4th Qtr Portfolio & Market Observations 2017

It has been a wonderful year for both investment advisors and their clients. For us as your investment advisor, it has been a great year because it has allowed us to continue to help our clients achieve and maintain their goals and objectives. Our focus is not solely the accumulation of wealth; it is also to make it easier for you to achieve what you want in life. Wealth is one of the vehicles that helps you get there.

2017 was an outstanding year for the stock market, following 2016 as an excellent year. In fact since March of 2009 market indexes were up over 300% or 17% per year. We are pleased to say our client portfolios performed extremely well in this bull market.

The basic reasons the stock market has done so well are as follows: 

1) The economy, while growing slowly, grew without any recessionary pressures.

2) Corporate profits grew faster than the economy due to improved productivity and tighter cost controls.

3) Inflation was historically low.

4) Lower interest rates make stocks more attractive.

So, where are we now? 

1) The outlook for the economy is continuing to improve at a faster pace.

2) Corporate profits are expected to increase faster due to the better economy and the new tax laws.

3) Inflation still seems to be under control.

4) Interest rates are creeping up.

The difference between now and the last few years is that the valuation of stocks has increased. Price-earnings multiples have increased from the low teens to over 21.7 times 2017 earnings and 19.5 times 2018 earnings estimates. While the S&P 500 index has traded higher historically, we are in the higher end of the range of market valuations.

Where do we go from here? 

There is talk about a market crash based on the fact that the market has performed so well. There is an important difference between a market crash and a market correction. Market crashes are declines of 30% to 50% or more. Market corrections are pullbacks of 5% to 15%. Corrections are an accepted part of owning stocks, they can occur at any time for any or no particular reason. Market crashes are almost always accompanied by a bad recession. Since we don’t see any indicators of a recession in the near-term we don’t foresee a market crash. However, we do see the possibility of a market correction, but it is difficult to predict at what level the market will be when the correction begins. Many analysts were calling for a correction last year however the market continued to advance beyond most expectations.

Our view and our game plan is to modestly reduce portfolio equity allocations, especially in those accounts where clients depend on income from their investment portfolios to cover their daily living expenses. We feel it is prudent to take some profits off the table and build up some cash reserves.

As investors, and not traders, we are concerned with the portfolio’s long-term returns and not short-term trading returns. The stock market is a tremendous vehicle for building wealth if used properly. We believe our traditional approach to managing your portfolio is the best way to achieve the quality of life you seek.

The Markets

The U.S. equity markets had a great year, remarkable not only for their strong returns, but also for their consistency. The S&P 500 experienced an unparalleled rally, rising every single month in 2017 for the first time in its history and ending the year with a 21.8% gain. The Dow Jones Industrial Average with a 28.1% advance for the year scored a record of its own. It posted its longest streak of monthly gains in nearly 59 years and reached seventy record highs in the process. 2017 was also surprising for the essential absence of volatility as the equity markets have gone a historic 282 trading days without a mere 3% correction. The market rally was relatively broad based, with double-digit returns for most of the sectors of our domestic economy except energy and telecommunications.

The international equity market was also a “bright spot” for investors during the last year with the help of the weakening dollar. The MSCI Emerging Market Index has been the best performer, gaining 38% in U.S. dollar terms, while the MSCI EAFA Index of developed countries advanced by 25%.

Although paling in comparison to equities, all the major bond market indexes posted positive returns for the year, contrary to what was anticipated. The Bloomberg Barclay’s Aggregate Bond Index gained 3.5% while the yield on the 10-Year U.S. Treasury note started and ended the year around 2.4%.

U.S. equities were widely supported by generally positive macroeconomic data. Our domestic economy grew 3.3% annualized during the third quarter, scoring its quickest pace in three years and thus making it the longest expansion since 1900. The manufacturing indexes continued to improve, with new orders and production leading gains. U.S. home sales increased more than expected, hitting the highest level in nearly 11 years. Employment grew steadily through the year, albeit at a slightly slower pace than in 2016. More importantly, we have seen stable increases in wages, salaries and employers’ cost for employees’ benefits.

The Economy

The U.S. economy continues to fire on all cylinders with consumption, business investment, and external trade showing strength entering 2018. The growth should accelerate assisted by the recently passed corporate tax reform. Although the way companies and individuals will respond to the tax change is the story to watch in 2018, we believe that as long as business and consumer confidence remains at multi-year high levels, our economy should enjoy its best two year stretch in more than a decade, as forecasters are increasingly optimistic that the U.S. economic expansion could continue beyond 2020.

As was widely expected, The Federal Open Market Committee raised interest rates three times in 2017. We expect, under the new leadership, the Fed will be cautious but continue along the current projected path of monetary policy, continue the balance sheet normalization and raise interest rates at least three, possibly four times in 2018.

This incredible bull market is set to celebrate its ninth birthday in March, and, if it remains intact through August, it will officially become the longest in history. After a year of double-digit gains, record-low volatility and unrestrained exuberance the stock market has a tough act to follow. However, given the strong start of the year, the best since 2003, the stock market exhibits evidence that the rally should continue, and it could take a very exogenous, non-fundamental event like war, impeachment or a natural disaster to alter the markets’ ascending momentum.

Dumont & Blake Investment Advisors, LLC
December 31, 2017

 

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