No question about it, 2017 offered rich rewards to those who invested in a well-diversified stock portfolio. The S&P 500 Index advanced 21.83%, which marked its best calendar year since 2013 and placed 2017 in the top third of best performing calendar years in the index’s history. Despite these returns, the US ranked in the bottom half of countries for equity performance for the year, placing is 35th out of 47 countries in the MSCI All Country World Index. Emerging Markets finished the year up 35.4%. Small Cap stocks, which had a stellar 2016, underperformed their big cap cousins by a wide margin; the Russell 2000 Index of Small Cap stocks was up “only” 13.1% last year.
The Federal Reserve raised rates 3 times last year. The Federal Funds rate now stands at 1.5%, still a historically low level. One bit of good news: you may finally see that you’re earning a little more interest in your bank account! Surprisingly, longer term interest rates didn’t move much, setting the table for a positive year in the bond markets (though not nearly as impressive as the gains seen in global stock indices).
Table 1: Key Index Returns
|YTD %||3-year* %|
|Dow Jones Industrial Average||+25.1||+11.1|
|S&P 500 Index||+19.4||+8.5|
|Russell 2000 Index||+13.1||+8.0|
|MSCI World ex-USA**||+21.0||+4.6|
|MSCI Emerging Markets**||+34.4||+6.6|
|Bloomberg Barclays US
Aggregate Bond TR
Source: Wall Street Journal, MSCI.com, MarketWatch, Morningstar
YTD returns: Dec. 30, 2016—Dec. 29, 2017
*Annualized **In U.S. dollars
So, does a sharp upward advance in one year set the stage for a pullback in the following year? Not if we use the historical data as our guide.
Since 1950, the S&P 500 has risen at least 20% (including reinvested dividends) 24 times (excluding 2017). You might be surprised to find out that in the year that followed, the S&P 500 finished higher 19 times (all examples include reinvested dividends). Put another way, the S&P 500 rose 79.2% of the time in the year that followed a 20% or greater advance, with an average gain of 18.1%. When the S&P 500 has declined following a 20%+ advance, the average drop has been 6.5%.
Based purely on the example above, last year’s impressive advance has little predictive value, with one exception. It simply tells us that stocks have an inherent upward bias over the longer term. I should also add that upward bias is a key component embedded in your financial plan. Longer term, it’s always about the fundamentals, i.e., economic growth and profit growth. Low inflation and low interest rates only sweetened the pot last year.
Last year’s lack of volatility was simply remarkable. According to data from LPL Research and the St. Louis Federal Reserve, the biggest drop in the S&P 500 amounted to just 2.8%. It was the smallest decline since 1995. The average intra-year pullback for the S&P 500: 13.6% (LPL Research). Despite the ever constant hysteria generated by the media, global stock markets remained resilient in 2017.
The momentum generated by a growing U.S. and global economy is likely to carry over into the New Year. While a 2018 recession can’t definitively be ruled out, leading indicators suggest the odds are low. That said, unexpected events can create short-term emotional responses in the market that are best avoided by long-term investors.