Let’s make this an annual update and talk about risk and reward. We are now far into the second-longest bull market in history.
I would make the argument today, that somebody who has a 60/40 equity to bond allocation has a riskier portfolio today than they did one, two, or even three years ago.
Now, why would I say that? I would say that because equity valuations have really gone through the roof. We have equity valuations at levels not seen since just before the Dot Com Bubble. I don’t want that to worry you because we’re keeping a really close eye on equity valuations, and they can remain elevated for long periods of time.
2017 shaped up to be a great year all around. We had equity markets up pretty much across the board with the exception of a couple of separate sectors, the Utilities sector and the Energy sector both wound up in the negative range. Energy was down about 5% and Utilities was down around 2.5% on the year. Other than that, the worst performing index was the SmallCap index, and that was up by 10%. The best performer was the NASDAQ up over 34% in 2017. So, a great year all the way around.
We’re going to go into a little more detail on the equity markets, but before we get to that I want to talk a little bit about interest rates. If you’ll recall we talked a lot about interest rates last year. The 10 Year Treasury actually began the year at around 2.45% and ended the year at 2.40%. So, the 10 Year Treasury barely moved, but as we will see in a chart below there have been changes in the shorter team on the interest rate yield curve. We’re going to look at that because that can tell us a little bit about what is ahead of us in 2018.
What happened in 2017? Well, we had tax reform that was passed in December. You now have companies issuing bonuses and raises. There are companies talking about repatriating assets back to the U.S. There is talk of plants being brought back to the U.S. for job creation. Unemployment is at the lowest level we have seen in decades. Homebuilder sentiment the strongest that we’ve seen it since just before the Great Recession. So, all kinds of really positive signs from an economic perspective.
As we go into 2018, we’re looking at the year with cautious optimism. Optimistic because of all the things in the economy that really look good. The caution is due to the overdone equity valuations we have today. When I say we are in the second-longest bull market in history; it is the second longest period, almost nine years now, without a 20% or more decline. A 20% decline or more is what defines a bear market.
Will we see that 20% decline here in 2018? I really don’t know, there’s no crystal ball that will let us know that. I will tell you this though, every bull market is followed by a bear market. However, when you think about bull or bear markets, bull markets are typically like taking an escalator up while bear markets are like taking an elevator down.
When the bear market does come it can be ugly. So, we have to be cautious about that. We have to understand that we are really long here in this current bull market and that a bear market could come around the corner. I don’t see anything that leads me to believe that there is danger on the immediate horizon. So, that’s why we are cautiously optimistic about 2018.
Let’s dive in and take a look at some of the different sectors and how they did in 2017. We’ll talk a little bit more about interest rates and where we think we’re headed for 2018.
Let’s get started with interest rates. Before we go into the interest rate discussion I want you to understand that the Federal Reserve controls the overnight lending rate. It’s the bank to bank rate. So, it’s really crucial for you to understand that when the Fed starts talking about raising rates, that the only rate that they control is that overnight lending rate. The rest of the rates are controlled by the markets themselves.
We’re looking at the blue line, which is where interest rates were on January 3, 2017, versus the green line which is where interest rates ended the year. The 1 Month Treasury was at about 0.5% on January 3, 2017, and by the end of the year that 1 Month Treasury was all the way up to 1.28%. As you can see most of the shorter end of the Yield Curve all came up.
Now when you get out to about the 7 Year Treasury, it was pretty much flat. The 7 Year Treasury was at 2.26% at the beginning of the year and closed the year at 2.33%. The 10 Year Treasury on the other hand actually wound up lower on the year down from 2.45% at the beginning of the year to 2.40% at the end of 2017. Then the 30 Year Treasury began the year at 3.04% and ended the year at 2.74%.
So, it’s interesting to note that the longer we go out on the Yield Curve the less interest rates have moved. In fact, on the very long end of the Yield Curve interest rates have actually come down. We would typically look at this as a sign that says, it doesn’t look really good for the economy going forward. However, there are some different mechanics at play here that we believe are telling a different story.
We still have global interest rates at extremely low levels. So, you have a lot of foreign buyers still buying our treasury. Even though the Fed has raised rates dramatically over the course of the last 15 months, it hasn’t translated into higher yields out on the longer end of the Yield Curve. Which bodes very well for the home builders, home buyers, and even home sellers. That’s what’s really keeping the momentum going in the housing market.
What does 2018 hold for us in the longer term of the Yield Curve? I made a statement at the end of 2015 that I thought that we would end the decade, so through 2019, with that 10 Year Treasury yield somewhere between 2-2.5%. Now, it’s right about at that same level now, and people have been talking about it going up dramatically. I don’t know where we’re going to end up this year, but my sense is that we will still end up seeing the 10 Year Treasury somewhere between that 2.25-2.75% by the end of the year. So, I don’t see any dramatic moves there. I think that we’re going to continue to see the 10 Year Treasury out there which is, again, going to be good for the home loans, home builders, and home sellers.
I want to turn our attention to the broad-based markets, and I’m going to cover a 12-month timeframe. So, this is actually 12 months coming up through the day of the video recording, January 8, 2018.
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As you can see here the NASDAQ or the technology-heavy sector of the NASDAQ, was up 34% over the course of the last 12 months. The biggest lagger down at the bottom was the SmallCap is up 10.07%.
What’s interesting to note if we look at this over the course of the last month you see that those SmallCap are still down at the bottom, NASDAQ still up at the top, and the Dow Jones Industrial Average still up at the top. So, we’ve got a lot of power behind the very large companies out there today. I think that is going to continue. We have seen some spurts of the small companies doing well from time to time. We are keeping some exposure to small companies, because small companies tend to, at periods of time, perform better than large companies. However, a lot of the money flow has been in larger companies.
Let’s take a look at some of the separate sectors starting off with the last 12 months. Technology again is the leader up 34.84%, followed by Materials, Industrials, and Health Care. We see the S&P 500 right in the middle and Financials just slightly below that. Then we come down to Consumer Staples and Real Estate. The reason why Real Estate hasn’t done very well is that Real Estate is typically an interest rate sensitive investment, and with the Fed raising rates it’s kept some pressure on there. So, you’re not going to see the Real Estate or the REIT type accounts perform well in an environment where you have a threat of rising interest rates. Utilities and Energy were down 5.5% and 2.03% respectively.
Not every single sector was a winner for 2017, however, I think if we look at things across the board it’s one of the best years we’ve had in quite some time, where just about everything made good money last year.
As we roll into 2018, as I stated earlier, we’re going to look at it with cautious optimism. There is a lot of strength in the economy. The tax breaks are going to start being felt by the average American here in the next couple of months. We believe that will translate into increased consumer spending which should translate into increased GDP. So, we see a positive from an economic perspective for 2018. Just because we see a positive economic perspective doesn’t always translate into a boom for the stock market. However, I think that this year we’re going to start off good, maybe hit a couple of pockets of softness in the market over the year, but overall if we don’t see something crazy happen around the world we should wind up with a good 2018.
Please stay tuned, watch your email because we are going to be doing additional workshops on more tactical asset allocation and investment management those workshops will be open to anyone who would like to attend.
With that I would like to wish you all a Happy New Year and hope to see you in the office soon. Thanks for joining me today.
As always, if you have questions about your retirement in 2018 and beyond, whether it’s related to investments, taxes, or you just want to get a second opinion, give us a call at 913-393-1000 or fill out the form below to request your meeting today.
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