2017 was a strong year for stocks with the S&P 500 up almost 19%, as stock valuations broadened out. We had been overweight stocks going into 2017 and remained overweight through the year. Bonds, however, returned only nominal returns, based predominantly on yield, as the Fed increased the Fed Funds Rate 3 times in the year. Bond yields traded in a tight range.
As we look forward to 2018 we believe that the stock and bond markets continue to enjoy good liquidity. Sentiment is strong at this writing, but we are aware that there might be a drawdown at any time. We believe that high beta stocks will outperform low beta stocks for the next several weeks. Financials, Energy, and Industrial sectors appear to be quite strong with healthcare and technology improving in the next several months.
Looking forward to 2018, we think that the major themes driving investment are:
1) The tax cuts work resulting in the development of a real business cycle.
2) Normalizing interest rates will be coincident with higher inflation.
3) The benefits of active portfolio management vs. passive investing become apparent.
4) The financial industry continues to consolidate.
5) We favor value over growth and small cap over large cap.
6) The FAANG stocks become regulatory targets.
7) Japanese stocks will outperform and European markets will continue to be soft.
We are frequently asked about valuations. Valuation is ultimately determined not by investor “animal spirits” but by the ability of a company, municipality, government, to generate predictable and consistent streams of cash flow. Earnings will be impacted by economic, regulatory and tax considerations, resulting in an ebb and flow in valuations in both bonds, stocks, and other types of investments. We believe the environment is favorable to earnings which should favor stocks and other alternative investments over bonds in 2018.
Please give us a call or send us an email if you would like more information about our full 2018 forecast.