S&P Logs First Perfect Year Ever – Week and Year Ended 12/29/17

Happy New Year-we look forward to continuing our work on your behalf in 2018!

When we look at the distribution of returns for the S&P relative to history, 2017 could be defined as a year with no left tail. Not only did the index conclude with all 12 months being positive (never happened before), but it also had just 4 trading days where it fell by -1% or more (and just 4 trading days where it rose by more than 1%). Not since 1970 did the market enjoy such persistently low volatility. The year concluded in-keeping with the theme of our November commentary: a year of lots of small, but positive returns that when linked together made for a very attractive year. What might be most interesting however is that the low volatility occurred despite a backdrop in which much was changing. The Fed raised rates four times even as inflation remained weak. US politics were also an area where no calm could be found as evidenced by a headline I observed over the weekend characterizing 2017 and the first of the Trump presidency as one marked by scandal (not sure if that is a fair statement amid what seems to be lots of smoke but a yet to be identified fire; but regardless of disposition toward him or work thus far, his first 11 months cannot be considered conventional or of high public approval either).

With both the monetary and fiscal policy backdrop shifting, it should be noted that many of the developments in 2017 are in fact longer-term positive. For instance, interest rates moving off their near-zero level is desired and healthy, particularly for financial institutions which serve as the transmission of any economy. Regulation also seems to be in a mode of easing for a number of industries critical to economic growth. 2017 was also the year in which international economies joined domestic in expansion; a missing trait throughout most of the post-financial crisis (2009) period. And, on the backs of rising portfolio values, home prices, and tight labor markets, consumer confidence in the US continued to improve and at high levels as we look toward 2018. Corporate earnings also logged healthy progress during the year; something that we said was requisite following the dramatic rebound that disciplined investors enjoyed from financial markets following 2 years of a sideways but volatile trading from mid-2014 to mid-2016. On that front, the passed tax reform package signed into law at the sunset of 2017 should provide a boost to the net earnings that corporate America can deliver, which should help support existing stock prices if not propel them higher on an absolute basis.

As we look to 2018, the economic and fundamental underpinnings of the financial markets appear to be in favorable shape. And, while it is easy to imagine that the historic calm of the markets witnessed over the prior 12 months simply cannot last and suggests that 2018 should contain at least a few more nervous moments, low real rates and a synchronized global economic expansion are supportive of the notion that low volatility can remain a theme. Perhaps the biggest question and risk to the markets in 2018 might actually be that the economy gets too strong. While that statement seems paradoxical, the logic is this: with unemployment already at historic lows in the US, and corporate earnings high, a further boost to earnings derived from reduced corporate taxes and high CEO optimism could well begin to flow to workers in the form of higher wages. Higher wages are desirable, but they also seed inflation. Should inflation meaningfully pickup, it would not be a stretch to envision the Fed and other global monetary authorities grow concerned that their pursuit of monetary policy and interest rate normalization is behind the curve and needs to hasten. Under that scenario, a policy mistake wherein the Fed or another central bank moves too quickly would cause something to break and a broader risk-off and economically cleansing cycle might ensue. For that, we will be watching the yield curve, and the relation of the Fed Funds rate to that of the 2-year treasury. Historically, an inverted yield curve, or a Fed Funds rate that exceeds that of the 2-yr treasury has been a good leading signal that monetary policy has become restrictive and a recession is not far off.

Again, we wish you all the best as we enter 2018. Look for our quarterly newsletter in the days ahead, and call upon us as we can be a resource to you in anything financial this year.

Posted in Blog Post.