Monthly Markets Memo - December 2017
by Dan Zalipski, CFA
2017 Year in Review
The markets have been more than kind to us this year. Both domestic, international developed, and emerging markets are all up double digits. The U.S. benefitted from a combination of earnings growth, and general optimism over the pro-growth agenda of President Trump.
Volatility (as measured by the CBOE VIX Index) has been bouncing around historical lows, which led to a near-unanimous expectation for increased volatility throughout the year. Despite brief spikes, sustained higher volatility failed to materialize, and as of this writing, is poised to end the year lower than where it started.
Looking elsewhere in the world to international markets, both developed and emerging markets enjoyed strong returns. These regions benefitted from robust growth and accommodative policies setting the backdrop for a positive year. Investors are convinced that the economic recovery in these various regions is taking hold. Many of the international indices we track have yet to hit their pre-crisis highs, whereas the U.S. markets represented by the S&P 500 passed its pre-crisis high back in 2013. The international markets remain attractively priced compared to the U.S.
The fixed-income markets had their share of ups and downs this year, technically making them more volatile than the equity markets, which is a bit unusual for the asset class. We saw yields rally (prices move the opposite direction as yields) in the first half of the year as investors, excited about future growth prospects under the new President, sold fixed income to take on more risk in equities. This was short-lived. Yields began to grind lower once the lofty political goals were met with legislative reality. In other words, it was not going to be as easy as some hoped, as illustrated with the attempted repeal of the Affordable Care Act. In addition, the fixed-income markets also had to digest three interest rate increases from the Fed, with three to four more expected in 2018. As interest rates move higher, bond prices typically move lower. On the other hand, strong demand from investors seeking income, both domestic and abroad, has acted to temper some of the impact of the Fed’s rate increases. These dynamics are expected to continue for the near-term, with the potential to further flatten the yield curve. Click here to review last month’s memo for more on this topic.
2018 Looking Forward
Next year is generally expected to be a continuation of 2017’s market environment, albeit with tempered expectations partly due to the unexpected strength this year’s returns. Expected returns for U.S. equities are constrained by above-average valuations, reinforcing the need for a diversified approach that includes both domestic and international markets. Despite the above-average valuations, equities still appear attractive compared to fixed-income. Fixed income securities should continue to feel downward pressure on their prices as yields begin to rise with the Fed’s expected interest rate increases next year. Investor’s will need to exercise caution to manage the risk of rising interest rates within their fixed income allocation.
The market is long overdue for a correction, which occur on average once per year and is defined as a 10% drop from recent highs. The last correction to hit the U.S. equity markets occurred in the first quarter of 2016. The typical warning signs of an impending recession are not currently present, and we do not anticipate a recession to begin in 2018. Unemployment is low and job growth is positive. Corporate earnings are expected to continue growing and manufacturing activity is solid. Consumer confidence levels are up along with personal spending and retail sales. Consumers and businesses alike may get a boost should the proposed tax reform legislation become law. Broadly speaking, the global investment environment for equities is attractive heading into the new year.
Entering 2018, most American investors should feel richly rewarded by a long economic expansion and extended bull markets in equities and bonds. However, looking forward, they should also recognize that this is not a great starting point and that the very length and strength of the bull markets to this point will limit returns going forward. - Dr. David Kelly, CFA - JP Morgan Asset Management
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendation for any individual. Although general strategies are revealed, this post is not intended nor does it reflect transactions within any one account. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. All data and information is gathered from accurate sources but is not warranted to be correct, complete or accurate. Statistical data has been obtained from sources not limited to but including www.bls.gov and www.morningstar.com