January 11 2018 Market Update

We must first return to November 8, 2016, the night of the US Presidential elections.  As news started coming in about Donald Trump’s ascent to the Presidency, we at JSF started to re-evaluate the impact of that night’s dramatic outcome on the economy and financial markets.  The narrative was that President Trump would be impossible to predict, and that his unexpected approaches to the many world challenges could induce much volatility onto financial markets. His initial promises to raise tariffs and tear up trade deals did not bode well for global trade. The expectation was for a Brexit Moment, i.e. a sharp and meaningful decline in the prices of risk assets, akin to the stock market’s reaction to the unexpected decision of Britons to withdraw from the European Union on June 24, 2016, when the S&P 500 Index dropped approximately 5.3% over the two days following the Brexit referendum.[1]

We now know full well that things did not turn out that way following the US elections of 2016.  The S&P 500 Index, which closed at 2,139.56 on November 8, 2016 (Election Day), was up slightly the next day, finished 2016 at 2,238.83; and by the end of December 2017 was at 2,673.61.  Indeed, an investor buying an ETF tracking the S&P 500 Index on Election Day would have been up 5.0% by the end of 2016, and another 21.1% in 2017, for a grand total of 27.2%; all including dividends and distributions.[2] So much for a Brexit Moment.  There are plenty of excellent hindsight explanations for both the pre-election consensus (which was proven wrong) and the post-election appetite for risk assets; we have outlined some of these explanations in prior newsletters. The number one lesson we have taken from 2017 is that one should take every financial prognostication, including the one you are about to read, with a huge grain of salt. Things just have a way of working out the way they please.

2017 proved to be a banner year for equities.  Large-cap domestic equities, such as those in the S&P 500 Index, were up by 21.1%.  Foreign investments outpaced their domestic brethren:  Developed markets equities were also up; an ETF tracking the MSCI EAFE Index was up by 25.0% in 2017, including dividends and distributions.[3] Both were handsomely bested by an ETF tracking the MSCI Emerging Markets Index, which was up by 36.8% in 2017, including dividends and distributions.[4]  Indeed, this was a very good year for risk assets. On the fixed–income side of the financial markets there was a different story. The yield on the 10-yr US Treasurys closed 2016 at 2.45%, a dramatic move up from the 1.86% on Election Day.  The 10yr Treasury yield moved up and down throughout the year, but closed 2017 at roughly the same place where it started it, at 2.40%. An investor buying an ETF tracking the Barclays Aggregate Index would have realized approximately 3.7% in 2017, including dividends and distributions.[5]

Looking out to 2018, market participants are talking about “global synchronized growth”[6] where all 45 nations tracked by the OECD are expected to see their domestic economies grow this year. At the same time, the same market participants are well aware that the S&P 500 Index is trading at about 20 times the next 12 months’ earnings, which might not be overvalued but is certainly not considered to be historically cheap.  We think the key question for deciphering the coming year is which of these two- steady economic growth globally or expensive equities, will have a stronger impact on financial markets in 2018.

On the monetary side, Jerome Powell was nominated to replace Janet Yellen as Fed Chair, was approved by the Senate Banking Committee and is waiting for the full Senate confirmation before he assumes his new job on February 3, 2018.  Powell is seen as a “more of the same” Fed chair whose policies will not be much different from Yellen’s, and the Federal Open Market Committee (“FOMC”) is expected continue to reduce its balance sheet by not reinvesting $10B/Mo. in bond coupons and by hiking short-term interest rates another 3 times in 2018. The Fed has recently been discussing the implications of the 2017 tax reform on its monetary policy, recognizing that increased economic growth due to the reform might cause it to hike interest rates faster than previously forecasted.

Two other key questions are also on our mind.  The first is related to political and geopolitical (e.g. North Korea, Brexit, and South China Sea) developments: how will such events affect the global economy and will they harm the global synchronized growth? What will be the effect on financial markets? It is fair to say that despite concerns from various quarters and many developments on the political and geopolitical fronts, neither had a strong impact on the economy and financial markets in 2017. Will that trend continue in 2018?

The second question is related to the length of time since the last meaningful correction.  Pundits often say that “we are due for a correction,” but is that so? Maybe we will learn the answer to that question in 2018, but we expect greater volatility in 2018 than we saw in 2017.

There are many questions regarding the tax reform act and we are trying to figure out the new regulations and their impact on all of us.  However, we continue to believe that the best approach for long-term investors is having a diversified portfolio (one that represents all the relevant asset classes) that is carefully tailored to the risk profile and objectives of each individual investor.

We would like to take this opportunity to welcome the newest member of the JSF Financial family, Seta Keshshian. Seta will be getting to know many of you as she settles in as an Associate Financial Planner.  Please drop by to say hello when you visit our office.

On a bittersweet note, JSF will be saying farewell to our beloved Financial Planner Don Peck, who is retiring at the end of January.  Don joined JSF over 12 years ago after retiring from a successful career at Disney Imagineering.  Don has proven to be a superb listener and a valuable resource for so many of our clients.  Don will sorely be missed but we know he will enjoy traveling and exploring the great outdoors as he embarks on this next chapter of his life.

We thank you again for your continued confidence, and ask that you let us know if there have been any changes to your financial situation or objectives so that we can review your portfolio and ensure that your financial needs are being addressed.

We look forward to our next review meeting with you in early 2018.

Sincerely,

JSF Financial