Higher
Vol in 2018
2017 was a memorable year for the stock market and certainly
a significant (positive) outlier in terms of returns. The total return for the
S&P500 in 2017 was 22%, which is way above the 100-year average annual return
for large-cap stocks of about 9%. We believe it is unlikely 2017’s level of return
will be repeated in 2018.
We think the risk for increased market volatility (and some sort
of stock market correction) in 2018 has risen for a couple of reasons: 1) the
current ebullient level of investor sentiment and 2) what appears to be a
developing seachange in the interest rate regime. Over the past few trading
sessions the market has experienced a very modest (1.8%) pullback due largely
to the recent backup in bond yields. The concern is that as a result of the
stimulative impact of the recently-passed tax bill and the potential for
acceleration in economic growth, the Federal Reserve may now have to be more
aggressive in raising interest rates this year. It could happen. That said, the
underlying fundamentals for U.S. stocks actually remain quite positive. Corporate
profits and cash flows appear poised for another year of strong growth and
there should be follow-on benefits from the tax bill in 2019 in the form of rising
capital spending which is highly stimulative.
As a result of all this, we expect earnings estimates will
continue to be revised upwards this year. Valuation, which appears a bit
stretched based on trailing earnings (21x), is not particularly high when
considering higher forward earnings estimates for 2018 and 2019. And with
respect to changes in interest rate regimes, history has shown that stocks can
and do rise in the early stages of a rising interest rate environment as long
as corporate profits remain healthy and inflation remains moderate. We expect
both these conditions to continue in 2018 and 2019.
So what does this have to do with financial planning? A few
things……We manage the majority of investible assets for most of our clients in
conjunction with their financial plans. As fiduciaries, we have a
responsibility to conduct research and make sound investment decisions for
their benefit. An important part of this responsibility is managing investment
risk which we do in a number of ways: diversified asset class holdings, a
disciplined investment model, and due diligence in the form of both research
and our quarterly investment strategy meetings. At some point, there will be
another correction the timing and magnitude of which no one can predict. Our
investment strategy and active risk management are ways of preparing for and
mitigating the effect of a market correction. The point is rather than try to
“time” a correction, which is virtually impossible, we stay true to a
time-tested investment discipline which we believe will deliver more stable
long-term returns with less downside risk in times of market turbulence.
Robert E. Toomey, CFA/CFP
Vice President, Research January 31, 2018
