A banner year for investments in 2017
U.S. financial markets finished 2017 with their strongest year since 2013 and for the first time since 2012 international stocks did even better. For the year, the Nasdaq index claimed the top spot with an impressive gain of 28.2% followed closely by the Dow, which was up 28.1%. The S&P 500 gained 21.8%.
This positive performance was driven largely by improving earnings growth. According to FactSet, as of year-end, the estimated fourth-quarter earnings growth for the S&P 500 was 10.9%, with all 11 sectors projected to grow from third-quarter levels. If we get this level of growth—and analysts have made much smaller downward revisions than usual—it would mark the highest level of annual earnings growth for the S&P 500 since 2011. As fundamental performance ultimately drives long-term returns, this would be a boon for investors.
International markets also had a successful year. The MSCI EAFE Index, which tracks developed markets, gained 25% for the year. The more volatile MSCI Emerging Markets Index returned an impressive 37.7% for the year.
Fixed income had a more volatile year than equities, as early outperformance was offset by rising rates. The Federal Reserve (Fed) increased the federal funds rate three times in 2017. Although these rate hikes are indicative of the Fed’s confidence in the ongoing economic expansion, rising rates can hit fixed income markets—and that is exactly what we saw. Markets currently anticipate two to three rate hikes in 2018, which could have similar effects. Despite the rate hikes, the Bloomberg Barclays Aggregate Bond Index gained 3.5% in 2017.
Consumers drive economic growth
The economic news in December was good pretty much across the board, but the best news came from the ever-important consumer. Shoppers helped the year end with a bang, as high confidence translated into much better-than-expected spending heading into the holiday season. Retail sales, which had lagged confidence all year, surprised to the upside. On an annualized basis, retail spending growth now sits at 5.8%, the highest level since 2012. This recovery in spending has been a long time coming, and seeing it is a positive sign.
Another positive sign is continued high levels of consumer confidence, which could spark further spending gains. The Conference Board’s consumer comfort survey hit a 17-year high in November. Although confidence pulled back a bit in December, it remains at very high levels historically.
Strong job growth also supports confidence and spending. In December, 148,000 jobs were added which was below the 2017 average but above the level needed to keep up with population growth. The unemployment rate remained unchanged at 4.1%, and the average hours worked per week increased, indicating strong demand for labor. Wage growth was up 2.5% as compared with last December. The tight labor market and healthy growth of the economy indicate that this may be an area where we see faster growth in 2018.
Finally, the strength of the housing market points to healthy consumer sentiment. Homebuilder confidence increased again in December to levels last seen in 1999. This increased confidence translated into more housing starts, which now sit at the second-highest annualized growth level since 2008. Homebuilder confidence has been driven, and matched, by buyers. Both existing and new home sales beat expectations last month, with existing sales growing 5.6% and new home sales rocketing up 17.5%. Some of this growth is still likely due to the effects of the hurricanes in the third quarter, but the overall strength of the housing market should not be dismissed.
Businesses also confident—and spending
Sentiment remained strong for businesses last month, as industry surveys remained in healthy expansionary territory across the board. Supported by this confidence, business investment spending also registered solid growth.
Business output was also solid in November. Both industrial production and manufacturing output grew by a steady 0.2%. Although this headline figure may not jump off the page, it comes on top of a very strong gain in October following a rebound from the hurricanes.
Persistent political risk looms over markets
As was the case for much of 2017, the major source of risk to the markets remains political. International risks include the ongoing Brexit process, as the United Kingdom and the European Union negotiations continue, as well as the continuing attempts to form a German government. In Asia, North Korea remains a major risk factor, with war a very possible outcome.
Here in the U.S., the passage of tax reform removes one source of risk, but we still face a new deadline to avoid a government shutdown in the middle of January. With both parties locked into confrontational modes, and with significant policy differences at stake, political risk remains substantial—and could rock markets. The markets largely ignored politics in 2017, but we can’t assume we will be that lucky in 2018. The biggest risk here is that politics might damage the confidence that is driving growth.
2018 starts with lots of momentum
With high confidence, continued job growth, and likely increase in wage growth, consumers enter 2018 in good shape. Similarly, with high confidence, increasing spending, and improving economic fundamentals, the business sector looks likely to keep growing. Combine all that with reduced regulation and the possible positive impact of tax reform, and we could see even faster growth in 2018. At a minimum, we certainly enter the year with a great deal of momentum.
Although politics will likely continue to dominate the news cycle, strong fundamentals should keep driving the economy and markets forward. More volatility is quite likely, though, possibly at worrying levels. The calm of 2017 is unlikely to last through 2018, and we need to remember that markets can go down as well as up. As always, a well-diversified portfolio that matches investor goals and time horizons and takes advantage of long-term growth opportunities remains the best path forward.
All information according to Bloomberg, unless stated otherwise.
Presented by Alexandra Armstrong, CFP®