March 26, 2018
Adrian Cronje, Ph.D., CFA
Chief Investment Officer, Balentine
Throughout 2017, the world was gripped by pervasive angst resulting from heightened political dysfunction in Washington and increased geopolitical tensions. Nevertheless, global stock markets saw strong, steady gains throughout 2017 and did not endure any correction along the way. In fact, for the first time ever, the S&P 500 was in the black for every month of a calendar year.
The rally was underpinned by synchronized economic growth across the world, setting the stage for strong corporate earnings growth, especially in international markets. Despite the sustained rise in economic activity and continued decline in unemployment, inflation readings remained well contained, allowing the Federal Reserve (Fed) to continue its path of normalizing monetary policy in a deliberate manner—a practice likely to continue under new chairman, Jay Powell. In December, the Fed announced it would begin reducing its bloated balance sheet while raising interest rates for the third time in 2017. The year ended with the 10-Year Treasury yield below 2.5%, a “flatter” overall yield curve, and tighter-than-average corporate spreads (i.e. a barren fixed income landscape offering few opportunities upon which to capitalize). As such, our exposure within fixed income remains as simplistic as possible to benefit from higher reinvestment rates as interest rates continue to gradually drift upward.
Given this backdrop, our emphasis of stocks over bonds was the most significant contributor to the substantial gains Balentine strategies achieved throughout 2017. The decision to emphasize international stocks also added value, with emerging markets leading the way. Within domestic markets, growth outperformed value, sharply reversing what looked like the beginning of a new value bull market that appeared to be developing in late 2016.
Despite the uptick in volatility in early February, our models continue to reaffirm our overweight position to global equities. As our 2018 Capital Markets Forecasts explains in more detail, stocks remain modestly expensive relative to bonds but not to a degree which generates historical concern from our models. Additionally, momentum remains strong, and international, U.S. energy, and U.S. growth stocks should continue to outperform. As 2017 drew to a close, the much-anticipated legislation on tax reform was passed. Large corporate tax cuts have boosted U.S. corporate earnings expectations in 2018, providing further support for valuations. Whether this fiscal policy boost will provide nutrition for sustained higher economic growth without igniting inflation remains to be seen. Business investment and productivity growth, the key elements which have been conspicuously missing from the recovery that began in 2009, will likely answer that question. Otherwise it may end up being “junk food,” leading to a short-term boost which would be quickly choked off as interest rates rise more quickly and significantly.
This calendar year is likely to be bumpier than the last after such a long period of calm. For now, our model discipline implies the party should persist and investors should continue to enjoy the libations before the punch bowl is eventually taken away.