Happy New Year! As we look forward to another year, we want to take our usual examination of the previous year and dissect what we saw. To sum up 2017 in two words, we’d describe what we saw as “uninterrupted growth.” Stepping back for a moment to look at the whole picture, such uninterrupted growth is an interesting development considering the many geopolitical events that took place during this time.
At the end of 2016 and moving through 2017, we saw, 1) the UK leaving the Eurozone, 2) Donald Trump elected President, 3) the Trump administration seemingly in a daily battle with Congress, the courts, and the media over policy, 4) consistent threats of armed conflict with North Korea (including nuclear threats) and/or various factions in the Middle East, 5) an ongoing investigation of the Trump administration and various parties within concerning alleged Russian interference in the U.S. Presidential election, and 6) the most significant overhaul of U.S. tax policy in over 15 years. If one were to look at all of these events in a vacuum without looking at other factors, one could reasonably conclude that the year must have been one of significant market volatility. As we all know, that conclusion would be been woefully incorrect. In spite of all of these factors, the U.S. economy and the financial markets responded with steady growth. Clearly, the optimism of the investing public outweighed any concerns that they may have harbored with respect to these U.S. and world events.
On a macro scale, the economic growth that we saw was largely attributable to several factors. To wit, 1) tight labor markets made jobs plentiful and put a lot of people back to work, 2) housing values have been steadily increasing, 3) access to credit has improved, 4) after the severe economic recession of 2008/2009 led by housing and debt woes, we’ve finally come to the end of a very long and healthy household de-leveraging cycle, 5) 2017 contained back to back quarters of 3% GDP growth, and 6) corporate earnings reports were very strong.
The collection of these positive factors contributed to a strong bull market across nearly all equity asset classes. For the first time in recorded history, world stock values, as measured by the MSCI All-Country World Index, saw an increase in every single month of the calendar year. The current S&P 500 bull market run that began March 9th, 2009 is now the second longest bull market run in history. And the S&P 500 hasn’t had a 3% or more pullback since November 4th, 2016 making it the longest stretch of time for the S&P 500 without a 3% pullback ever!
Calendar year 2017 was a great year for the U.S. equity markets. The total return for the aggregate S&P 500 index in 2017 was 21.83%. Leading the way among sectors within the index was the Technology sector, which returned an astounding 37.14% for the year. Looking at the data further, we see that the largest companies tended to perform better than smaller companies within the index, low dividend companies performed better than high dividend companies, “growth stocks” performed better than “value stocks”, and companies with heavy international exposure outperformed those with more of a concentrated domestic exposure. As the result of such strong earnings performance among large U.S. companies, S&P 500 companies increased dividend payouts by an average of 5.4% for the year.
Strong market returns weren’t all contained within the large cap asset class in 2017. Small cap companies also performed well, with the Russell 2000 index returning a more modest, yet still robust, 14.65% in the aggregate.
On the fixed income side of the ledger, the U.S. Aggregate Bonds Index posted a total return of 3.54% in 2017. Bond returns continue to be anemic for anything that isn’t longer term or higher risk. Fed policy is still pushing investors toward the equity markets. To try to obtain additional yields, investors are forced to move into longer term fixed income investments. In a potentially rising interest rate environment, such longer term fixed income investments are subject to a significant degree of interest rate risk.
As strong as the U.S. equity markets were, the international markets were the real winners of 2017. Emerging Markets, as measured by the MSCI Emerging Markets Index, returned a whopping 37.3% in the aggregate in 2017. This came off a period of more subdued returns in prior years and frankly, our observation is that the participation of the international markets in the bull market run was overdue. In addition to the emerging markets, developed international markets (measured by the MSCI EAFE index) produced a stellar 25% return.
As a result of such strong market returns, the question that has arisen is whether the rising prices of global stocks in our current bull market is supported by the underlying fundamentals. The good news is that very strong global corporate earnings have supported much of the recent market optimism. Going forward, however, it will be interesting to see whether the bull market cools a bit in order to digest the recent gains and allow the underlying fundamentals to keep pace.
As we’ve said many times, it’s impossible for anyone to consistently predict what the markets will do going forward. That is why we stress the importance of constructing and adhering to a well thought through asset allocation plan that 1) is based upon the investor’s personal goals and objectives and, 2) takes into account the investor’s appetite for risk. We continue to embrace the philosophy that over the long term, proper asset allocation is the primary driver of investment returns. It takes psychological discipline to adhere to such plans in times of market volatility, but market history shows us that those that do are rewarded.
We’ve been getting a few questions lately surrounding the current trend of trading Bitcoin and other cryptocurrencies. If you’ve been following the news recently, you may have seen that the financial news media has been breathlessly reporting on the astronomical “returns” on investments in Bitcoin. Seven years ago, Bitcoins were trading for 10 cents. Today, Bitcoin prices are trading at nearly $15,000. Along the journey, Bitcoin prices have experienced intense volatility. In one trading session alone, the value of Bitcoin dropped by 20% in a 24-hour period!
For those unfamiliar with Bitcoin and other cryptocurrencies, such currencies are electronic in nature and were created by a private individual (in fact, nobody knows the true identity of this individual…the person uses an internet alias!). Bitcoins are “created” when persons seeking to “mine” Bitcoins are rewarded with Bitcoins when they solve complex math problems. After creation, the Bitcoins are then traded on electronic exchanges that trade in Bitcoin and other cryptocurrencies. If you are still confused by what supports the value of Bitcoin, you aren’t alone. Our observation is that Bitcoins are a fictionalized creation by an anonymous private individual with private profit motives, operating without any regulatory oversight, and with the potential to do great harm to investors.
We view Bitcoin to be a potentially hazardous investment for the following reasons:
- Extreme price volatility
- Bitcoin is not backed by any recognized government and therefore, there is no governmental body that has legitimized it nor pledged to support its value as a currency; in fact, there appears to be no real reason for ascribing value to it other than market enthusiasm
- There is no monetary insurance with respect to any prospective losses in Bitcoin, such as the FDIC insurance that the U.S. government provides banking clients for checking and savings account deposits holding U.S. dollars
- Due to the lack of regulatory oversight, Bitcoin lends itself to being used on the black market for illicit activities
- Due to the lack of regulatory oversight, Bitcoin has significant exposure to severe de-valuation from over-supply as more and more Bitcoin is created with seemingly no underlying economic reason for its creation (i.e. a person has simply solved a math problem and been rewarded just as a computer game similarly rewards a child for winning a game)
- Due to its inherent nature as a cryptocurrency, Bitcoin has significant exposure to hacking; indeed, in 2014 in Japan, a supposedly “secure” Bitcoin exchange was forced to shut down after its system was hacked and millions of dollars in Bitcoin value was stolen
- Nobody knows the true identity of the original creator of Bitcoin and therefore nobody is ultimately accountable for what happens with Bitcoin; the originator of Bitcoin has never come forward with his or her identity and that factor alone is concerning
Our position is that clients should politely decline if approached about any sort of investment in Bitcoin or other cryptocurrencies. As appealing as the allure of potentially “easy money” is, our observation over many years of studying the financial markets is that there is no such thing. To quote famed investor Warren Buffett, “Nothing sedates rationality like large doses of effortless money.”
We wish you and your family a very healthy and prosperous 2018.
The DBK Financial Counsel Team