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Napa Valley Wealth Management - St. Helena, CA
Market & Economic Commentary | January 2018

Market & Economic Commentary | January 2018

| January 20, 2018
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The last quarter of 2017 delivered excellent results, capping an outstanding year in the markets and in global economies. Strong growth in the U.S. continued as the recovery in Asia and Europe extended. Political risks in the U.S. seemed to ebb in the final days of the year as Congress finally passed a tax bill that the President signed. Attention is now shifting to our new year and the prospects for further growth, interest rate increases, and potential inflation (or recession). Below is our assessment of the main factors affecting the investment markets.

Q4 2017 DRIVING FACTORS           

Oil

Commodities in general remain weak with little return over the past 3-5 years. But, as world economies gain strength, we see demand increasing, which will lead to higher prices. Oil prices began to climb last quarter, topping $60 at year’s end, and continued their ascent by another $3 during the initial weeks of 2018.

Interest Rates

The Federal Reserve Bank met expectations and increased key interest rates by 0.25% during their December meeting. The probability of further rate hikes in 2018 is strong—the Fed has hinted at three more increases this year; however, the futures market has only priced in two. The inflation rate, though muted, is finally cracking the 2% mark, which is close to the Fed target rate. Labor costs remain stable and commodity costs low. Interest rates in the bond markets are climbing very slowly, even with the Fed selling assets to reduce its ballooned balance sheet. All of these factors together suggest that we may be 9-18 months away from rates being a real negative force in our economy.

U.S. Growth           

The new tax bill has boosted the U.S. economy. Tax cuts will likely increase corporate earnings and may bump consumer spending. Full employment and rising interest rates are negatives, but likely only minor factors in the next 9-12 months. It is highly unlikely that a recession will begin during 2018. Recessionary forces take time to build, and few indicators are pointing that direction today.

EFFECTS ON ASSET CLASSES

Equities

Global stock markets pushed higher for the third straight quarter. U.S. stocks set new record-highs as earnings growth remains positive and the tax bill promises tax cuts for many businesses and consumers.

Large-cap fund returns were excellent, with growth up 6.38%1and value 5.79%. Mid-cap stocks were similar, with growth at 5.88% and value gaining an average 5.28%. Small-cap funds gained 5.20% for growth and 3.56% for value. 

Technology and financial stocks outpaced health and utilities. Foreign equity gains were remarkable for the fourth quarter in a row. Strength in emerging markets was notable (except in Latin America), where China moved higher by 7.29% and Europe and Asia performed well in general. Natural resources rebounded again, but REITs lagged with interest-rate fears looming over the real estate market. 

Bonds

The bond markets remain resilient in the face of the Fed moving rates higher. The recent move by the Fed was absorbed reasonably well by the markets during the last quarter of 2017. Here are the returns: Mid-long positions results were mixed, with small losses in mortgage-backed and gains in corporate positions; short-term bonds finished with little return, foreign bonds posted gains in emerging market positions and high yield municipal bonds moved higher by 1.24%. Corporate high-yield continued to rally, with returns of more than 0.50%. Preferred stocks were mixed for the quarter. 

Bonds continue to provide income and stability. The income is consistent and we have not seen the benefit of stability during a declining stock market in quite some time. Volatility in stocks is inevitable, and bond positions will help provide a buffer and direct income when that time comes again.

LOOKING FORWARD

EconomyKey indicators point to further economic expansion. Though numbers may be skewed a bit high by post-hurricane rebuilding, we expect short-term growth to continue.

EquitiesWe are evaluating additional foreign holdings—ones that would give us exposure to opportunities while maintaining our targeted allocation and risk levels. U.S. prices are relatively high, but international stocks—whose total returns since the 2009 bottom are 117% versus the U.S. 272%—have room to grow. As well, the flow of funds may be moving toward internationals, and this will create additional tailwinds for those funds.

BondsThe focus on rising rates continues. We believe the action by the Fed will remain steady and slow as they rein in the stimulus. Banks, growth, and employment are healthy, which further encourages the Fed. We believe higher-yielding bonds will continue to perform well and should be maintained until the economic expansion slows or interest rates rise sharply. Any short-term pullback in stocks will likely increase the demand for bonds and help keep prices up. 

We live in a world focused on short-term results and costs. The tax bill’s economic impact will be felt strongly in the short-term, but the long-term economic gains must justify the long-term cost. The same applies to portfolio returns; however, often the myopic views prevail and drive people to make decisions that may reduce cost, but don't align with risk-and-return expectations for the duration of their plans.

* * *

We publish these insights quarterly for our clients, with further detail on specific asset classes. Our personalized investment management strategy is built around each client’s personal Financial Plan and Investment Policy Statement. We review both as we make changes to each client’s portfolio, working to ensure their investments match their personal risk tolerance, return goals, and tax picture.

We welcome the opportunity to talk about how we might help you plan, build, preserve your wealth.

From left, our Investment Committee members include:

Earl Knecht, CFP®, Portfolio Manager
Kelly Crane, CFP®, CFA, CLU, MBA Chief Investment Officer
Robert Lance, Director of Operations

                                                                        


1 The Federal Reserve raised key interest rates by 0.25% in their December 13, 2017, meeting, as reported on https://www.federalreserve.gov/monetarypolicy/fomcpresconf20171213.htm.

2 All asset-class quarterly data pulled from Barron's Lipper Quarterly Performance Report, dated 1/3/2018.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. 

The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful. 

There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk. 

Investing in Real Estate Investment Trusts (REITs) involves special risks such as potential illiquidity and may not be suitable for all investors. There is no assurance that the investment objectives of this program will be attained. Bonds are subject to market and interest rate risk if sold prior to maturity. 

Bond values will decline as interest rates rise and bonds are subject to availability and change in price. An increase in interest rates may cause the price of bonds and bond mutual funds to decline. 

Stock investing involves risk including loss of principal.

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