investment markets will prove a meaningful benefit to our clients.
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