As we roll into 2018, it’s a good time to take stock of the previous year. In this note, we recap the results of our CycleWise Investment Models, and look ahead to what 2018 might have instore for investors.
A Look at 2017
2017 was a good year for investors as equity markets made solid double-digit gains and interest rates stayed relatively stable. Investor optimism has increased substantially since early 2016 when most of the business media was talking about the US falling into a Recession. In fact, during 2017 the largest decline for the S&P 500 was just 3%. Compare that to the average intra-year decline of 13.8% and you can say that investors had it easy last year.
While many politicians and talking heads in the media point to various factors that drove the results of the stock market, we take a far simpler approach. Our Business Cycle Indicator continues to point to a continued expansion in the US Economy, as it’s been in since 2009. In years when our indicator points to expansion, the S&P 500 rises roughly 15%. Given that 2015 and 2016 saw weaker results, 0% and 10% respectfully, the roughly 20% return on the S&P during 2017 was simply the market catching up to the average gains that occur during an expansion.
The recent tax cut that was signed into law will likely do more for shareholders than it will for the real economy. The bill is designed to lower the corporate tax rate encouraging companies to invest in their businesses through increased wages and capital expenditures (i.e. – expand their business). The problem is that many companies have more money than they know what to do with. As the chart below shows, more money is spent on dividends and share buyback than is spent on expanding businesses. Adding more money to the corporate coffers is unlikely to change corporate behavior. This should be a positive for equity investors as corporate leadership directs more of the tax savings to investors in the form of dividends and stock buybacks.
CycleWise Investment Model Results
Our investment models all performed slightly better than their long-term averages with our Aggressive model leading the way with a 15.99% return (net of fees). For a full break-down of each model, refer to our CycleWise Portfolios Page.
A Look Ahead
The Good
Business Cycle Indicator continues to point to expansion. As such, equity markets should continue to march higher in 2018. The equity market typically sees low double-digit returns during an expansion. However, investors should be prepared for more ups and downs going forward. As discussed above, the average intra-year correction is 13.8% and investors should be prepared. Not because they’ll need to take action, but to set their expectations so they don’t take the wrong action if/when a correction occurs.
While our research continues to point to a continued expansion, some components of our research are beginning to show signs that the end of this cycle is getting closer. While this is not a concern yet, it is worth noting. Keep in mind, our Business Cycle Indicator historically leads recessions by over a year.
The Not So Good
By most measures, the stock market is anything but cheap. This increases the likelihood that the next recession will bring outsized loses for equity investors (remember the Dot.com Buble?). As a result, we’re watching our Business Cycle Indicator closely for signs that the next recession is on the horizon.
The Federal Reserve has signaled that they plan to raise interest rates four times in 2018. If this occurs, it will likely lead to the end of this business cycle. Keep in mind, the Federal Reserve has raised interest rates aggressively prior to the end of every business cycle. They raised interest rates in the late 1990’s to slow investor speculation in Internet stocks. During the early 2000’s they raised interest rates to slow the housing bubble. In both instances, they triggered recessions. Following the Fed is about as exciting as watching paint dry, but their importance can’t be over-stated.
Interest rates remain stubbornly low and continue to put pressure on savers. It’s hard to believe, but 30 years ago you could earn 10%+ in treasury bonds. Today, you can’t earn 3%. This era of low interest rates has pushed many savers into other investments that carry increased risks. Those risks have been rewarded handsomely over the last several years. However, when the next downturn comes, those same investments that rewarded investors will come back to bite them.