More of the Same
In reviewing the past year, we spend a portion of our time evaluating our theses and scrutinizing our investment choices. Although this is an iterative process, the New Year is a good time to examine our strategies and deployment. For 2017, we, along with many others, got the direction right on US equity markets, however, failed to predict the magnitude of its increase. Our case for high single digit returns, based on a continuation of sustained, yet slow economic growth continues to support reasonable fundamental valuations. Fortunately, we remain enthused and many of our core holdings participated in the market rally as profits support valuation increases.
In fixed income markets, our long-held concern regarding interest rates partially proved right as the rate on the US 10-Year Treasury remained far more stable during the previous 12 months than we expected. However, the FOMC hiked its Federal Funds Rate three times. Including the move in December 2016, rates increased one percent for the trailing 1-year off a base of essentially zero. The aggregate US investment-grade bond index return was 3.5%, but this significantly trailed global credit’s 8.5% return. The risks that we perceived a year ago concerning rate and currency risk remain.
We expect that even with the change in leadership at the Fed, short-term rates will increase another 50 basis points (half a percent) in 2018. Should this occur, the difference in yield between short and long term rates will likely shrink, unless longer-term rates increase. Neither scenario bodes well for fixed-income returns. We believe the best one can hope for (and “hope” is not our strategy) in this environment is low single digit returns from the asset class. The addition of credit, which has already appreciated significantly in recent years, and/or currency exposure will be required to maintain purchasing power.
When considering the impact of the recently enacted tax law changes in the US, we see additional benefits accruing to owners of assets, both financial and real. As most of the world’s commodities are priced and traded in US Dollars, we expect to see a steady albeit slow increase in the price of most materials and consumables. The growing Federal deficit poses a significant risk to continued prosperity.
Below are a few of our predictions for the year that lies ahead.
On the back of increases in consumer optimism globally:
· Global GDP continues to expand at an increasing rate (3%+), led by developing and emerging markets
· Equity returns from Asia and Europe (+12%) will top those from the US (+8%)
· Secondary and tertiary issues (small and mid-cap companies) will provided stronger returns than bellwether large capitalized companies
· We see a significant upturn in the number of companies going public, a sign of healthy markets
· Volatility increases, however, remains well below historical averages
· Technological innovation drives productivity gains keeping inflation in check
· The US Dollar loses ground against other developed and emerging currencies
· Emerging market debt provides greater returns than US government and corporate bonds
· US Bonds produce zero return, cash from interest payments make up for the decline in prices
· Crypto currencies remain volatile with Ethereum and Ripple replacing Bitcoin as market proxies
· Governments from around the world increase regulation on ‘digital’ currencies
· Energy prices climb 15%, oil to a range high of $70 Barrel, Natural Gas to $3.30
· Demand for lithium continues to grow with continued adoption globally of electric vehicles
· With favorable demographics, both single and multifamily housing continues to perform well
· The Minnesota Vikings make it to the Super Bowl, but not sure if they will be on the field or in the stands
While we paint an optimistic picture for risk assets, we continually concern ourselves with what can go wrong in individual situations. We undoubtedly will miss the mark on several of the predictions above, but we have informed confidence that we have the macro picture correct.
We look forward to sharing our updated thoughts with you in the spring along with your first quarter results.
Wishing you a healthy and prosperous 2018!
Please reach out to continue the conversation.
- EPIQ Forum - March 1st @ The Kenwood – 8:00am – 9:30am
We are hosting an EPIQ forum at The Kenwood restaurant. Please contact us if you are able to join us. Space is limited.
Dan Aronson, CFA Bruce Langer, CFA Ben Frey, CTP