2017 and 2018: recap and outlook

The story of the year was really how little global markets reacted to key events.

Tuesday, December 19th 2017, 2:13PM

by Pathfinder Asset Management

The U.S inaugurated a new President, North Korea flexed its nuclear capabilities, hurricanes tore through the Caribbean, Brexit tensions soared and, after nine years of National, New Zealand changed its government.

Markets generally shrugged off all the world threw at them, performing well across the board. The only standout decline was the Kiwi dollar, following the announcement that NZ First would put Labour and the Greens into power. The NZD traded at 73.3 cents to the US$ on the Friday before the election, and in the week following Winston Peters’ announcement, the dollar was trading below 68.5 cents.

A quick look at global markets for the year to 14 December shows handsome returns in NZD terms:

MSCI World Index up 18.2%
S&P 500 up 18.0%
STOXX 600 European Index up 19.3%
MSCI ESG Leaders up 20.2%
NZX50 (gross) up 21.0%

A healthy year for developed markets equities. The S&P 500 is heading for its ninth straight year of gains. In fact, the S&P 500 has risen in 14 of the last 15 years! Incredible.

Below are some of the key events that markets had to deal with through 2017:

January and February

The first major story of the year was the inauguration of America’s 45th President, Donald Trump. This was quickly followed by the newly minted President signing an executive order barring seven, majority Muslim countries from entering the U.S. The S&P 500 slipped slightly after both events, but soon brushed off the news and pushed higher.

March and April

The next big stories stem from Europe, when Theresa May triggered Article 50 (or its divorce papers with the EU in layman’s terms) at the end of March. Sterling was trounced while the FTSE 100 took a smaller fall. What really set the market off was the calling of a snap election (April 18), three years early. Prime Minster May hoped to strengthen her hand in the forthcoming Brexit negotiations… let’s chalk this up as a slight miscalculation on her part. Election day (in June) ended with a hung parliament and the Tory’s losing net 13 seats. After an initial bump up the FTSE sold off more than 200 points - although recovering above pre-election levels within a couple of months.

May

Continuing a year of surprise election results, the French elected a new President, the pro-EU ex-investment banker, Emmanuel Macron. At 39, he is the youngest President in France’s history. He has pledged to restructure the French economy – 2018 will tell us if he is up to the challenge.

June and July

Qatar was hit with sanctions from Saudi Arabia and several other countries abruptly cutting diplomatic relations – given 10 days to meet 13 demands. Among the accusations was the state sponsorship of terrorism. Qatar broke into chaos with supermarkets being stripped of food (80% of Qatar’s food requirements come from Gulf neighbours). Equity indexes globally have a habit of selling off on instability in the Middle East. However, the MSCI Qatar index was flat on the news, and actually increased in the following month (however, this was short lived with Qatar being one of the poor performers this year, down 18.2% in NZD terms).

August

Back to the Americas, where the 2017 Atlantic hurricane season proved to be one of the worst on record. It began with Hurricane Harvey devastating downtown Houston, in what was the costliest hurricane on record, with an estimated US$200 billion in damages. The second major hurricane (Irma) devastated the Caribbean and countries like Puerto Rico. The storm claimed 134 lives and was unofficially the second-costliest Caribbean hurricane on record. Markets, for the most part, took the devastation in their stride. Although August was one of the more volatile months for the S&P 500, it still closed the month higher than it began.

September

Lock and load, we are off to Asia, where North Korea fired a second intercontinental ballistic missile over Japan – one of 16 launches in 2017. This caused outrage by the international community and prompted the (in)famous “little rocket man” Trump tweet referring to North Korea’s dictator Kim Jong-Un.

October

Back in the U.S., and October 1 marked the tragic mass shooting at a country music concert in Las Vegas, killing 58 people and injuring 489 more. In previous years, these sickening mass killings had hit the S&P 500, but the world and markets seem to have become numb to the events. Sadly, they happen far too often.

November

We should probably mention Bitcoin at some point. In November, it shot up to US$9,683 (up about 50% in the month) and the price frenzy continued into December; it is now double November’s close. If you are feeling the urge to jump on board, just be aware of behavioural biases to price momentum (don’t extrapolate it will continue upwards forever…)!

December

Finishing the year, Janet Yellen delivered her final speech as Governor of the Federal Reserve, before Jerome Powell takes up the position in the new year. Janet Yellen and the board voted 7-2 for increasing the Fed rate by another 25 basis points. Markets had anticipated this, with the move already priced in. As Powell steps up in the US, Adrian Orr has been appointed as the next Governor of New Zealand’s Reserve Bank.

Key themes for 2017

A few key thoughts really stuck out for us in 2017:

Low volatility for equity markets was a theme throughout the year - the VIX Index twice reached new record lows. It currently sits at 10.5 - its record low of 8.5 came late November. That is significantly below the all-time high during March 2009 of 44.
Market strength: So why has the market been so reluctant to sell off? There are a few reasons: first, the U.S. tax cut plans have kept markets enthusiastic. President Trump has tweeted the word “tax” 60 times this year (with a heavy weighting to the last three months). Companies will massively benefit from the corporate tax rate decreasing from 39.1% (highest in the OECD) to near 20% (19th in the OECD). There’s a lot of horse trading ahead to get the tax plan through. Another factor explaining market strength is the unprecedented flow of capital to passive strategies, which look to just buy the broader market, indiscriminately driving prices up.
No surprises: While voters certainly delivered surprise results in elections, regulators did not ruffle feathers with monetary policy. Low rates and QE continued for major economies, and any changes (like the rate rise in the US) were well signalled.

And looking ahead to 2018? Time to start polishing the crystal ball….! Frankly no one knows how 2018 will shape up. Here are three very different possible scenarios from blogger and portfolio manager Ben Carlson (www.awealthofcommonsense.com):

Stocks could continue to march higher, even in the face of high valuations. Rates could stay low for a prolonged period and the economic recovery could continue to slowly grind away without getting too hot or too cold for a few more years; or
Stocks could get crushed. Inflation could rear its ugly head driving bond yields higher. Corporate profit margins could get destroyed in this scenario; or
Maybe something else happens like stocks going nowhere for a while. Maybe the U.S. takes a breather and allows foreign markets to finally have their day in the sun. Maybe commodities or some other beaten-down asset class takes a turn at the head of the class.

Despite how different they are, any of these scenarios could happen. None is outrageous. Carlson’s advice is “think in terms of a huge distribution of outcomes and approach the markets with an understanding that no one has it all figured out.” Given the uncertainty, we remain reasonably defensive in Pathfinder’s global equity funds. All the best for investing in 2018.

By Karl Geal-Otter and John Berry from Pathfinder Asset Management Limited. This commentary is not personalised investment advice - seek investment advice from an Authorised Financial Adviser before making investment decisions.

Pathfinder is an independent boutique fund manager based in Auckland. We value transparency, social responsibility and aligning interests with our investors. We are also advocates of reducing the complexity of investment products for NZ investors. www.pfam.co.nz

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