The past 13 times that a calendar year has ended in seven, dating back to 1887, the Dow Jones or its predecessor has suffered a sharp downturn at some point in the last half of the year. Not only did 2017 buck this historical trend, it was one of the best years in recent memory.
Each of the three major U.S. stock indexes ended the year the same way they began the year — marching upward. In the fourth quarter, the S&P 500® was up 6.64%, the Dow Jones was up 10.96% and NASDAQ was up 6.55%. Looking at the full 12 months, each produced gains. For the year, the S&P 500® was up 21.83%, the Dow Jones was up 28.11% and NASDAQ was up 29.64%. Astoundingly, all three indexes hit record highs more than 60 times each during the year — with the Dow Jones and NASDAQ both closing at all-time highs over 70 times — accounting for approximately 25% of all trading days.
International equities did just as well as their U.S. counterparts. The MSCI EAFE Index, which measures equity market performance in global developed markets (excluding the U.S. and Canada), was up 4.23% for the quarter and 25.03% for the year. The MSCI Emerging Markets Index, which measures equity market performance in 24 emerging market countries, was up 7.44% for the quarter and 37.28% for the year.
Multiple factors contributed to this upswing in equity markets. First, liquidity was prevalent throughout the year as interest rates remained low across the globe and many central banks continued to inject their economies with proactive stimulus measures. Second, the world’s major economies appear to be growing in fairly harmonious fashion. No major economy is currently contracting — in fact, all 45 countries tracked by the Organization for Economic Cooperation and Development (OECD), which include both developed and emerging economies, are forecasted to expand in 2017 (final figures will be released by the OECD in the new year). According to the International Monetary Fund (IMF), “The global upswing . . . reaches more broadly than any in a decade — roughly 75% of the world economy.” Third, business and consumer optimism was strong during the year. The November 2017 IHS Markit Global Business Outlook Survey showed worldwide business optimism at its highest level in over three years, while the Thomson Reuters/Ipsos Primary Consumer Sentiment Index, also dated November 2017, showed global consumer confidence at all-time highs. Finally, volatility was incredibly muted in 2017 as investors demonstrated a preference for risky assets despite many potential headwinds. The VIX, which measures the expected volatility of the S&P 500, hit record lows throughout the year — in fact, of the 56 lowest closing levels in its history, 47 of them occurred in 2017.
Indexes for both investment grade and high yield bonds ended the quarter relatively flat, with the Bloomberg Barclays U.S. Aggregate Index up 0.39% and the Bloomberg Barclays U.S. High Yield – Corporate Index gaining 0.47%. Despite middling performance during the quarter, the indexes were positive for the year, with the Bloomberg Barclays U.S. Aggregate Index ending up 3.54% and the Bloomberg Barclays U.S. High Yield – Corporate Index up 7.50%. In commodities markets, the price of WTI crude, buoyed by a further tightening of global oil supplies, ended the fourth quarter up nearly 20% to close the year at $60.42 per barrel, a 15% increase from the beginning of the year. Gold fell a bit in October but rallied in November and December to close 2017 up over 12%.
In late December, Congress passed and President Trump signed into law the long-promised and much-anticipated tax reform bill, the biggest overhaul of the U.S. tax code in over 30 years. Key highlights of the legislation include: a reduction in the corporate tax rate from 35% to 21%; a near doubling of the standard deduction from $6,350 to $12,000 for single filers ($12,700 to $24,000 for joint filers); and lower tax rates for most personal income tax brackets. Interestingly, many Americans believe they will not benefit from the tax reform bill, an opinion likely influenced by negative media attention and Republicans’ well-documented struggles to write and pass the legislation. In actuality, nearly everyone — four out of every five taxpayers, according to the nonpartisan Tax Policy Center — should experience a reduction in their taxes. The corporate tax cuts are permanent, but unless future changes are made, the tax cuts for individuals are set to expire in 2025.
At its December meeting, the Federal Reserve raised the Federal Funds' rate for the third time this year, increasing it by 0.25% to a new target of 1.25% to 1.50%. Despite stubbornly low inflation, this increase was widely expected and, as such, caused little reaction in financial markets. Two to three additional rate hikes are forecasted to occur in 2018, dependent upon the continued health of the U.S. economy. In addition to raising rates, the Fed began reducing its $4.5 trillion balance sheet in October — specifically, the Fed stopped reinvesting in maturing mortgage-backed securities and Treasuries totaling approximately $10 billion per month, which will gradually increase until the monthly total reaches $50 billion. As mentioned in our third quarter review, this unwinding is anticipated to be very measured and telegraphed so as not to unduly upset equity markets. However, the Fed is in uncharted territory, as it has never before developed and executed a strategy to exit a prolonged period of quantitative easing and zero interest rates. This could lead to some degree of volatility for risk assets in the coming year, especially coming on the heels of a historically low volatility period like 2017.
In other Fed news, President Trump in November announced his nomination of Jerome Powell to succeed existing Fed chair and architect of the Fed’s current tightening strategy Janet Yellen when her term expires in early 2018. While the change from Yellen to Powell is expected to be a relative non-event, there is a risk that a Powell-led Fed may deviate from the slow pace of policy normalization favored by Yellen, especially if inflationary pressures pick up.
As we look toward 2018, many questions exist. Will markets continue their seemingly unabated upward trajectory? When will volatility tick back up? The market seemingly ignored several major political and geopolitical events in 2017 — what will prove to be the catalyst for market upheaval? Unfortunately, the answers to these questions aren’t often known until after the fact. For 2018, we believe that interest rates and inflation, which were the major drivers of 2017’s “Goldilocks” environment, are the main indicators to pay attention to. If both remain low, Goldilocks could extend her stay in 2018. However, there is also a historical precedent for volatility to soon increase — dating back to 1962, U.S. equity markets have averaged an 18% correction in a mid-term election year (which 2018 will be). In the face of uncertainty, an active manager like GuideStone ® can help investors play multiple positions on the investment field — offense if markets continue to rise and defense if markets reverse course. GuideStone works to identify opportunities and risks in financial markets and is well-positioned to make opportunistic moves within the Funds in anticipation of, or in response to, specific market events or changing market conditions.
Thank you for your confidence in GuideStone. Please feel free to contact us if you have any comments or questions.