Market Review and Outlook
By Cliff Hodge, CFA® Portfolio Manager at FinTrust Investment Advisors
The S&P 500 Index returned 21.8% in 20171, and for the first time in its 90-year history, posted positive returns for all 12 months. The current bull market is now the second longest in history, continuing 105 months since March 9, 2009 without a decline of 20% or more from peak to trough. Growth stocks led in 2017, as the Nasdaq composite was up 29.6%, while Telecom and Energy stocks were the only sectors to have negative years returning -1.3% and -1.0% respectively, though oil prices ended the year on a sustained rally. Stocks are extended in our view in the near term, and a correction at some point during 2018 would not be a surprise. In fact, we would even go as far to say should be expected given the historically low levels of volatility that have persisted and global central banks becoming more hawkish. We still prefer an equal balance of growth and value stocks, as the divergence of performance is still within historical norms.
Emerging market stocks continued their torrid pace to close out the year up 37.3% YTD. Developed markets also performed solidly, returning 25.0% YTD for investors, bolstered by a weaker dollar and a strong global economic backdrop. We continue to view international and emerging markets favorably going into 2018 as both are still attractive in our models compared to the US. International markets experiencing an acceleration in economic activity and are backed by relatively easier monetary policy and lower valuations relative to the US.
Bonds were up 3.5% for the year, as measured by Barclays US Aggregate Bond Index as the yield curve continued to flatten in 2017. As are many market participants, we are waiting to see if the 10 year remains range-bound, or finally has the breakout that everyone has been awaiting. With a new Fed Chair set to take over in February, and a divergence of forecasts on rate hikes between the Fed and what the markets are pricing in, we remain cautious of traditional fixed income investments and are encouraging investors not to reach too far on credit or duration to pick up incremental yield. While we would never claim to have a crystal ball that predicts the future, we feel pretty strongly that ~$10 trillion in negative interest rate debt in the system does not create a favorable environment for fixed income investors.
During 2017, the Fed continued on the current course of tightening the reins on monetary policy, and it continues to forward down the path of normalization. A change in leadership at the Fed is on the precipice, as nominee Jerome Powell takes the helm on February 3. Transcripts released recently from monetary policy meetings in 2012, (transcripts are released on a 5-year lag) illustrate his skepticism regarding the size and scope of the program, and concerns about how the market would perceive QE reversals. Powell stated,
“[W]hen it is time for us to sell, or even to stop buying, the response could be quite strong; there is every reason to expect a strong response. So there are a couple of ways to look at it. It is about $1.2 trillion in sales; you take 60 months, you get about $20 billion a month. That is a very doable thing, it sounds like, in a market where the norm by the middle of next year is $80 billion a month. Another way to look at it, though, is that it’s not so much the sale, the duration; it’s also unloading our short volatility position.”
This statement, which is extremely candid from a Fed official, highlights our view on the major risk of the tightening, which is underappreciated by the market. He continued further,
“I think we are actually at a point of encouraging risk-taking, and that should give us pause. Investors really do understand now that we will be there to prevent serious losses. It is not that it is easy for them to make money but that they have every incentive to take more risk, and they are doing so. Meanwhile, we look like we are blowing a fixed-income duration bubble right across the credit spectrum that will result in big losses when rates come up down the road. You can almost say that that is our strategy.”
With roughly $10 trillion in negative rate debt globally, we would agree wholeheartedly with the soon-to-be Fed Chair’s assessment, and are encouraged by the fact that he seems to “get it.”
We have yet to see a dramatic increase in volatility as the Fed tightens because the other global central banks in Europe and Japan are just now looking to transition toward tightening. We remain confident in our view that volatility should rise significantly from depressed levels as we progress through the year. The Fed is forecasting 3 more hikes in 2018, at odds with the market, which is currently pricing in 2 hikes. The last few instances of divergent expectations have seen the Fed move toward market expectations, and with volatility near all-time lows it appears that the market is conditioned to this pattern. If this time is any different, and markets are forced to adjust to the Fed, we could see a substantial pickup in volatility. Our chief concern from a monetary policy standpoint is that Fed overshoots the target on tightening, which pushes the economy into recession over the next 18-24 months, as it has been known to do in the past. Our models appear to be leaning toward an expectation of higher inflation and market volatility.
At FinTrust, we try to take a balanced approach to portfolio construction. In addition to surveying the market landscape for risk and opportunities, we employ disciplined portfolio strategies, construction, and rebalancing rules to manage portfolios along the way, helping to ensure that our clients stay on track. This approach assists in creating a diversified investment strategy designed to manage volatility so that clients can be confident regardless of market conditions.
Cliff Hodge, CFA
FinTrust Investment Advisors
This material was prepared by FinTrust Brokerage Services, LLC (“FinTrust”) and is excluded from the definition of “research report” found in FINRA Rule 2241. This material is a market commentary and does not constitute research and is not intended to form the basis for any investment decision. Any statements regarding market or other financial information is obtained from sources which FinTrust believes to be reliable, but we do not warrant or guarantee the timeliness or accuracy of this information. The information contained herein has been obtained from sources considered reliable, but its accuracy and completeness are not guaranteed. The material has been prepared for information purposes and is not a solicitation or an offer to buy any security or instrument or to participate in any trading strategy. Past performance is no guarantee of future results. Diversification does not ensure a profit or guarantee against a loss in a declining market. As with any investment strategy, there is potential for profit as well as the possibility of loss. All investments involve risk and investment recommendations will not always be profitable.
Securities offered through FinTrust Brokerage Services, LLC, member FINRA/SIPC
Advisory services offered through FinTrust Investment Advisory Services, LLC, an SEC registered investment advisor.
1. All return data from Morningstar Direct and assumes reinvestment of dividends