By: John Cox, CFA, CAIA
Year 2017 began with the inauguration of the 45th president of the United States, Donald J. Trump. It was a year in which the word “bitcoin” became a commonly-used term by many Americans. This volatile digital currency captured the attention of both investors and non-investors by having rapid increases and precipitous declines in value during the year. It is unclear whether bitcoin has the staying power to compete with fiat currencies, such as the U.S. Dollar, Euro and the Japanese Yen. Regardless, the technology behind digital currencies, referred to as blockchain, has implications that go far beyond the currency markets. In terms of the investment landscape, much anxiety was caused by the possibility that Marine Le Pen might win the French presidential election, which was held in April. Her populist, anti-Euro views would have a significant impact on the future of the Eurozone and the Euro currency. Le Pen was defeated by a 39-year-old up-and-comer in European politics named Emmanuel Macron, and global markets rallied upon the news.
In the summer, North Korean nuclear threats and hurricanes in Texas, Florida and Puerto Rico dominated the headlines. In spite of all of these worries, the markets and economy continued to perform well. Year 2017 may also be remembered as the year when the global economy began to experience synchronized growth. Since the financial crisis and recession in 2007-2009, certain economies have done well while others have struggled. Year 2017 was the first in which almost all countries around the world experienced prosperity. Whether it was global manufacturing or the ever-important service sector, expansion began to replace stagnant or declining data points. In the U.S., small business optimism and consumer confidence reached levels not seen in many years.
Investors were focused on changes at the Federal Reserve during the latter part of the year. The “Fed” continued to gradually raise short-term interest rates in an effort to get them back to normal levels, given that they had remained abnormally low for almost 10 years. Additionally, the Fed began a systematic plan to reduce its balance sheet, which had risen to over $4 trillion, by not reinvesting its holdings of maturing U.S. treasury and mortgage securities. Once again, this was an indication to the markets that the extreme measures which were required in the deep global recession were no longer necessary — a return to normalcy. Lastly, Jerome Powell was nominated by the president and approved by the Senate Banking Committee as the next Fed Chairman, and he will replace Janet Yellen in February 2018. He was viewed as a non-controversial pick with an economic philosophy very similar to Yellen’s; therefore, the market seemed to cheer this selection.
As 2017 came to a close, the tax reform proposal was passed by the House and Senate and then signed in to law by the president. The markets were expecting the bill to pass, so there was not a big rally when passage occurred. While the new law has both individual and corporate tax features, the main take-away for investors is that the statutory rate for corporations is reduced from 35% to 21%, making the U.S. more competitive in attracting global businesses. The lower tax rate will also add to corporate earnings, providing an opportunity for hiring, capital expenditures and shareholder-friendly practices, such as buying back stock and increasing dividends. The policy now on the front-burner for 2018 appears to be infrastructure spending, which includes investment in our highways, bridges, railways, water systems, airports, schools and other public structures.
In terms of market performance, the fourth quarter continued the positive trend of the first three quarters. The proxy for U.S. large company stocks (S&P 500) was up 6.6%, while the Russell Mid-Cap index returned 6.1%, and the Russell Small Cap index gained 3.3%. International stocks in the developed markets of Europe and Japan, as measured by the MSCI EAFE index, rose 4.2%, and the MSCI Emerging Markets benchmark did slightly better, gaining 7.4%. The bond market also managed to stay in positive territory, producing a return of 0.4%, based on the Barclay’s Aggregate index. For the full year, Non-U.S. stocks (MSCI ACWI Ex U.S. Index) outperformed the broad U.S. stock market (Russell 3000 Index), with the former generating a 27.2% return, while the latter captured a 21.1% return. With rates staying somewhat consistent, bonds returned 3.5% for 2017.
As with any year, there were both positives and negatives. The year 2017 was the first year in the history of the U.S. stock market in which every single month finished higher than the month before. While we’ve previously had better years of total market performance, there’s never been a year that had more consistently-positive results. No one can say with certainty what 2018 has in store for us, but as long as investors stay focused on the long term (five years and beyond), it will be easier to get through the difficult times and enjoy the benefits that investing can deliver.