Kimberly Good

KCG Investment Advisory Services

PO Box 15416

Savannah, GA 31416

912.224.3069

kimberly@kcginvestmentadvisory.com

Market Commentary and Investment Perspective 4Q2017
Market Update
(all values as of 08.31.2020)

Stock Indices:

Dow Jones 28,430
S&P 500 3,500
Nasdaq 11,775

Bond Sector Yields:

2 Yr Treasury 0.14%
10 Yr Treasury 0.72%
10 Yr Municipal 0.81%
High Yield 5.38%

YTD Market Returns:

Dow Jones -0.38%
S&P 500 8.34%
Nasdaq 31.24%
MSCI-EAFE -6.23%
MSCI-Europe -7.39%
MSCI-Pacific -4.42%
MSCI-Emg Mkt -1.18%
 
US Agg Bond 6.85%
US Corp Bond 6.94%
US Gov’t Bond 8.09%

Commodity Prices:

Gold 1,973
Silver 28.43
Oil (WTI) 42.82

Currencies:

Dollar / Euro 1.19
Dollar / Pound 1.33
Yen / Dollar 105.37
Dollar / Canadian 0.76
 

Macro Overview

The rally in stocks that began following the election in 2016 propelled through 2017 as optimism and expectations that growth oriented policies and tax cuts would materialize. Political turmoil was not a deterrent for the markets, as major U.S. equity indices finished the year at near record levels.

The Tax Cut & Jobs Act was signed into law by the President on December 22nd, setting the stage for new tax codes and rules effective January 1, 2018. Following the passage of the new tax law legislation, small businesses and larger corporations prepare for optimal methods of spending capital and expanding in 2018.

Congress passed a short-term funding plan to avert a government shutdown between December 22nd to January 19th. Since federal funding gaps are common, Congress institutes a continuing resolution or CR to provide interim funds in order to maintain government operations.  Then on Friday, January 19th, Congress failed to pass a CR because of political discord over immigration issues.  While it had minimal effect on the markets, it  quickly became apparent that voters had no appetite for this kind of deadlock and a short-term deal was reached on Monday morning, with the S&P and Nasdaq reaching new highs in response.

Strengthening economic conditions throughout the international markets helped buoy global stocks and mildly boost inflationary pressures, which can be beneficial for certain equities. Economic stimulus efforts by central banks were reigned in during 2017, as developed and emerging market economies exceeded growth expectations.

The Federal Reserve raised rates as expected with the objective of curtailing inflationary pressures. The December rate hike was the third of the year, pushing shorter-term rates higher, which are more sensitive to Fed rate increases. Overall, rates remained fairly stable in 2017, as inflation and economic growth were tepid. The 10-year Treasury yield ended 2017 at 2.40%, down from 2.45% at the beginning of the year.  Just three weeks into 2018, the 10-year yield is at 2.63.

(Sources: Congress.gov, Federal Reserve, IRS, U.S. Treasury)

 

Equity Overview – Global Stock Update

Global markets accelerated throughout 2017, marking new highs and sending broader market indices higher. The election prompted rally in domestic stocks continued on in 2017 as optimism and expectations that growth oriented policies and tax cuts would fuel earnings appreciation.

International markets excelled in 2017 as both developing and emerging stocks were boosted by expanding economies throughout Europe and Asia.

The new tax law imposes a repatriation tax on cash held overseas by U.S. corporations. A tax of 15.5% on liquid assets will affect various sectors and numerous companies that are estimated to have amassed over $2 trillion overseas. The new rate is considerably lower than the previous rate of 35%, incentivizing companies to bring cash back to the U.S.

Of the several sectors encompassing the equity markets, technology and healthcare companies hold the most cash overseas, placing them at the forefront of bringing billions of dollars back to the U.S. at the preferable tax rate. (Sources: Bloomberg, Reuters, www.congress.gov/bill/115th-congress/house-bill/1)

KCG has experienced excellent performance in our choice of International and Emerging Market mutual funds.  As long as they out-perform the MSCI EAFE index, we will continue to hold more mutual funds than indexed ETFs.  In 4Q17, we saw a trend with our International funds to underperform EAFE because their allocations diverge from the index Japan holdings.  The fund managers intend to maintain this posture.  If the index continues to outperform, we expect we will continue to hold both, but rebalance to outperform as needed.

IMF Revises Global Growth Upward – International

Revisions to the initial World Economic Outlook were released in October, revealing stronger than expected estimates for the remainder of 2017 and all of 2018. Growth estimates now are 3.6% for 2017 and 3.7% for 2018, an acceleration from the 3.2% growth that occurred in 2016.

The IMF report states that a global cyclical upswing that began in the middle of 2016 is still intact and gradually gaining momentum. Financial conditions remain buoyant in the U.S. and internationally regardless of any monetary stimulus efforts discontinued by global central banks.

The IMF did attest that the global economy has achieved a level of momentum during a short term that has not occurred for many years. The identified growth is also broad based, more so than any other time over the past decade. Global growth is expected to be the strongest this year since 2014, with the majority of developed economies strengthening. (Source: IMF; World Economic Outlook Report revised October 2017)

 

 

 

Short Term Rates Heading Higher – Bond Market Overview

The Federal Reserve raised a key short-term rate as expected by the markets and made fairly optimistic comments about economic growth projections for 2018. The federal funds rate rose to a target range of 1.25 – 1.50%. The increase is a strategy of tightening and also meant to alleviate inflationary pressures. Concurrently, the Fed is also shrinking its $4.4 trillion balance sheet, a dual monetary policy effect expected to curtail inflation and reduce stimulus. Members of the Federal Reserve indirectly expressed concern about the labor market, suggesting that improvements in the job market were expected to ease. The Fed committee also maintained a conservative growth estimate for 2018 of 1.8%, hinting that the new tax plan may not yet produce economic benefits in 2018. The yield curve flattened throughout 2017, with a rise in short term rates and a drop in longer-term rates. The yield on the 2-year Treasury Note had its largest annual increase in over 10 years, ending the year at 1.89%, up from 1.22% at the beginning of January 2017. The benchmark 10-year Treasury bond yield saw almost no change in 2017, falling to 2.40% at year end from 2.45% in the beginning of January. The current Chair of the Fed, Janet Yellen, is scheduled to chair her last Fed meeting on January 30th & 31st, with Jerome Powell assuming the post in February. (Sources: Federal Reserve, U.S. Treasury, Bloomberg)

The New Tax Bill – Fiscal Policy Review

Both individual taxpayers and companies will see broad changes for deductions and tax rates. The emphasis of the tax bill, known formally as the Tax Cuts & Jobs Act, is to stimulate economic activity via new and higher paying jobs. This is why many of the changes directly benefit large and small businesses in order to encourage hiring.

Some of the tax provisions enacted by the new tax act will be temporary, while others permanent. The cost of reduced tax revenue brought about by tax cuts may only be viable for a certain period, thus producing more immediate benefits from tax cuts rather than later.

Affecting essentially every taxpayer is the increase in the standard deduction, which is meant to simplify the tax preparation process by replacing itemized deductions with a larger standard deduction.

The IRS estimates that about 95% of the businesses in the United States are pass-through entities, such as sole proprietors, S-Corps, LLCs, and partnerships. These entities are called pass-throughs because the profits generated are passed directly through the business to the owners, which are taxed at the owners’ individual income tax rates. The new tax law allows for a 20% deduction of that income, thus reducing overall taxable income. According to the Tax Foundation, pass-through businesses account for over 55% of all private sector employment, representing over 65.5 million workers nationwide. (Sources: IRS, www.congress.gov/bill/115th-congress/house-bill/1)

 

 
The Three Big Things - Looking Ahead

If 2017 was the year of missed opportunities, 2018 may be described as the year when investors finally believe.  Bear markets have never started when profits are accelerating, and yet, in 2017, sophisticated investors and Advisors continued a nine-year practice of building portfolios around the low probability of a recession.  There was a far greater possibility of a bull market, but cash remained on the sidelines,  and “safe” allocation choices often caused significant under-performance.

Since the 2018 new year was rung in, more and more analysts have united in their positive outlook for the year to come.

Having adopted that positive outlook in 4Q 2016, KCG continues to diversify using zero and low correlated assets and hold hedged equity, as well as merger/arbitrage funds.  We have sought to select small allocations to these because they are the most appropriate type of hedge and will continue to allow us, in fact help us to outperform.  During a bull market, these are a source of additional return, tend to stabilize principal and further diversify our portfolios.  When we see that the profit cycle has become negative, we will prepare for a bear market by adding a significant weighting into managed futures and/or increasing our holdings in the basic materials sector to further stabilize principal.  This can cause some under-performance in the short term but is intended to conserve assets in the long run. (Source: “Proven Risk Management Strategies,” Investment & Wealth Monitor)

Profits are accelerating globally.  US profits troughed  globally in 2Q15 and in the US in 4Q16.  Because growth has been muted over the last nine years, many have have lost faith that the business cycle was actually playing out as normal.   In reality, it has simply been made longer because of the slow growth.   We are now 1 1/2 to 2 years into a profit expansion,(Source: Richard Bernstein, LLC) and while we are in the later phases of the cycle, the new tax deal has made it far more likely that this game will have extra innings.

Liquidity is the primary factor affecting the VIX.  Greater liquidity has resulted in a long period of lower down-side volatility as measured by the VIX.  The source of this liquidity lies not only with the Central Bank, which continues to moderate its actions according to the needs of the economy.  There are also enough un-committed Private equity buy-out funds for about 10 years of deals.  Also, board-approved repurchases not yet executed are at a ten-year high.  Corporate balance sheets continue to hold significant levels of cash.  Dry powder. (Source: Richard Bernstein Advisors, LLC; CBOE VIX; Seeking Alpha)

Sentiment is now one of acceptance, but not yet euphoria.  Before the tax package was passed, KCG believed we were in the last few months of the US profit cycle.  Now we seem to be closer to half-way through.

Some warnings are coming from the bond market because the spread between the 2-year and 10-year treasury yields has narrowed.  But narrowing does not equal inverted.  Of 43 global yield curves, only Turkey and Russia have inverted.  In the US, the 10-year treasury yield has increased more than 26 basis points in the last three weeks compared with the 2-year yield up by 16 basis points, narrowing the spread YTD 2018.  Should the yield curve actually invert, it has historically taken 6-12 months for a bear market to develop after an inversion. (Source: Richard Bernstein Advisors, LLC; Bloomberg.com)