“We have two classes of forecasters: Those who don’t know – and those who don’t know they don’t know.” –John Kenneth Galbraith
Annual Market Review 2017
The year 2017 was eventful, to say the least. President Trump and Congress tried, without success, to repeal the Affordable Care Act, known as Obamacare. However, the new year-end tax law included the elimination of the individual health insurance mandate. The U.S. economy started slowly but picked up steam as the year progressed. Ten years after its onset, the financial crisis officially came to an end in 2017. Economic growth, as measured by the gross domestic product, expanded throughout the year, increasing at an annual rate of 3.2% in the 3rd quarter. As we enter 2018, political unrest continues in Washington and the cloud of the Russian investigation still lingers overhead.
As we begin our review of 2017, let us first reiterate our philosophy of advice. Generally speaking, our experience has been that successful investing is goal-focused and planning-driven, while most of the failed investing we’ve observed was market-focused and performance-driven.
Let’s rephrase this. We’re saying that the really successful investors we’ve known were acting continuously on a plan—tuning out the fads and fears of the moment—while the failing investors we’ve encountered were continually reacting to economic and market “news.”
Most of our clients are working on multi-decade and even multigenerational plans, for important goals such as education, retirement, and legacy. Current events in the economy and the markets are therefore distractions of one sort or another. For this reason, we make no attempt to infer an investment policy from today’s or tomorrow’s headlines. Rather, we work to align clients’ portfolios with their most cherished long-term goals and objectives.
We don’t forecast the economy, we make no attempt to time markets, and we cannot—nor, we’re convinced, can anyone else—consistently project future relative performance of specific investments based on past performance. In a nutshell, we are planners rather than prognosticators. We believe our highest-value services are planning and behavioral coaching—helping clients to avoid overreacting to market events, both negative and positive, and making inappropriate decisions at inappropriate times.
Let’s take a deeper review of equities, bonds, the Federal Reserve and interest rates, and inflation.
Equities: Going back to 1980, the average annual intra-year decline in the S&P 500 has exceeded 14%. Yet even without counting dividends, annual returns have been positive in 29 of these 38 years, and the Index has gone from 106 at the beginning of 1980 to 2,673.61 at year-end 2017, an increase of over 250%. We believe the great lessons to be drawn from these data are that—historically, at least—temporary market declines have been very different from permanent loss of capital, and that the most effective antidote to volatility has simply been the passage of time. We can’t predict whether it will always work out this way. Looking toward 2018, we’ll see if the low volatility continues and watch for external shocks or event risks that could be strong enough to trip up this bullish storyline.
Bonds: The bond market also saw low volatility driven by gradual economic growth, low inflation, and the FOMC’s forward guidance. As stock prices soared for much of 2017 and interest rates moved incrementally higher, the demand for long-term bonds was muted. The yield on the benchmark 10-year Treasuries closed 2017 at 2.41%, down from the 2016 yield of 2.44%. During the early part of the year, bond prices rose as yields sunk below 2.30%. However, as investors saw a strengthening economy and rising interest rates, a period of bond sales occurred, which peaked during the last quarter, ultimately pushing yields closer to last year’s final value.
FOMC/interest rates: The Federal Open Market Committee raised interest rates three times during 2017. The first increase occurred in March, followed by a rate increase in June and another in December. Each rate increase was 25 basis points (0.25%) for a total rate increase of 75 basis points (0.75%). Following each rate increase, the Committee expressed the expectation that the labor market would remain strong and the economy would continue to expand, while noting that inflation had not risen as quickly as anticipated. The Committee forecasts three 25 basis point rate increases in 2018. However, there is the possibility inflation is still drifting lower, which could cause the Fed to delay the projected rate hikes.
Inflation: Inflationary trends did not keep up with economic growth in 2017. Inflation, as it relates to the consumer (Personal Consumption Expenditures), remained below the Federal Reserve’s stated target rate of 2.0%. Indications are that inflation is expanding, albeit at a deliberate pace. Another measure, the Consumer Price Index, which measures the price level of a basket of consumer goods and services purchased by individuals was 2.2% higher for the 12 months ended November 2017.
The nature of successful investing, as we see it, is the practice of rationality under uncertainty. We’ll never have all the information we want, in terms of what’s about to happen, because we invest in and for an essentially unknowable future. Therefore we practice the principles of long-term investing that have most reliably yielded favorable long-term results over time: planning, a rational optimism based on experience, and patience and discipline. These will continue to be the fundamental building blocks of our investment advice in 2018 and beyond.
All of us at The Nalls Sherbakoff Group, LLC, wish you and your family a wonderful, prosperous, and happy New Year.