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4th Quarter 2017 Market Commentary

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2017 was a remarkable year for stocks.  Gains were relatively large, but the smoothness with which those gains occurred was unprecedented.  


Every month of the year saw gains in the MSCI All Country World Index of global stocks (ACWI), something that has not occurred in over 30 years.  The S&P 500 index, returning 21.8% for the year, also saw twelve months of positive returns last year on a total return basis - something it has not done since its creation in 1957.  This is not, however, evidence that we have entered into some wonderful new era for stocks: a world without market declines.  To the contrary, it is a warning: when markets run straight up, investors tend to under-appreciate risk.  

After modest returns over the last four years, international stocks came to life last year with emerging markets returning 37.3% and established markets returning 25.0%.  Short-term interest rates rose last year as the Fed hiked rates three times, but long interest rates slightly declined as the 10-year Treasury yield began the year at 2.45% and ended it at 2.43%.  Economic and earnings backdrops were strong through 2017 and are widely expected to strengthen going into 2018 with the reduction in corporate tax rates from 35% to 21%.  It's tricky to comment on taxes in a hyper-polarized political environment, but we'll note that US corporate tax rates have been high within the industrialized countries, putting US companies at a competitive disadvantage.  The new corporate rate appears to address that, and should result in increased business investment for expansion.

Yet investment risks are heightened. US stock valuations are exceptionally high, geopolitical and political tensions are elevated, and the monetary environment is moving in the direction of tightening with more rate increases expected in 2018.  Because inflation has been muted for many years, the consequences of renewed inflation may be more onerous than generally recognized (even as its likelihood remains unknowable).  

Investment risks are always with us, they just take different forms (in the last correction, markets were focused on an economic slowdown in China, which remains over-leveraged today).  But these risks are just possibilities.  What can be asserted is that 2018 will not likely repeat this past year's experience of no monthly market declines in global stocks.  The year ahead (and the others that follow) may be expected to generate at least some monthly losses for global stocks, if not a "correction".  Therefore, the benefit of holding diversifying strategies in portfolios is highly likely to increase going forward relative to 2017.  We have been emphasizing diversifiers and rebalancing among asset classes.  

In early 2018, we intend to improve diversification by increasing international diversification within stock portfolios.  None of these steps should be a surprise.  When markets have been strong, long term investors should focus on risk.