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Fourth Quarter 2017 - Pinnacle Investment Management, Inc.

Fourth Quarter 2017

January 11, 2018 / Investments, Quarterly Newsletters

Global equity markets enjoyed a profitable and incredibly smooth ride in 2017.   Many US and international equity indexes posted double digit gains but perhaps the most remarkable aspect of the year was the extremely low level of volatility. There has not been a 3% “correction” in the S&P 500 since November 2016, the longest stretch since the S&P 500 was established in 1957. Further, 2017 was the only year in which the MSCI All Country World Index posted positive gains every month since that index was established in 1988. The market advances have been very broad, and the vast majority of stocks benefited.

Emerging markets, especially Brazil, South Korea, Chile, and India posted the strongest gains, but Europe and the US were not far behind.

The S&P 500 index of large US stocks gained a respectable 21.8% while the Russell 2000 index of small US stocks gained 14.6%, however both were eclipsed by the 27.5% return for a market index of all international stocks and the NASDAQ return of 28.2% fueled by technology stocks. Approximately 10% of international returns arose from foreign currencies appreciating vs. the US dollar. Foreign investments which were “currency hedged” did not enjoy the extra 10% boost from their appreciating currencies. Strong growth in corporate earnings, along with anticipation of a reduction in the US corporate income tax rate helped spur the advances in the US markets.

Global equity markets advanced in spite of tensions relating to North Korea and the US political uncertainty, including the Mueller investigations into President Trump’s possible ties with Russia.

The Federal Reserve gradually raised its short term “federal funds” target rate three times, by a total of 0.75%, to a range of 1.25% to 1.5%. Short term 2 year US Treasury bonds followed the Fed’s lead and rose from 1.2% at the beginning of the year to 1.9% by year-end.

The Fed also began reducing the $4.5 trillion in US Treasury and mortgage securities they acquired during the financial crisis. They will initially reduce bond holdings by $10 billion per month and gradually increase that to $50 billion per month. If anything, this planned reversal of QE (quantitative easing) would be expected to increase long term rates, but to date that has not happened. In fact, interest rate on long term ten year US Treasury bonds closed the year at 2.4%, slightly lower than the 2.45% a year earlier.

Bonds achieved modest returns for the year. with the US Aggregate Bond Index advancing 3.6%

Returns for key indexes (including dividends) were:

 
4th Qtr

2017

Full Year

2017

Dow Jones Industrials index 11.0% 28.1%
S&P 500 index 6.6% 21.8%
NASDAQ 6.3% 28.2%
S&P 400 mid-cap index 5.8% 14.5%
Russell 2000 small-cap index 3.3% 14.6%
Total International, excluding US 4.8% 27.5%
Dow Jones Global Stock index 5.5% 21.8%
Barclays US Aggregate Bond index  0.4% 3.6%

 

Economic and Market Outlook    Although growth is slow, the US economy appears healthy and resilient. Interest rates remain low by historic standards and US unemployment is a low 4.1%.

The complexity of the recent US tax legislation makes it difficult to forecast its overall impact. Anticipation of the significantly lower corporate tax rates provided catalysts for the stock market advance and will help US corporations remain competitive internationally. Changes in the personal income tax will impact people differently, depending upon where they live and how they earn their living. Individuals living in states with high income and property taxes will not fare as well as those who do not. Individuals who are sole proprietors or owners of “pass through” entities such as LLC’s (limited liability companies) or “subchapter S” corporations will likely see their taxes lowered. CPAs and attorneys who can help individuals advantageously navigate the new regulations will benefit. Future generations of US taxpayers will face a higher national debt.

In spite of their 2017 advances, foreign stock markets, especially emerging markets remain more attractively valued than the US, and should produce better returns over the intermediate term. Of course they are also subject to more political and currency risk than US stocks.

Most economists expect interest rates to continue to rise, which will reduce the value of existing bonds. This will impact long term bonds more than short term bonds. If the increase is slow, as expected, it will present a mild headwind for fixed income investors but most bonds (and bond funds) should continue to produce positive returns as interest income more than offsets the loss in value. A significant increase in interest rates would likely produce volatility in the stock and bond markets. In addition to the risk of rising interest rates, significant increases in inflation or indictments in the Mueller Russian investigation could produce volatility in the financial markets.

We remain cautiously optimistic for 2018, but feel it unlikely that the “Goldilocks” environment of high returns and low volatility will persist through 2018. Single digit returns in the equity market and a 10% “correction” would not be surprising.

The US National Debt represents money the federal government owes to others. According to a recent Wall Street Journal article, our debt currently stands at 108% of our GDP (gross domestic product), not including unfunded Social Security and Medicare benefits. Studies have shown that in countries which have incurred national debt in excess of 90% of GDP, economic growth slows by 1% per year for 20 years, resulting in fewer jobs, lower salaries and lower growth of corporate profits. Some countries are in worse shape than the US. Japan’s national debt is in excess of 240% of GDP, Greece is 180%, Italy’s is 133% and Portugal is 125%% The US was not always such a debtor, however the 2009 stimulus package resulted in nearly $1 trillion of additional spending and the recent tax legislation will result in $1.5 trillion in increased deficit spending over the next ten years.

Bitcoin has been in the news as the reported value soared from under $1,000 at the beginning of 2017 to over $14,000 at year end. It has very little of the merits of traditional investments and, in spite of warnings from the likes of Warren Buffet and Jamie Dimon of JPMorgan, some buyers do not seem deterred. If you feel a need to partake in what seems to be a very speculative purchase, we advise to do it with your “play money”. Treat it like a trip to Las Vegas, for entertainment purposes only, and not with your “serious money”.

Pinnacle is proud to have joined Mercer Advisors and believe their commitment to serving clients as a fiduciary, along with their technology, administrative and financial planning resources will enable us to do an even better job serving our clients.

 


About the author

John Eckel:

CFP®, CFA is President of Pinnacle Investment Management Inc. of Simsbury. He has been included in BusinessWeek.com’s list of the Most Experienced Independent Financial Advisors, has been named four times to Worth Magazine’s list of Top Financial Advisors, included twice in Medical Economics list of Top Financial Advisors for Doctors and named twice in JK Lasers list of Top Professional Advisors for Baby Boomers.


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