2017 Q4 Quarterly Update

By now we expect that you are aware that both the domestic and foreign equity markets enjoyed impressive results last year. The S&P 500 gained 21.8% for the12-month period and the Russell 2000 index of smaller U.S. companies was up 14.6%. In foreign markets, the MSCI Europe Index returned 25.6% for the year, aided by a decline in the dollar, and the MSCI Pacific Index was up 24.9% under similar conditions. Small stocks in the developed markets roared ahead with a 33.9% twelve-month gain and the winner among the equity indices was the combined emerging markets with the MSCI Index coming in at 37.7%.

Perhaps even more impressive than last year’s performance is the extent of the bull market in U.S. stocks that has occurred since the market bottomed out at the end of the Great Financial Crisis in March of 2009. The S&P 500 Price Index (excluding dividends) has increased a staggering 295% during that nine year interval, as indicated in the above chart[i]. For investors who have been lulled into a state of complacency by this long period of stock market prosperity the graphic illustrates the market’s steep ascents, and descents, that have occurred since 1997.

Continuing with our brief survey of asset returns, the yield on the benchmark 10-Year Treasury barely changed in 2017, having begun and ended the year at roughly 2.4%. However, short-term rates trended upward as the Federal Reserve increased the Fed Funds Rate several times over the course of the year. U.S. Inflation ended the year at 2.2%. The 12-monh total return on the Bloomberg Barclays U.S. Aggregate Bond Index was 3.5%.

Given the paltry yields and modest total returns, at least when compared with the stellar results from equities in recent years, investors might wonder “why is it advisable to hold bonds in my portfolio”? Academics would argue that the role of bonds in a portfolio has more to do with their ability to dampen the risk of the portfolio’s equity component and less to do with their ability to generate returns net of taxes and inflation.

Just how this assertion plays out is demonstrated by the graphic[ii] above that shows the performance of the S&P 500 and two balanced portfolios from the market peak in October 2007 through the end of last year, again taking into account the market drop that resulted from the Financial Crisis. Note that it took a $100,000 investment in the   S&P 500 four and a half years to recover from the $50,000 loss incurred in ’08 and early ’09. A portfolio invested 60% in the S&P 500 and 40% in the Aggregate Bond Index recovered in just three years and the 40% stock and 60% bond portfolio returned to its previous value in just 21 months. More telling still is just how long it took for the S&P 500 to then overtake the two balanced portfolios (almost eight years).

So if you are wondering about the future direction of the index line on graph 1, it may be reassuring to know just how useful your bond positions can be in helping a portfolio recover from even the most egregious of market downturns. If you are also wondering if your ratio of stocks to bonds is appropriate relative to your evolving circumstances and objectives let us know. Our firm specializes in addressing that particular question.

[i] Source Graph 1: Standard & Poor’s.

[ii] Source Graph 2: Barclays, FactSet, Standard & Poor’s and J.P. Morgan Asset Management.

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