Happy New Year and Hello 2018!

 In Quarterly Update, Strategy Updates

In terms of investment performance it is almost sad to say goodbye to 2017.  Global politics, tragedies and dramas aside, it was an unusually great year for stock market investors. The global economy had just the right ingredients to make for stellar stock market returns – a global economic and profit cycle recovery, coupled with historically low interest rates, and a large crowd of underinvested institutional and individual investors. Historically, this rare combination delivers above average stock price performance and 2017 did not disappoint! It was a particularly good year for global investors – like us – as foreign markets outperformed US indexes.  However, can we expect more of the same for 2018?

Though we would welcome a repeat of ‘17 in ’18, we find it highly doubtful based on our research and historical precedent. As we discussed one year ago, the first year of a global economic recovery and profit cycle can produce tremendous stock price performance and we would suggest most of that is now behind us. Many of the data points that sent stock prices soaring over the past 18 months – namely better economic and corporate profit growth – were a surprise to most investors.  This coupled with a large crowd of underinvested institutions and individuals caused a huge appetite for stock purchases and this tremendous demand for stock itself is the primary reason for the “way better than average” return of stocks.  At this point the element of significant positive surprises on the economic and profit fronts are quite slim and most of the underinvested have put their funds to work.  Does that mean that the party is over for stock market returns?  No way.  The party is just likely to be more subdued, and much better than the bond market could muster in terms of return.

As you know, our team has suggested that we have been at the beginning stages of a new business cycle and bull market for over a year now, and that the bull market of 2009-15 died with the 20 percent decline in equities during ‘15-‘16.  This was not and is still not conventional wisdom.  As we follow our theory, we see no reason why the current economic, profit cycle and bull market cannot continue for a number of years.  Unlike the media and many other investors today, we believe that the stock market is reasonably priced and that economic growth and corporate profits will continue to expand, supporting even higher stock prices as we move forward.  However, the stock price trajectory of 2017 will most likely shift down a few notches in 2018 to a level more in tune with profit growth in the 8-12% range, still far superior to just about any other liquid investment!  In terms of volatility 2017 exhibited one of the least volatile years in history with no corrections of 3% or more!  Investors would be wise to expect normal volatility (8-10% corrections) to return in 2018 as both foreign and domestic stocks churn higher. It should be a good and more normal year for stock investors.

As you may be aware Janet Yellen, the Federal Reserve chair, raised interest rates four times in the past 12 months and she and her replacement Jerome Powell will likely continue this policy to normalize interest rates.  Expect two to three rate hikes in 2018 assuming the economy and profit growth stay on course.  As we have written previously, these rate hikes pose risks to bond mutual fund and bond Exchange Traded Funds – areas that we always avoid.  A significant rise in rates could cause these bond funds to fall in value and create massive selling and significant volatility in these instruments.  That risk (which we are not subject to) aside, a higher interest rate environment is welcome to those of us that buy individual bonds and can lock in these higher yields.  Hopefully, a healthy economy will bring attractive bond yields to your portfolio in the coming year.

As you know, we are quite self-effacing about the fact that we are dealing with the unknown, which is why we are data centric in our work for you and diligent about using risk management tools to mitigate catastrophic loss. Should we be wrong about 2018 and should 2017 repeat itself, we would be ecstatic! On the other hand if the global economy, profit cycle and stock prices take a turn for the worse in 2018 – beyond a normal correction – we will be managing this risk through your portfolio’s asset allocation, sector management, and the use of carefully placed stop loss orders.

We hope you find this year end update helpful.  If you have experienced a significant change in your financial circumstances or would like to discuss your portfolio, please let us know at your earliest convenience. As always, if you have any friends or colleagues who you feel may benefit from our services, we would be happy to introduce ourselves to them with a no-obligation introductory meeting.

From all of us a very Happy New Year to you and your family! Thank you for your vote of confidence in our work.

Your Team at Main Street Research