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Investment Newsletter - Q1 2018

2017 was a year for the stock market that was historic in many respects, and defied expectations of almost everyone. As we have stated before, and it remains true, we should just learn to expect the unexpected.... 

In this issue of our Investment Newsletter:
  • An overview of recent market activity and expectations of 2018 along with Our Perspective...as well as links to 2018 stock market outlooks from three different financial firms
  • A recap of the performance of major market indices from the past quarter and for the year. 
  • Financial resolutions for the new year
  • Upcoming Economic Calendar

You will find past investment articles , and recent stock market commentary and outlook , by clicking on the relevant Quick Links on the right , or peruse past investment topics by clicking the  Articles tab above or directly on our website. 

If there is a topic of interest you would like to see covered in the future, please reply back to this email to let us know, or click here . Likewise, i f you have any questions on this or anything else, feel free to reply back.
Investment Topic:
Using Managed Futures to Lower Volatility
 
For our investment topic, " Using Managed Futures to Lower Volatility", we attempt to give a high-level overview of the topic in 2 pages. To learn more, please click here

Our Perspective on Recent Market News and Activity

Our synopsis of the past quarter, 2017, a look ahead, and putting it all in perspective:

The 4th Quarter of 2017 was another quarter of growth for the markets once again coupled with extremely low volatility.  2017 was a year that saw the Dow continue to record 87 new record closing highs since the election in November of 2016.  The world economy has reached an unusual state of stability.  Just about every country is seeing positive growth, but no country is seeing that growth booming out of control.  Inflation has been firmly in "goldilocks" territory, meaning not "too hot" and not "too cold".  The past year turned out to be more bullish than we anticipated, and the magnitude of asset returns surprised many.  Many firms predicted a year ago a "sideways market". For instance, Vanguard had a "modest outlook" for the US and "positive but muted" and "guarded" globally. Both Goldman Sachs and Credit Suisse estimated in January 2017 the S&P would close out 2017 at 2300 (essentially flat as it started the year at 2275). The S&P closed the year at 2673.

Many of the events that people worried about in early 2017 - including the election of a far-right government in France and aggressive U.S. trade policy - didn't materialize. The MSCI ACWI closed at a record high 61 times, and 30-day realized volatility of the S&P 500 Index hit its lowest level since the early 1960s. Other surprises: Inflation fell and long-term bond yields were flat even as the economy improved, while cryptocurrencies posted huge returns.
 
Looking forward to 2018, here are some thoughts from Russell Investments that we agree with which highlights things to consider and look for to play out in the coming year (the full outlook from Russell Investments is accessible by clicking here):
The belief is that global growth momentum is likely to persist into 2018, pushing up equity markets over the first part of the year. Japan, Europe and emerging markets are likely to outperform the U.S. Similarly, the euro, Japanese yen, British pound and emerging market currencies may offer investors more potential upside in 2018 than the U.S. dollar.

The strategists also believe that the timing of the next U.S. recession will be a critical issue for the global economy in 2018 as this almost always results in an equity bear market.  The U.S. still dominates global markets and is further advanced in its cycle than other economies, which means that most scenarios for 2018 are likely to be driven by the U.S. By next April, this will be the second-oldest U.S. economic expansion on record. The Business Cycle Index (BCI) model puts the probability of a U.S. recession in the next 12 months at around 25%, a high, but not alarming, percentage given the age of the expansion. This probability, however, could easily rise through the year, if, as we expect, the Fed tightens another three times in 2018.
 Further out, they see the risk of a recession in 2019 if additional policy tightening by the Fed causes the yield curve to become inverted. They believe the 10-year U.S. Treasury yield could rise towards its fair value before declining in the latter half of 2018 as recession fears grow.

In contrast to the U.S., the Eurozone is amid a mid-cycle renaissance and at the early stage of its exit from a very loose monetary policy, which the strategists believe may keep core Eurozone bond rates range bound through 2018. They also expect another strong year for the Asia Pacific region, buoyed by an accommodative policy at the Bank of Japan, although re-emergent wage and price inflation may cause the Reserve Bank of Australia to raise rates twice in 2018.

Key global market outlook highlights include:

U.S. equities could push higher before facing headwinds later in 2018 

Three U.S. Federal Reserve rate hikes expected

Recession fears likely to rise as U.S. yield curve continues to flatten

Europe, Japan and emerging markets expected to outperform U.S.

In addition, credit and equity markets tend to price in recessions around 6-12 months ahead of time. Given all this uncertainty, we believe it's best to look at various scenarios for 2018, rather than focus on one story. We think there are three plausible scenarios, with the central scenario the most likely:

Central scenario
Equity markets face increasing headwinds later in the year. Japan, Europe and emerging markets (EM) outperform the U.S. in what could be a relatively flat year for global equities.
Growth and earnings are stronger in Europe, Japan and emerging markets.
The U.S. 10-year Treasury yield approaches its fair value of 2.7% before declining as recession odds grow. The yield curve flattens and potentially inverts by year-end.

Upside scenario: blow-out rally
Fed is dovish and tightens by less than expected. Growth is ok and inflation doesn't rise much.
USD is weak. Emerging markets do very well.
Euphoria takes hold and investors leverage into the market.

Downside scenario: Fed mistake triggers a 2018 recession
Fed overtightens into a sluggish economy.
R-star (the real rate consistent with full employment/neutral real rate) turns out to be much lower than expected.
Markets hit turbulence in early 2018.

Euphoria: Still to come?
There's an old saying that bull markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria. The phase we have yet to encounter this time is euphoria. This is when we would see the blow-out rally scenario.
Sentiment , from our investment decision-making process of cycle, value and sentiment, provides the main guide to this scenario. It currently seems complacent and overbought, but not euphoric. One of the best indicators is that margin debt has yet to take off. According to the New York Stock Exchange (NYSE), margin debt grew by just 15% in the year through October 2017. Looking through this NYSE data, it often grows by more than 40% in the year before a major market peak, as overconfident investors borrow to gain market exposure.
 
Could a Fed mistake bring markets down?
Bull markets don't have to end in euphoria. As another market saying holds, they can be killed by the Fed. One of the key recession-risk issues is working out when Fed policy becomes restrictive. It's entirely plausible that a couple more Fed funds rate hikes could turn policy restrictive.
We will be monitoring the yield curve closely. This is one of the key inputs into the BCI model. The yield curve has inverted before every recession over the last 50 years. The spread between yields on 10-year and 2-year Treasuries has narrowed from 140 basis points, when the Fed started tightening at the end of 2015, to 60 basis points in late November.
Other risks
Our 2018 annual outlook overview is very U.S.-centric. It's worth asking whether there are any global factors that could trigger a global bear market. The main candidate for a non-U.S. shock is China. We're not expecting a China-sparked crisis, but high debt levels are a risk and outgoing People's Bank of China governor Zhou Xiaochuan recently warned about the risk of a "Minsky moment" (a Minsky Moment refers to a sudden collapse of asset prices after a long period of growth, sparked by debt or currency pressures. The theory is named after economist Hyman Minsky) .
The recent Communist Party National Congress entrenched the power of President Xi Jinping, giving him the authority to pursue his reform agenda in his second five-year term. Near the top of his list is deflating the debt bubble. Chinese central bankers have many more levers than their counterparts in developed markets, so the likelihood is they will be able to engineer a gradual deleveraging. But tightening credit in a high debt economy is a fraught exercise. China's monthly money and credit growth statistics will bear close watching for signs of a sharper-than-expected slowdown.
The wrap: In sum, we're not especially bullish or bearish about the year ahead. 2017 delivered better returns than most industry analysts expected, but the cycle is old and the U.S. Federal Reserve (Fed) is about to step up the pace of rate hikes. Our 2018 outlook view in one sentence? Equity markets may push higher over the first part of the year, before facing headwinds later in 2018, as markets factor in rising risks of a 2019 recession.
The views in this 2018 Global Market Outlook are subject to change at any time based upon market or other conditions and are current as of the date on the cover. While all material is deemed to be reliable, accuracy and completeness cannot be guaranteed.
Please remember that all investments carry some level of risk, including the potential loss of principal invested. They do not typically grow at an even rate of return and may experience negative growth. As with any type of portfolio structuring, attempting to reduce risk and increase return could, at certain times, unintentionally reduce returns.
Keep in mind that, like all investing, multi-asset investing does not assure a profit or protect against loss.
Major Market Indices

Below is the Q4 '17 price return performance of some of the major indices:

Index Q4 2017 2017
US Treasury 3 Month T-Bill
0.32% 0.97%
Barclay's US Aggregate Bond Index
-0.31%
0.72%
Barclay's Municipal Bond Index
-0.29% 1.11%
S&P 500 Index (US Large Cap)
 6.12%
19.42%
Russell 1000 (US Large Cap) 6.08% 19.34%
Dow Jones Industrial Average 10.33% 25.08%
Russell Mid Cap  5.60%  16.51%
Russell 2000 Index (US Small-Cap)  2.99% 13.14%
MSCI EAFE International: Developed Markets
3.90% 21.78%
MSCI International: Emerging Markets
7.09% 34.35%
Bloomberg Commodity Index
4.39% 0.75%
Credit Suisse Long/Short Equity*
*as of 11/30/17
2.99% 12.47%
DJ US Select REIT Index -0.96% -0.08%

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Financial Resolutions in the New Year - CARPE DIEM!



As a new year begins, it is often a time that people are reflective, and look to make resolutions for positive changes going forward. Many people use the expression "carpe diem" ("seize the day") to inspire them to make the most out of the day. We thought we would apply that for helping to set your financial year for success:
 
C reate a plan: A basic plan will include explicit, attainable actions, specifically stating how to get from Point A to Point B.
 
A ssess your situation/portfolio: Are you actively saving and investing to reach your goals? It is not too late to get your savings and investing on the right track. 
 
R e-assess your situation/portfolio and adjust as needed: The only constant in life is change. We cannot direct the wind, but we can adjust the sails.
 
P repare for the unexpected and the unavoidable: Do you have a will, living will, health care proxy, etc.? Enough insurance coverage?
 
E mergency fund: Things happen. There should be money not invested in stocks or bonds that is easily accessible, that can last a number of months.  
 
D iscipline: Maintain perspective and long-term discipline. Do not over-react to short-term events. Ignore the temptation to chase last year's winner.  
I mplement the plan: The best plan will do you no good unless you take action and implement it. "A journey of a thousand miles begins with a single step." 
E fficient: Manage your portfolio for tax efficiency. It's not what you make, but what you keep. 
M onitor and Track: "I have a sound plan and implemented it. Can't I just leave my portfolio alone?" You or your advisor needs to make sure that you are proactive and reactive, when needed. A loss avoided can be better than a gain.

On the Investment Horizon
Upcoming Key Dates on the Economic Calendar 

  • First Friday of each month: Unemployment report for the prior month, released at 8:30AM.

  • Monday, January 15: Martin Luther King Jr. Day - Market are closed. 
  • Friday, January 26 at 8:30AM: GDP, 4th quarter advance estimate. 
  • Tuesday January 30 - Wednesday, January 31: The Federal Open Market Committee (FOMC) meets, and releases their announcement on Wednesday at 2PM.
     
  • Monday, February 19: Presidents Day - Markets are closed. 
  •  Wednesday, February 21: Federal Open Market Committee (FOMC) releases minutes of previous meeting at 2PM
  • Wednesday, February 28 at 8:30AM: GDP, 4th quarter and annual 2017 (second estimate).

  • Tuesday March 20 - Wednesday, March 21: The Federal Open Market Committee (FOMC) meets, and releases their announcement on Wednesday at 2PM.
  • Wednesday, March 21 at 2:30PM: Fed Chair Janet Yellen to hold her quarterly press conference to explain the FOMC's latest quarterly economic projections.
  • Wednesday,  March 28 at 8:30AM: GDP, 4th quarter and annual 2017 (third estimate); Corporate Profits, 4th quarter and annual 2017.

If you desire an appointment, have any questions on any of this material, or any other financial subjects may relate to your own financial circumstance, please reach out to us at the contact information below:

 

 

Sincerely,

 

 


Brian Cohen, CCO; email: brian@landmarkwealthmgmt.com; phone: 631-923-2487
Joe Favorito, CFP®; email: jfavorito@landmarkwealthmgmt.com; phone: 631-930-5336

Direct office email: info@landmarkwealthmgmt.com 




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