2017 in Review and a Look Ahead

What might investors expect in 2018 after surging equity prices, low volatility, and a relatively flat 10-year Treasury yield in 2017?

January 03, 2018

2017 was an active year. Equity markets reached new highs, while volatility and the 10-year U.S. Treasury yield were largely unaffected by the Federal Reserve’s three rate hikes and onset of mortgage backed security reinvestment tapering, heated political rhetoric, nuclear threats, and a wave of natural disasters. Bond spreads tightened in 2017, especially in non-government sectors such as corporate, structured product, and emerging market debt. Oil prices continued their roller-coaster ride, but all in all, crude oil ended the year up 12%.1

In the U.S., the Trump administration struggled to push through health care reform earlier in the year, but passed the 2017 Tax Cuts and Jobs Act just before the year closed out. Globally, populism remained at the forefront. Brexit negotiations moved along as expected and other countries seem to be following suit.

A look back on 2017

Equities rallied

The U.S. equity bull market celebrated its eight-year milestone and climbed a respectable 22% in 2017, but the real showstopper was emerging market equities, which rallied 37% and helped global equities (+24%) outperform U.S. equities for the first time in six years.

Market volatility remained low

Volatility remained low, with the VIX averaging 11.1x in 2017, well below its historical average of 19.4x (since inception in 1990), as it was relatively unfazed by global political instability, muted growth, uncertainty around the execution of the U.S. administration’s pro-growth agenda, and worries about enriched valuations.

10-year Treasury was range bound

The 10-year U.S. Treasury yield started the year at 2.44% and ended it at 2.41%, after peaking at 2.63% in mid-March and bottoming at 2.04% in early September. Treasuries remained fairly unmoved by the year’s events and the Fed’s drawn-out rate hike process, which ultimately resulted in three hikes in 2017.

Oil prices had another wild ride

Crude oil prices traded in both bear and bull market territories during the year, trading down 21% through June 21 before rallying 43% through year-end on the back of higher global demand, a reduced supply glut, and an OPEC production-cut deal extension through the end of 2018.


Source: Morningstar Direct, Bloomberg as of 12/31/17. U.S. equities represented by S&P 500 Index, emerging market equities represented by MSCI Emerging Markets Index, global equities represented by MSCI All Country World Index, volatility represented by VIX, and oil prices represented by WTI crude oil.

A look ahead: 2018 key themes

Global growth abounds, and a stable economic backdrop presents continued opportunities in the markets, with the next recession likely several years away. Uncertainty, however, remains, as the current U.S. administration strives to deliver on its pro-growth agenda, changes at the Fed and fiscal policy continue to unfold, and stocks continue to rise coming closer to matching the longest bull market on record. At the same time, emerging markets continue to represent the primary driver of growth over the next decade.
 

  1. Global growth firing on all cylinders

    Global growth is expected to continue at a solid pace through the next year or so, with inflation rebounding slowly. Although the current expansion has been slower than those in the past, it may prove to be quite durable. Despite tightening labor markets, high debt levels, and worldwide political risks, the prospects for continued global economic growth appear optimistic.
     

  2. Cross-currents continue for bonds

    The Fed’s dot plot remains on target, showing three rate hikes in 2018 and two more in 2019, and despite Janet Yellen’s upcoming exit, the Fed’s stance is unlikely to change significantly under Jerome Powell’s leadership. Most analysts expect the ongoing expansion to result in inflationary pressures and, ultimately, higher short- and long-term interest rates as central banks reduce policy accommodation.
     

  3. Equity bull market (r)ages on

    The current equity bull market has been growing at a rapid pace with a cumulative price return of 291% as of the end of 2017.2 While this trajectory has raised concerns about a looming pullback, several measures support a continued rally (albeit with bumps in the road). Equity market volatility is near record lows and well below historical averages. At the same time, a stable economy combined with strong corporate earnings should help keep this bull from fading into old age.
     

  4. Growing opportunities in emerging markets

    Emerging markets (EMs) are expected to be the primary driver of global growth over the next decade, but a shift in the forces shaping EMs is under way. As EMs continue to be buoyed by youthful populations and a rising middle class, consumption patterns will transition from “needs-based” spending to more “wants-based” spending, driving opportunity in the technology, consumer, and health care sectors. On the bond side, EM debt looks increasingly attractive as economic reforms have helped to bring down risks, making countries fundamentally less vulnerable.
     


1 Source: Bloomberg as of 12/31/17.

2 Source: Morningstar Direct. S&P 500 Index from 3/9/2009 to 12/31/17.

The Federal Reserve Dot Plot is a chart that shows interest rate projections with each dot representing where a Fed official expects the fed funds rate to be over time. The MSCI All Country World Index is a market capitalization-weighted index designed to provide a broad measure of equity market performance throughout the world. The MSCI Emerging Markets Index is a float-adjusted market capitalization index that consists of indices in 23 emerging economies and is designed to measure equity market performance in global emerging markets. The S&P 500 Index is a market-weighted index of 500 of the largest U.S. stocks in a variety of industry sectors. The VIX is a measure of the implied volatility of S&P 500 Index options. Often referred to as a fear gauge, it represents one measure of the market’s expectation of stock market volatility over the next 30-day period. West Texas Intermediate (WTI) crude oil, also known as Texas light sweet, is a grade of crude oil used as a benchmark in oil pricing. An investment cannot be made directly in an index. Past performance is no guarantee of future results.

Certain information in this commentary has been obtained from sources believed to be reliable as of the date presented; however, we cannot guarantee the accuracy of such information, assure its completeness, or warrant such information will not be changed. The information contained herein is current as of the date of issuance (or such earlier date as referenced herein) and is subject to change without notice.

Any projections or forecasts presented herein are subject to change without notice. Actual data will vary and may not be reflected here. Projections and forecasts are subject to high levels of uncertainty. Accordingly, any projections or forecasts should be viewed as merely representative of a broad range of possible outcomes. Projections or forecasts are estimated, based on assumptions, subject to significant revision, and may change materially as economic and market conditions change.

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