Our Chief Investment Officer, Eric Cramer, gives a brief 2017 recap and an overview of the markets going into 2018.
Thanks for listening today. Please join us for one of several upcoming BIP 2018 Annual Market Report presentations.
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By mid-year, many investors were starting to ask themselves if the stock market rally could possibly continue. We answered “yes”, and talked more than a few investors out of pushing the “sell button”. While we don’t try to predict the markets over the short term, we couldn’t help but notice some encouraging trends.
It should make us proud, as U.S. investors, that much of the global economic landscape has been playing catch-up to us for years. For all the problems and bad policies we could debate, the U.S. did a pretty good job of helping its markets recover from the Great Recession. But now many overseas economies are rapidly accelerating, setting a pace the U.S. is unlikely to match. The World Bank predicts that the East Asia and South Asia regions will grow at 6.1% and 7.1% respectively in 2018, and that the growth rate in the U.S. will be less than half of that.
The rate of GDP growth in the U.S. remained steady throughout 2017, as did employment, but neither metric grew at rates as high as seen previously in the nearly decade long recovery. Tax cuts passed at the end of the year are likely to give the U.S. economy a boost to some degree, and if nothing else they will make many corporations worth more. So that probably helped.
But perhaps the best way to look at things is to see that the international situation isn’t dragging on the U.S. markets the way it has in recent years. Markets move before economies do, and in 2017 stock market returns for international developed markets, and especially emerging markets, led the way for U.S. Dollar-based investors. For instance, the MSCI Emerging Markets Gross index return for 2017 was an incredible 37.75%.
In response to these growth projections, the U.S. Federal Reserve raised rates again in the fourth quarter, giving us three rate increases for the year. This was despite the fact that inflation was nowhere to be found. Their actions raised short-term yields, although not enough for bank accounts to generate a positive return once you subtract the effects of our modest inflation rate of less than two percent. So the Fed would like to raise rates even more in 2018, calling for three more increases in its December meeting.
But the Fed doesn’t set longer term yields—the market does—and the market was stubbornly resistant to any good news. Long term rates actually dropped in 2017. This twisted the yield curve to one of the flattest lines in years, with the 10-year Treasury yield closing out the year at 2.40% vs. the 30-year Treasury yield of only 2.74%.
An additional .34% in annual yield is not much compensation for buying a bond that matures 20 years later, especially when you consider the extreme volatility that these long-term bonds generate for their owners. Consider that the 2017 annual return from the Bloomberg-Barclays Long U.S. Government Bond index was an attractive 8.53%, but the five-year average annual return is only 3.49%. In 2013 this same index lost 11.36% when long term rates went up—just one percent.
So, that leaves the markets in what we might call an incongruous position. The bond market is not predicting much growth, because long-term bond yields should be a few percent higher than the rate of economic growth. And yet the stock market is on what seems like an unstoppable path upwards, and stock market prices are supposed to reflect growth rates. What gives?
Well something is going to give, but we don’t know when. If the bond market is wrong, but suddenly figures that out, then lots of investors are going to lose a lot of money very quickly in their fixed income portfolios. Or maybe the stock market is wrong, and despite the fact that the price of volatility is very, very low, something bad is lurking around the corner. Or perhaps, just maybe, there is something else going on, and there is something new to learn about how governments reacted to the great recession that has forever changed what the markets expect about the future. We’re going to try and figure that out for you in our Annual Market Report.
Thanks for listening today. This is Eric Cramer, Chief Investment Officer at Buckhead Investment Partners. Goodbye for now and I look forward to seeing you at one of our upcoming Annual Market Report dinners, lunches, or on the webcast.
Disclosure: This communication contains general investing information that is not suitable for everyone and is subject to change without notice. Past performance is no guarantee of future results and there is no guarantee that any views and opinions expressed will come to pass. The information contained herein should not be construed as personalized investment advice, tax advice, or financial planning advice, and should not be considered a solicitation to buy or sell any security. Investing in the stock market and the bond market involves gains and losses and may not be suitable for all investors. The Global Equity index is the MSCI ACWI IMI Index, which is a free float-adjusted market capitalization weighted global index selected as the best available proxy for a diversified stock portfolio consistent with modern portfolio theory. Approximately 55% of the index is comprised of the U.S. stock market and 45% is comprised of international stock markets, including both developed and emerging countries. The “Net Total Return” version of the index is reported here, which means the index reinvests dividends after the deduction of withholding taxes, using a tax rate applicable to non‐resident institutional investors who do not benefit from double taxation treaties. The Emerging Market index is the MSCI Emerging Markets Gross Index. The U.S. Fixed Income index is the Bloomberg Barclays Capital U.S. Aggregate Bond Index, which is a broad-based benchmark selected as the best available proxy for a high quality, diversified fixed income portfolio suitable for a U.S. investor. It is comprised of the Barclays Capital U.S. Government/Credit Bond Index, the Mortgage-Backed Securities Indices, and the Asset-Backed Securities Index. It is an unmanaged market value-weighted performance benchmark for investment-grade fixed-rate debt issues, with maturities of at least one year, and an outstanding par value of at least $100 million. The “Total Return” version of the index is reported here, which means that dividends are included and reinvested. It is not possible to invest directly in this or any other index.