See our recap of December's key statistics and market commentary below.
The S&P 500 continues its record streak of positive monthly returns to 14. The index was positive by 1.11 percent during December.
The S&P 500 gained 6.64 percent in the fourth quarter of 2017. This represents the strongest quarterly return seen for the index since the fourth quarter of 2015.
The spread, or difference, betwen the yields on 10 year and 2 year U. S. Treasury securities fell to 52 by the end of Decmeber. The closing of this gap has been an accurate predictor of U.S. recessions for decades.
Welcome to 2018, readers. We at ACG hope that you had a nice holiday season and that you look forward to the coming year with as much enthusiasm as we do. From an investor’s perspective, 2017 will be tough to beat, though it’s our opinion that conditions at home and abroad set the stage for another year of positive returns.
We recapped most of 2017 in last month’s newsletter, and much of December followed those same storylines with the exception of one key development: The U.S. passed the largest overhaul to the tax code since Ronald Regan’s administration. Easily the most significant aspect of the new tax bill is the massive cut to the corporate tax rate from 35 percent to 21 percent. This lower rate will directly impact the earnings of publicly traded stocks, which in turn provides a case for continued bullishness in the domestic stock market. According to FactSet as of December 22, the estimated earnings growth for the S&P 500 in 2018 is 11.8 percent. Earnings growth is a key driver of stock returns because the more that the earnings of a company grows, the higher that company’s stock price can rise without being considered too overvalued.
Corporate earnings aren’t the only strong point of the U.S. economy, either. The consumer also appears strong heading into 2018. The last reading of the Consumer Sentiment Survey came in at 98.5, admittedly a drop from October’s 100.7 reading but still representative of an optimistic outlook. And while sentiment doesn’t always translate into actions, it appears to in this case: Mastercard recently estimated that shoppers spent over $800 billion during the holiday season, which would be an all-time record for the U.S. With the labor market continuing to strengthen and inflation in check, it is not surprising to see consumers doing so well.
What will be interesting to see in 2018 is, if the U.S. markets see strong positive returns, will those returns be enjoyed by all sectors? This wasn’t the case in 2017. The dispersion between the best performing sector of the S&P 500 and the worst performing sector was over 40 percent (Tech stocks were up 38.83 percent while Telecom stocks lost 1.25 percent). This was the largest dispersion since 2009, when the Tech sector outperformed the Telecom sector by nearly 53 percent. The forecasted earnings by sector suggest a similar story playing out in 2018 with Energy and Materials expected to grow above the average and Utilities and Telecom sectors lagging again.
Despite the rosy outlook heading into 2018, don’t be surprised to see volatility tick up. There are a number of reasons to expect higher volatility this coming year, not only generally speaking but more specifically in January. One driver of volatility in January may be a tax effect. There will likely be many investors who have been waiting for January to sell appreciated positions so as to defer their tax bill for another year. One investor doing this is unlikely to move markets, but when aggregated across individuals and institutions around the world it could very well depress prices. Another reason you can expect more volatility is reversion to the mean—which is just a fancy way of saying that volatility in 2017 was drastically lower than the historical average and it would be abnormal for it to continue.
From our perspective, the markets are in as “Goldilocks” of an environment as can be expected. It’s difficult to forecast how long these conditions will last, but it’s easier to assert that they’re not likely to get any better. The Fed is sending interest rates in only one direction—up. The difference between the yield on 10 year and 2 year Treasury securities compressed from 58 basis points to 52 basis points during the month of December; each of the last five times this indicator has gone below zero, recession has followed. Inflation, whether it increases or decreases from here, could potentially give cause for the markets to spook. Geopolitical tensions do not appear to be relaxing. No one can say what the breaking point of these directional trends will be, or when those points will arrive, but history tells us that such a time is inevitable. As we kick off 2018 we encourage you to adjust your portfolio as needed if your goals or time horizon have changed.