Fourth Quarter 2017 Review & Outlook

“There are two main drivers of asset class returns – inflation and growth.” – Ray Dalio

Review

Wow! What a year 2017 turned out to be for the stock market. The Dow Jones Industrial Average achieved more than 70 record-setting closes in 2017, which is the most ever recorded in one year. Additionally, the Standard & Poor’s 500 Index hit a record high in excess of 50 times during the year. The Dow Jones Industrial Average and the S&P 500 have each posted their ninth straight quarter of positive returns, along with the best calendar year returns since 2013. Not to be outdone, the NASDAQ Composite beat both the Dow and the S&P 500, while itself increasing for a sixth quarter in a row.

The strong upturn in the stock market has lacked typical sharp price corrections. It is noteworthy that the S&P 500 has not experienced a daily decline of more than 2% since September 9, 2016. Furthermore, there were only four days when the index dipped more than 1% in all of 2017. In the previous thirty-year period, the market averaged a 1% drop every seven or eight trading days, and a 2% daily decline approximately 10 times each year. In fact, the S&P 500 has now gone over 60 weeks without a 2% weekly decline, which is the longest stretch since 1965.

Wall Street has now had an eight-year love affair with stocks. This year the stock market’s advance accelerated along with a strengthening economy, anticipation of tax reform, and a continuing lack of other compelling investment alternatives. Surprisingly, the quickening pace of economic activity and lower unemployment rates did little to raise historically low interest rates. Investors endured fiery rhetoric between the White House and North Korea, a series of significant hurricanes, and frightening west coast fires. Despite the turbulent backdrop, The Conference Board reported consumer confidence reached a 17-year high in November.

The resurgent overall economy has been the dominant driver supporting investor psyches, corporate earnings, and in turn, the stock market. Market observers and commentators have repeatedly used the phrase “synchronized global expansion” to describe the strong worldwide economy that transpired in 2017. What’s more, world economic growth has continued to get stronger, while the US dollar has weakened. The weaker dollar has helped boost earnings of the many large multinational corporations based in the United States.

The first major overhaul of the US tax system in decades was passed by Congress and signed into law by President Trump in December. The new tax law greatly reduces corporate tax rates, saving companies billions of dollars over time. Additionally, the new tax law provides incentives for companies to repatriate cash earned and held outside the borders of the United States. Moody’s has estimated that the cash held overseas by US corporations to be $1.4 trillion. This potential repatriation of cash and tax savings can be used to fund the purchase of new equipment, the expansion of factories, increased employee compensation, and the creation of new jobs. It is anticipated that a portion of this cash will fuel expanded stock buy-backs, increased quarterly dividends, and the pay down of corporate debt. Therefore, it is not hard to see the stock market as a likely major beneficiary of the new tax law.

Outlook

Market prognosticators are optimistic that 2018 will be another good year for the stock market. Their positive outlook is based on improving growth in the overall economy, rising corporate profits, and lower tax rates. Due to the positive outlook, the Federal Reserve is forecasted to increase short term interest rates three times in 2018, despite the continuance of an inflation rate hovering around 2%.

The Federal Reserve’s intentions seem to be in recognition of an economy that is at, or very close to, full employment. Many employers are looking to hire qualified employees, but instead are finding too few to meet their needs. Many forecasts for the labor market in 2018 call for the unemployment rate to drop below 4%. The lower rate of unemployment should result in higher wages, which are normally a pre-cursor to inflation, and likely lead to higher interest rates. It has been over a decade since we have experienced any significant inflation. Expectations for inflation may have implications for our individual stock selection and stock sector allocation as we move through the new year.

Sincerely,

Marietta Wealth Management, LLC