Market Monitor & Recap

Market Recap

4th Quarter Recap and Outlook-September 30, 2017 to December 31, 2017

Recap

During the 4th quarter, the market rally continued as the S&P 500 closed the year at 2673, above our 2600 target from the beginning of the year. The S&P 500 returned 6.6% in the 4th quarter, its best quarter since 4Q 2015. Volatility remained subdued outside uncertainty of the passing of the tax reform bill in November, as economic data and earnings remained strong. 3Q GDP of 3% outpaced estimates, adding consecutive quarter of  +3% GDP which has not been seen since 2014. The Federal Reserve increased the federal funds rate from 1.25% to 1.50% in the December meeting, spurring more optimism for 2018 growth. With estimates already forecasting double digit earnings growth for the S&P 500, the run up in markets seems justified as valuations have remained consistent with historical averages.

Large cap stocks outperformed mid and small cap stocks for the year by more than 5% as investors fled to higher quality stocks with stronger balance sheets. International stocks led the worldwide markets as MSCI EAFE Index returned 25.6% as valuations overseas still remain at a discount to the United States. Markets were led by technology stocks and materials stocks as metals and energy prices rebounded. OPEC production cuts remained in place pushing crude oil closed the year over $60/barrel, which hasn't seen since summer of 2015. The underperforming assets for the year were in fixed income as the Bloomberg Barclays US Aggregate Index returned 3.50%. Corporate bonds outperformed again in 2017 returning over 6%. As we expected, the yield curve flattened throughout the year, as the Federal Reserve raised rates more than investors originally anticipated. The hunt for more yield lead investors to high yield bonds which returned 7.50% for the year. A strong year for investors closed with optimism surrounding the economy and tax reform that will liking continue into the start of 2018.

The underperforming assets for the year were in fixed income as the Bloomberg Barclays US Aggregate Index returned 3.50%. Corporate bonds outperformed again in 2017 returning over 6%. As we expected, the yield curve flattened throughout the year, as the Federal Reserve raised rates more than investors originally anticipated. The hunt for more yield lead investors to high yield bonds which returned 7.50% for the year. A strong year for investors closed with optimism surrounding the economy and tax reform that will liking continue into the start of 2018.

Outlook

The performance of risk assets over the first two months of 2018 will act as a barometer for their potential over the next twelve months. Our baseline outlook for the year is that the U.S. equity market will post a modest single digit return for the year, and will exhibit more volatility than it did in 2017. As a result of these expectations, we believe that it behooves investors to attain a more neutral allocation if we see a strong start in the first half of the year. It is also important to note that not only is the S&P 500 trading at an all-time high, but it also hasn't had a correction of 10% or more in nearly two years.

Though much of the economic stimulus from tax reform has been discounted into asset prices over the past year, we still expect the recent momentum spurred by the long-awaited passing of the bill to push the stock market higher over the near-term. Going into 2018, the sectors in which we expect to see the strongest performance are financials, technology and materials. The extent to which the Trump Administration will roll back some of the burdensome and futile regulations that have been imposed on financial institutions has yet to be determined, but offers a great deal of potential for U.S. banks and insurers to perform well.

In regard to monetary policy, we expect that the Federal Reserve will stay on the same trajectory as 2017, raising interest rates 2 to 3 times during the year. In addition, we expect the yield curve to continue to bear flatten, i.e., short-term rates rising faster than long-term rates, throughout the year. We do expect that inflation pressures will reemerge during the year, which will push long-term rates higher. Therefore, along with the flattening, all points along the yield curve should end the year higher than they did at the close of 2017. Our analysis also suggests that along with other risk-assets, corporate credit, both investment grade and high yield, should continue to outperform relative to government and agency mortgage-backed securities for the first quarter of 2018.

 

Media Perspective

A recent article from the Wall Street Journal, (Global Stock Surge Mints More Than $9 Trillion in Market Value) - Almost every major yardstick for global stock prices ended the year with double-digit percentage gains. (By Chris Dieterich)

Read More of Chris Dieterich article at the Wall Street Journal online.

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