Fourth Quarter 2017 Market and Economic Review

Market Review

Bolstered by strong global economic growth and promises to cut taxes and regulations – many of which materialized during the year – the fourth quarter of 2017 saw record advances throughout global equity markets.

Large US companies, measured by the S&P 500 index, increased 6.91% in the fourth quarter and ended the year up 19.43% – the strongest performance since 2013.

Looking at large US companies on a sector level, technology, healthcare, and financial companies led the march, with technology companies in the S&P 500 up 39.7% year-to-date.

Small US companies, measured by the Russell 2000 index, finished the year up 13.1% after gaining 3% in the fourth quarter.

Global stocks continued to advance on the year, feeding off a recovery in global economic growth which also lifted company earnings and commodity prices. The global stock market increased in total by around $12.4 trillion in 2017. We see additional value in international markets during 2018, as many of these companies have lower price-to-earnings ratios and higher dividends. Thus, we will be making more trades than usual in January to take advantage.

On the fixed income side, 2017 saw short term interest rates rise significantly, with 2-year Treasury yields increasing to 1.89% from 1.20% a year ago. This is a positive indication as it shows that investors are confident about stronger economic growth over the short-term. 10-year Treasury yields were virtually unchanged at 2.40%, down from 2.45% a year ago.

When short term bond interest rates increase and long term bond interest rates decrease, it results in a smaller difference between the two. In a healthy economy, long term yields should be higher than short term yields. While that is the case today, if the yields invert with short term yields higher than long term yields, there is a good chance (but not always) of an economic recession within the next 18 months. Flattening to where it is now has no significant correlation to recessions, but we should be cautious if the spread gets more narrow. Any time long term yields increase, it shows investor confidence in the economy over the long term.

The benchmarks, listed in the table below, are the same benchmarks as those in the Risk/Return and Account Analytics sections of client quarterly performance reports. By comparing your portfolio’s return to the benchmark with the closest risk/return characteristics, you get a more accurate reading of portfolio performance than using a less diversified benchmark, such as the S&P 500 index.

* Each benchmark is allocated based on assumed Risk Profile of underlying indexes.

**Benchmarks include a mixture of ICE BofAML US 3-month Treasury Bill Index, Barclays Global Aggregate Bond Index, Barclays US Aggregate Bond Index, MSCI EAFE Index, and the Value Line Composite Index (Geometric).

Economic Review

At their fourth-quarter FOMC meeting, the Federal Reserve raised its benchmark interest rate to a target range of 1.25% to 1.5%.

While raising interest rates is a clear sign of a healthier economy and a necessary step, rising rates can suppress economic growth if the rate of increase is too rapid. Jerome Powell, the next chair of the Federal Reserve, has somewhat similar views to those of current Fed Chairman Janet Yellen. Analysts forecast that the Fed will raise interest rates 3 times in 2018, same as the 3 rate hikes that occurred in 2017.

Using an estimate for the fourth quarter, the U.S. gross domestic product (GDP) is expected to have grown 2.2% during the year 2017. This is after growing 1.6% during 2016. At the December meeting, Fed members raised their GDP growth forecasts for 2018 and 2019 to 2.5% and 2.1%, respectively.

As we wrote in our November 2016 market commentary, Reaching American Economic Potential, if the U.S. economy averages 2.5% GDP growth, the U.S. will reach its maximum potential GDP growth in three years. If the economy somehow saw 3% GDP growth, it would take just one year to reach potential GDP.

During 2017 the U.S. unemployment rate reached lows not seen since the year 2000. The rate was 4.1% at the end of November. Despite the fact that about 4.5% less Americans are in the job market today than in 2000, more than 16.5 million adults are employed today than in 2000. An unemployment rate this low shows a healthy economy where the vast majority of people seeking a job have been able to obtain one.

Congressional passage of a tax code overhaul, the first of its kind since 1986, lowers the corporate tax rate to 21% from a top rate of 35% and provides individual tax cuts for the vast majority of Americans. These tax overhauls will provide fiscal stimulus that should lift GDP growth and inflation. One hidden outcome of tax reform in the U.S. is that other countries will likely respond with incentives and lower rates, which should result in even greater international growth.

Overall, in 2017 the U.S. continued to demonstrate its resilience and economic prowess in the face of devastating hurricanes, a polarized political landscape, rising interest rates, and external global threats.

During 2018 we anticipate equity markets to continue the positive momentum, though we think broad market returns will come down closer to their long-term averages.