In a Nutshell –
- U.S. Stocks close out a historically low year of volatility.
- International stocks are gaining strength.
- It may be time for bonds to drop the sails and start rowing.
- Can I use my tulip bulbs or Beanie Babies to buy Bitcoin?
U.S. Stocks – Historic Year for (Low) Volatility
As good as a 22% return for the stock market is, it’s not historically significant. There have been many years where it has notched 20%+ returns. What is historic is the way it achieved that return, with very little downside. 2017 was the first year since 1995 that it went without even a 3% correction. In fact, we’re now in the middle of the longest streak ever without a 3% drop from the market’s peak. And as of January 22, this market also holds the record for the longest streak every without a 5% correction at what is now 400 days and counting (Source: LPL Research). For reference, the stock market averages two 5% plus drops each year.
So does this mean we’re about to see a significant correction? While we’re certainly due for one and the market is priced to expect perfection, that could have been said any time over the past 9 months. I’m in the camp that no one can consistently call market pullbacks. Even the experts that get handsomely paid to make financial forecasts are pretty bad at it. And the last time we had volatility this low, 1995, it did not end with a bear market. The market just returned to a more normal ebb and flow. In fact, we saw another 4 years of strong growth before the bear came out of hibernation.
Now just because the overall market performed well, that doesn’t mean every stock had a great year. There are always winners and losers and 2017 was no different. Small and mid-size companies couldn’t keep up with the blistering pace set by the largest stocks, but overall they had solid quarterly and annual returns. Looking deeper, home builders, health care companies and anything to do with lithium batteries in general had standout performances, many up 40% or more for the year. On the other hand, oil and natural gas pipeline companies and phone companies struggled, with a number of negative 4th quarter performances and some down 20% plus for the year.
International Stocks – Ready to Take the Lead?
Over the past several months, international stocks, from parts of Europe and Japan, and especially emerging markets such as China and India, have been outperforming even the strong U.S. market. Historically, U.S. and international stock markets alternate leadership every 5 – 7 years and since 2010 the U.S. has outperformed foreign markets by an average of 10% per annum (Source: RiverFront Investment Group).
So is it time for international markets to lead? Economic growth outside the U.S. has lagged and many countries are now starting to gain steam. Stock values are not nearly as stretched so fundamentally it would make sense that they would take the baton. Time will tell.
Bonds – Starting to Feel the Headwinds
With stock markets booming, the economy growing at a solid pace and the Federal Reserve continuing to raise interest rates, many experts predicted that 2017 was the year bonds would struggle to generate any type of a return (bond values tend to fall as interest rates rise). However, during the first 3 quarters, bonds bucked that trend with a positive showing. The reason was that although the Fed raised interest rates 3 times during the year for a total increase of 0.75%, yields on longer maturity bonds did not rise by the same degree. In fact, at the beginning of 2017, 10 year U.S. Treasury bonds were yielding 2.45% and at year’s end the had actually gone lower, to 2.41% (Source: JPMorgan)
During the past few months, however, returns have been more muted. It looks like the impact of higher interest rates is starting to be felt. And the Fed has already stated that it expects to raise interest rates another 0.75% – 1.0% during 2018 so the headwinds should continue to blow for the foreseeable future.
Does that mean investors should abandon bonds? No. While consistently positive bond returns may now be more difficult, if the economy or stock market hits a rough patch, investors will likely rush back to the relative stability of high quality bonds. For this reason they are still an important part of a well-diversified portfolio, especially if some of the money will be needed within the next few years. But this does mean that the days of simultaneously positive stock and bond returns may be behind us for a while.
High yield bonds have historically been more tied to the fortunes of the stock market. However, just as with stocks, valuations are stretched. And while investors were willing to continue pushing stocks up during the quarter, they were less willing with high yield bonds as seen by their flat return (0.03%). Maybe it’s because investors now believe that since the difference in interest rates (the spread) between them and their higher quality counterparts is as low as it has been in a while, the small amount of additional yield is not worth the extra risk.
Commodities & Alternative Assets…and Bitcoin
Commodities were a mixed bag in the quarter as they have been much of the year. Industrial metals such as copper and aluminum continued to increase in value reflecting the strength of the global economy while agricultural products such as wheat and corn continue to struggle. Oil prices rebounded, again primarily due to increasing global demand. Natural gas prices fell however as winter got off to a warmer than normal start in November and early December.
For the year, commodities on the whole were an asset class that most investors were wise to avoid. While gold, industrial metals and livestock notched solid gains, lower prices in agricultural crops and natural gas offset most of the appreciation.
The U.S. dollar also lost value over the course of the year, finishing down around 10% relative to a basket of global currencies including the Euro and Japanese Yen. A weaker dollar is better for U.S. exports and foreign tourists. The flip side is that we may see prices on imported products creep up and international travel get more expensive.
And I would be remiss if I didn’t mention Bitcoin. Even though the cryptocurrency has been around since 2009, it didn’t come into the mainstream until this past year as the price went from about $1,000 per coin in January to its all-time high (so far anyway) of over $19,000 in mid-December (It has since dropped to ~$11,000 as of this writing). And though it is not difficult to buy, there are few ways to invest in it with a standard brokerage account. A number of mutual fund and ETF companies would like to change this and recently filed applications with the SEC to create more securities for investors to use. They were told approvals would be denied until the cryptocurrency market had become more mature. Question is, when will that happen? Your guess is as good as mine. Until then, if you do buy some cryptocurrency, don’t lose your password.