“Years ago my mother used to say to me, she’d say, “In this world Elwood, you must be” – she always called me Elwood – “In this world Elwood, you must be oh so smart, or oh so pleasant.” Well, for years I was smart. I recommend pleasant. You may quote me.” Elwood P. Dowd (James Stewart), from Harvey, by Mary Chase.
With 2017 in the books, we can contemplate the remarkable bull market in U.S. stocks that has now spanned nine consecutive calendar years of positive returns. The only other time the U.S. stock market has recorded nine consecutive years of positive returns was from 1991 to 1999. While similar in some aspects, there are some critical differences between these two bull markets. The most obvious of these is the magnitude of the returns each bull market generated. In the bull market of 1991-99 the S&P 500 returned a cumulative 442.2%. The most recent bull market, while equal in calendar-year length, has been much less generous in terms of total return – the S&P 500 has returned “only” 254.2% cumulatively over this time frame. Valuations were also much richer following the 1991-99 bull market than they are today. On January 1, 2000 the 12-month trailing P/E ratio of the S&P 500 was 29.0 and the Shiller P/E ratio (which uses 10 years of trailing earnings) stood at 43.8. By contrast, on 1/1/2018 the S&P 500’s 12-month trailing P/E was 25.6 and the Shiller P/E was 32.3. While these recent valuations are higher than the historical averages, they are well below the levels seen at the end of the last 9-year bull market.
In contrast to 2016, when U.S. stock markets dominated other asset class returns, a wide range of asset classes enjoyed stellar returns in 2017. Foreign stock markets produced better returns in 2017 than U.S. markets. The S&P 500 was up 21.8% in 2017, but the MSCI-EAFE Index returned 25.0% for the year and emerging markets, as measured by the MSCI-EM Index, performed even better, up 37.3%. The best performing sector in the U.S. was technology, up 38.8% for the year. This helped growth stocks outperform value stocks yet again – the Russell 1000 Growth Index was up 30.2% while the Russell 1000 Value Index returned just 13.6%. While 2017 was a great year for a number of asset classes, Energy stocks and MLPs were notable exceptions. Despite a fourth quarter rally that saw energy stocks gain 6.0%, the sector still returned -1.0% for the year. MLPs did not enjoy a fourth quarter rally and returned -6.5% for the year as measured by the Alerian Index.
Fixed Income markets enjoyed positive returns in 2017. Despite the turmoil caused by the fiscal crisis in Puerto Rico, the Barclays 5-Year Municipal Bond Index was up 3.1% for the year. The positive return was due, at least partially, to the fact that demand for municipal bonds continued to exceed the new supply coming to market. Municipal bond investors also received some good news with the passing of the Tax Cuts and Jobs Act in December. Municipal bonds emerged unscathed in the new tax regime with no changes to the tax exemption itself and the full exemption remaining available to everyone without limits. Going forward bond investors will have to deal with a yield curve that is becoming increasing flat. The 2-Year US Treasury began the year at 1.19% and rose to 1.88% by year end as the Federal Reserve continued to hike short term interest rates. The yield on the 10-Year Treasury, however, actually fell slightly, from 2.44% to 2.41% by year’s end. The decline in yield of the 30-Year Treasury was even greater, from 3.07% at the beginning of 2017 to 2.74% by year’s end.
Moving forward from a year such as 2017, which provided investors with strong returns across a broad range of asset classes with minimal volatility, presents some unique challenges for investors. Assuming the recent “Goldilocks” environment will continue indefinitely is probably not smart. Likewise, assuming an immediate reversal in trends is probably similarly ill-advised. But “smart” hasn’t been much in vogue lately. While we wait patiently for “smart” to come back in vogue, we’re working hard on “pleasant.”