Fourth Quarter 2017 Market & Economic Summary

Fourth Quarter 2017 Market & Economic Summary

The stock market continued its persistent upward march in the fourth quarter as investors anticipated passage of tax legislation which finally occurred on December 22nd. The S&P 500 has not experienced a 3% correction since November of 2016 despite geopolitical tensions, massive natural disasters, political infighting in Washington, and tighter monetary policy. Low market volatility mirrors slow but steady improvement in the world economy amid low inflation. Also, economic indicators are showing a low risk of recession in the near future.

Speculation in bitcoin, the internet currency, reached a fever pitch in the fourth quarter as its price went parabolic. Bitcoin began 2017 at $970 and had reached $4,000 by late August. In October its price reached $6,000 and then it skyrocketed to $19,800 by December 17th. Then the price plummeted to near $11,000 on December 22nd before finishing the year at $14,292.

Bitcoin mania obscured the fact that gold had its best year since 2010. The leading gold fund, the SPDR Gold Shares ETF, gained 12.8% in 2017. Gold’s rise was aided by a dramatic drop in the U.S. dollar. The U.S. Dollar Index fell 9.7% on the year, its steepest drop since 2003.

Domestic Equity Markets

The S&P 500 added 6.12%, the Dow Jones Industrial Average 10.33%, and the Nasdaq Composite 6.27% in the fourth quarter. Those three indices gained 19.42%, 25.08%, and 28.24% respectively during 2017, for the best performance by the U.S. market since 2013. Large-cap stocks outperformed small-cap with about one-fourth of the increase in the S&P 500 coming from the five largest companies by market value: Apple, Alphabet (parent of Google), Amazon, Facebook, and Microsoft.

Energy stocks continued their recovery in the fourth quarter as the price of West Texas Intermediate Crude Oil gained 12% on the year to close at $60.42. Production cuts led by the Organization of Petroleum Exporting Countries (OPEC) have reduced supplies at the same time demand is increasing due to global growth.

International Markets

International stocks added to their yearly gains in the fourth quarter with the MSCI EAFE index of developed international stocks up 3.9% and the MSCI Emerging Market index up 7.09%. Those indices gained 21.78% and 34.35% respectively in 2017. International equities were aided considerably by the falling U.S. dollar. The STOXX Europe 600 index, for example, gained just 7.7% in Euro terms.

All of the world’s 45 largest economies tracked by the Organization for Economic Cooperation and Development (OECD), making up more than 90% of global Gross Domestic Product (GDP), are in growth mode for the first time in a decade.

Bond Markets

The U.S. 10-Year Treasury Note traded between a high of 2.63% in March and a low of 2.04% in September before finishing the year at 2.41%, just below its 2016 close of 2.45%. The 2-Year Note, however, rose sharply all year in response to the Federal Reserve raising interest rates three times, moving from 1.21% to 1.89%. The spread between the 10-Year and the 2-Year has fallen to a narrow 0.52%, and that often signals slowing growth, a result seemingly at odds with the strong economic numbers being posted (see below).

Treasury bond prices could be pressured by increased supply, as economists at Wells Fargo expect new issuance of about $1 trillion per year in 2018 and 2019, about double the amount in 2017. In addition,   tax cuts in the new law could increase that amount.

The Economy

The manufacturing index for December from the Institute for Supply Management came in at 59.7, the second fastest rate of expansion in six years. (Any reading above 50 indicates expansion). In addition, new orders came in at 69.4, the highest reading in more than 13 years, forecasting strong future growth. U.S. GDP growth has been above 3% for two quarters in a row, and hopes are high that GDP growth will average 3% for all of 2018.

One negative for the U.S. economy is that auto sales declined by 1.8% in 2017, the first decline since the financial crisis eight years ago. Auto executives are concerned that the sales decline could continue as pent-up demand for vehicles after the recession may have been met. Rising interest rates and a possible decline in the value of used cars (often used for trade-in) may also hurt.

Conclusion

While economic growth appears to be accelerating, the Federal Reserve is set to raise interest rates three times in the coming year after three increases in 2017. Additional increases could be necessary if inflation heats up. Eventually rising rates could slow down or choke off further growth.

As always, we will closely monitor all developments affecting your investments and keep you advised.