Q4 2017: Peak Market Commentary
The holiday season is a wonderful time of year to take stock of all the good things life offers and to appreciate those around us through the spirit of giving. The period also provides opportunities to suspend our rationality in order to fully embrace the magic and miracles characterized by this special time. For proof as to this season’s enchantment, December’s end marks a true stock market miracle. For the first time since records have been kept (over ninety years), the S&P 500 has risen every month of this past year and has yielded a positive return now for fourteen consecutive months.
To even a casual observer, this feat is truly impressive. What the U.S. stock market has done for over a year now puts it in rarified air and may not occur again for another ninety years. Considering the nearly unanimous dire stock market predictions leading up to and immediately following the Presidential election, writing about the longest continuous stock market rally in history is truly miraculous. However, the stock market streak is not the only impressive accomplishment of 2017. As written regularly in these pages, the stock market this year set records for low volatility not seen since the early 1960s. That trend continued right through the fourth quarter. Put another way, stock markets all over the world rose spectacularly without any hint of true consolidation or a correction in prices.
Clearly, investors’ optimism for meaningful tax reform and a loosening of business regulations seemed to be the major catalyst for the persistent stock market rally. Now that the nation’s first major tax reform law since 1986 is in the books, passed solely by Republicans, there appears to be bipartisan support for crafting major infrastructure legislation. Unlike the tax bill, lawmakers (especially those facing difficult midterm election campaigns) will be eager “bring home the bacon” for their respective constituencies. With deficit hawks few and far between in Washington, we anticipate smoother passage than the tax bill. While we expect more volatility next year than in 2017 (that’s hardly going out on a limb), passage of a large scale infrastructure bill could potentially provide solid footing for the U.S. economy in 2018.
From an economic point of view, the lack of fiscal support greatly contributed to the largely sluggish growth since 2009. Following the Great Recession, the Federal Reserve slashed interest rates and embarked on the greatest monetary stimulus experiment in modern human history to revive a failing global economy. Over the last decade, Federal Reserve members openly expressed that lawmakers must complement these monetary measures with fiscal reform in order to stimulate more robust economic growth. After years of gridlock, many Federal Reserve governors openly aired their frustration at Washington’s inability to meaningfully contribute to the economic equation. Now, as the Federal Reserve is starting to raise rates, the baton of economic growth is being passed to government leaders. Let’s hope they don’t drop it.
Before turning our attention to next year, let us take a moment to recap investment performance in 2017. At Peak, we take advantage of nearly every opportunity to espouse the major pillars of our firm’s investment approach: diversification and cyclicality. While markets often do behave irrationally in the short term, over the long term, these time tested principles have always proven themselves true.
Fortunately, 2017 provided plenty of support for our philosophy. After several years of material underperformance, developing international markets generated robust returns in 2017. As well, concentrated international sectors such as emerging markets and international small cap stocks surged. Even broad based and lower volatility international markets performed admirably, lending credence to our contention that it is essential to have exposure to non-U.S. markets in a truly diversified portfolio.
Peak’s domestic equity exposure continued to benefit from its strategy of pairing specific sector investments with outsized general equity exposure. For example, the firm has maintained overweight positions in the technology and healthcare sectors, which turned out to be among the S&P 500’s top performing sectors in 2017. Late in Q3 2017, Peak sold its direct holding in technology on valuation concerns and potential changes in economic conditions. The proceeds were distributed equally between the materials sector and a broad basket of commodities, which, with both asset classes providing solid returns through the end of the year.
Elsewhere in the Peak portfolio, many of the strategic diversifying investments also generated solid performance in 2017. For example, within our fixed income holdings, we emphasized longer dated U.S. investment grade bonds and international high yield bonds, areas of the bond market that produced double digit annualized returns. Within the bond space, mortgage REITs performed even better.
While many of Peak’s holdings enjoyed solid gains in 2017, not everything went according to plan. For example, positions in real estate and master limited partnerships (i.e. energy pipelines) did not participate in the yearlong rally in domestic equities or the strong rebound in the price of crude oil. As sectors that borrow significant amounts to maintain their operations while simultaneously paying a high dividend rate, concerns over rising interest rates justifiably weighed heavily on investors. As a result, Peak’s holding in real estate lagged the broader market for the year while its investment in pipelines fell also turned in a disappointing 2017. However, returning to the point made above about cyclicality, we contend that after several years of underperformance, these sector may be poised to surprise investors in 2018.
Looking forward to 2018, lower returns with higher volatility seem a given following 2017. While far from a “hot take”, we are instead focused primarily on potential causes for disruption to the relative calm experienced in 2017. It is over ten years since inflation has been cause for investor concern. The Great Recession and the unprecedented monetary easing that followed spawned an era of low interest rates and disinflation, intended to foster a recovery in asset prices. Now, stock markets are booming globally and prices of many other assets, such as high end real estate, have eclipsed their pre-recession highs. However, the world economy is not sufficiently strong enough for Central Bankers to raise rates or withdraw stimulus at the necessary pace to keep a lid on these runaway prices. Add the fiscal stimulus from tax reform and a potential infrastructure bill, and inflation could very quickly become an issue indeed.
Over the last several months, Peak has actively prepared for this possibility by gradually reducing exposure to highly valued and inflation sensitive assets. In their place, portfolios now hold assets with returns that have a positive correlation to rising inflation. Examples include commodities, inflation linked bonds, precious metals, real estate, and materials stocks. While this scenario may take time to unfold, we feel strongly that a turn in inflation expectations is at hand and that many investors will be caught flatfooted.
Overall, we are pleased to have participated in this robust year for the investment markets and that Peak’s globally diversified approach proved its mettle. So, from everyone here at Peak, we thank you for the continued faith and trust that you put in us each and every day to invest and protect your hard earned wealth. And as always, should you have any questions, whether pertaining to this market commentary or your own personal finances, please do not hesitate to reach out.
We wish you a prosperous 2018 and very much look forward to working with you this year and beyond.
This presentation is not an offer or a solicitation to buy or sell securities. The information contained in this presentation has been compiled from third party sources and is believed to be reliable; however, its accuracy is not guaranteed and should not be relied upon in any way, whatsoever. This presentation may not be construed as investment advice and does not give investment recommendations. Any opinion included in this report constitutes the judgment of Peak Financial Management, Inc. (Peak) as of the date of this report, and are subject to change without notice.
Information for periods greater than one year is annualized. Performance is net of
Additional information, including management fees and expenses, is provided on Peak’s Form ADV Part 2. As with any investment strategy, there is potential for profit as well as the possibility of loss. Peak does not guarantee any minimum level of investment performance or the success of any portfolio or investment strategy. All investments involve risk (the amount of which may vary significantly) and investment recommendations will not always be profitable. The underlying holdings of any presented portfolio are not federally or FDIC-insured and are not deposits or obligations of, or guaranteed by, any financial institution. Past performance is not a guarantee of future results.