2017: A Tough Act to Follow…
Where Are Markets Headed in 2018?
Q: We’ve just closed out a pretty remarkable year for investors in 2017. Where is our Investment Committee’s thinking? Will this continue?
You’ve posed the most frequent question we get from clients. This question was being asked even before the end of 2017, because this strong up move in the financial markets has been in place, virtually uninterrupted since early 2016. We are close to the two-year mark of this upward advance. The U.S. market returned almost 22% last year (S&P 500 Stock Index). Foreign stock markets, in the aggregate (excluding the U.S.) did even better, surpassing 27%. Even dull and boring bonds had a nice year, producing a solid inflation-beating return of more than 3% with little volatility. It’s hard to remember a year when portfolios moved ahead “hitting on all cylinders.”
Q: That is good perspective. Does that mean we have concluded the party is about over?
The short answer: not necessarily. We get this question from clients and friends for a few reasons. One reason often behind the question: this bull market has extended longer than average in terms of time and advance. That said, it does not represent the all-time record. The answer to your question has to be more than some simplistic appeal to “reversion to the mean.” Yes, the U.S. market has attained record levels of price appreciation when you look at popular benchmarks, but that is only part of the story. It is equally true that we are in an economy where the corporate profits encompassed within the U.S. stock indices are also at record levels, and that is before counting the positive effects of the recent tax changes. What we tell clients is that you must put this question in some sort of frame to have a sensible perspective. The “frame” on one side is a U.S. economy that appears to be in steady growth mode with no serious signs of impending recession risk. The other side of that frame is that U.S. stocks, while not a bargain, are nonetheless selling at reasonable price multiples relative to expected earnings. There are a number of ways to measure valuations. Our team looks at several different metrics and compares them to historical averages, different periods in history, and makes adjustments for the current economic environment. In that sense, we believe U.S. equity markets are fairly valued.