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Banner Investment Year in 2017: But What Does that Mean for 2018 Outlook?

It was a banner year for U.S. equities as the S&P 500 rallied 21.83% for the year with the NASDAQ, led by technology companies, finishing the year up 29.64%. On the international front, developed and emerging market stocks finished up 25.03% and 37.28%, respectively. This was the best year for stocks since 2013. The surge in the equity markets was fueled by optimism surrounding President Trump’s “Pro-Growth” agenda, an accommodative Federal Reserve, and a Global Economic Recovery. We believe that corporate earnings drive stock prices, and it was a momentous year for U.S. companies. Corporate earnings for the S&P 500 were up over 7% for the year, and after two years of an earnings recession, we are seeing fundamentals improve across the board with 15% earnings growth projected for 2018.

On December 20th, the U.S. Senate and House of Representatives passed a tax reform bill (informally known as the Tax Cuts and Jobs Act), effectively lowering taxes across all tax brackets and lowering the corporate tax rate from 35% to 21%. This should make the U.S. more competitive on the world stage, encourage U.S. companies to “repatriate” their overseas cash and bring (or keep) more jobs on U.S. soil. Every few days we are hearing news of another company issuing a bonus to their employees or promising to build or invest in their business.

Recap Chart 2.jpgHowever, 2017 was a highly unusual year in that there was essentially no volatility. The stock market averages a 14% correction each year, and this year we didn’t even witness a 3% pullback. Additionally, it was the first year in history that we had 12 consecutive positive months of stock returns. There was no buying opportunity in 2017 for investors “waiting for a pullback.” Headlines surrounding our President’s Twitter feed, threats from North Korea, hurricanes, and uncertainty over a new Fed Chairman were completely overshadowed by an improved economic backdrop for global equities.

“He who lives by the crystal ball will eat shattered glass” - Ray Dalio

Surely there is much to be made of all the predictions and forecasts thrown at us from every direction. The rise of cryptocurrencies like Bitcoin is a notable example of this. Few people truly have any idea what they are, let alone how to value them — yet everyone has an opinion. We are not in the business of making such bold predictions. Rather, let’s talk about where we are today and if there are any lessons to be drawn from history.

This bull market appears to be intact as there are few signs of recession, inflation is low, and the Federal Reserve is accommodative (although less now than a year prior) and valuations are reasonable (especially overseas). Historically, one of these factors is the root cause for a bear market to occur, or at least for a severe correction.

U.S. GDP growth surged in the second and third quarters of 2017, while estimates for 2018 are increasing with the hopes of infrastructure spending and business investment. Leading Economic Indicators (i.e. building permits, manufacturing hours worked, consumer expectations) are gliding higher, indicating a low probability of recession. The yield curve (although flattening) is indicating strength in the U.S. economy.
Recap Chart 3-167661-edited

Inflation remains low, and below the Federal Reserve’s target. Fed Chair Janet Yellen has been quoted as saying, “We don’t fully understand inflation” and adding “the shortfall in inflation this year is more of a mystery.” With record low unemployment numbers, we should be experiencing some wage growth to put pressure on inflation levels, but it just hasn’t been there. Oil prices have picked up a bit in 2017 to just over $60/barrel but remain well off their highs. Many economists are attributing this to the technology disruption, making goods and services easier to access.

The Federal Reserve increased short-term interest rates three times in 2017 by a predictable 25 basis points each. There were no surprises, which the market liked. Expectations are for another three interest rates hikes in 2018. A slow, gradual increase in rates has historically benefited equities.

Valuations for U.S. equities ticked up a bit in 2017. Compared to cash and bonds, stocks still look attractive. Until valuations on equities become extreme (euphoria) or interest rates increase enough where the risk/reward for investing in stocks favors bonds/cash, we expect valuations to not be a concern going forward.

While we view the global economy as strengthening, it is not without its share of threats. A pickup in inflation causing the Fed to raise rates faster than expected, midterm elections that alter the pro-business fiscal policies, or action from North Korea could cause a scare to the markets. It’s more important than ever to be prudent in your investment decisions, focusing on a broad, long-term view of your financial plan.

McKinley Carter’s advisory team is well-prepared for what may come in 2018. We will work closely with you to ensure you remain on track with your ‘good life’ goals for the new year, and well beyond.

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