As we look back on 2017, it’s helpful to reiterate the lens through which True Wealth Design sees the investing world.
“Successful investing starts with your goals brought together in a well-integrated financial life plan. Your allocation is then designed and investments selected with the help of science-based evidence to match your goals over time. Risk should be measured primarily in terms of the likelihood that you will meet these goals. Costs and taxes should be minimized. Discipline and patience are required in large amounts as markets are unpredictable in the short run and may be quite volatile.” (Abridged version of True Wealth Design’s investment philosophy.)
At the beginning of 2017, a common view among money managers and analysts was that the financial markets would not repeat their strong returns from 2016. Many cited the uncertain global economy, political turmoil in the US, implementation of Brexit, conflicts in the Middle East, North Korea’s weapons buildup, and other factors. The global equity markets defied their predictions, with major equity indices around the world posting strong returns for the year.
The broad global advance is yet another example of why following an investment approach based on diversification and discipline rather than prediction and timing is likely to lead to better results over time. Attempting to predict markets requires investors to not only accurately forecast future events, but also predict how markets will react to those events. The 2017 markets were a good reminder that there is little evidence either of these objectives can be accomplished on a consistent basis.
Instead of attempting to make predictions, investors should appreciate that the market reflects expectations and expected returns of all market participants.
“Everybody has some information. The function of the markets is to aggregate that information, evaluate it, and get it incorporated into prices.”
Merton Miller, Nobel laureate.
Equity Market Highlights
Global equity markets posted another positive year of returns in 2017. The S&P 500 Index recorded a 21.83% total return and small cap stocks, as measured by the Russell 2000 Index, returned 14.65%.
Returns among international markets were even higher. The MSCI World ex USA Index, which reflects non-US developed markets, logged a 24.21% return and the MSCI Emerging Markets Index a 37.28% return, making this the fifth highest return in the index history.
As the S&P 500 and other indices reached all-time highs during the year, a common media question was whether markets were poised for a downturn. History tells us that a market index being at an all-time high generally does not provide actionable information for investors.
For evidence, we can look at the S&P 500 Index for the better part of the last century. From 1926 through 2017, the frequency of positive 12-month returns following a new index high was similar to what is observed following months of any level. In fact, over this time, almost a third of the monthly observations were new closing highs for the index. The data shows that new index highs have historically not been useful predictors of future returns.(1)
The S&P 500 Index’s 21.83% return marked its best calendar year since 2013 and placed 2017 in the top third of best performing calendar years in the index’s history. Despite these returns, the US ranked in the bottom half of countries for the year, placing 35th out of the 47 countries in the MSCI All Country World Index (IMI).
China provides an example highlighting the noise in year-to-year single country returns. After a flat-to-negative return (USD) in 2016, Chinese equities returned more than 50% (USD) in 2017, making China one of the best performing countries for the year.
True Wealth Design adheres to a science-based approach to both planning and investing. Empirical evidence has shown certain factors provide a return premium over time. The primary equity market factors are the market, value, small, and profitability factors. (Learn more here.)
Though 2017 generally marked a positive year for absolute equity returns, it marked a change in factor performance from 2016. In 2016, size and value factors were generally positive across global markets but not so in 2017. The profitability factor, however, was positive in most markets.
Taking a longer-term perspective, these premiums remain persistent over decades and around the globe despite recent years’ headwinds. It is well documented that stocks with higher expected return potential, such as small cap and value stocks, do not realize these returns every year. Maintaining discipline is the key to effectively capturing the return premiums associated with the size, value, and profitability factors.
Both US and non-US fixed income markets posted positive returns in 2017. The Bloomberg Barclays US Aggregate Bond Index gained 3.54%. The Bloomberg Barclays Global Aggregate Bond Index (hedged to USD) gained 3.04%.
In the US, the yield curve flattened as interest rates increased on the short end and decreased on the long end of the curve. Recall, that when rates decrease bond returns increase and vice versa.
The yield on the 3-month US Treasury bill increased 0.88% to end the year at 1.39%. The yield on the 10-year US Treasury note decreased 0.05% for the year to end at 2.40%. The yield on the 30-year US Treasury bond decreased 0.32% to end the year at 2.74%.
Prudent investors were handsomely rewarded in 2017. How long can this run continue? Of course, no one knows. Eventually, there will be a broader bear market which will see most stocks lose value. It will be impossible to accurately time this in advance. Yet, where we sit today, interest rates are still quite low and stocks – even at more expensive levels – still look to offer increased expected returns over bonds.
The key is of course to have a plan and purpose for your money. If you need funds in the next years for spending, those funds shouldn’t be invested in stocks but in cash and bonds. If you have expenses to meet in more than ten years, well those will likely be more prudently met with stocks rather than paltry rates on bonds.
The year of 2017 included numerous examples of the difficulty of predicting the performance of markets, the importance of diversification, and the need to maintain discipline if investors want to effectively capture the long-term returns the capital markets offer. No doubt these attributes will continue to be required in large amounts.
This article adapted with permission from Dimensional Fund Advisors.
Past performance is no guarantee of future results. This information is provided for educational purposes only and should not be considered investment advice or a solicitation to buy or sell securities. There is no guarantee an investing strategy will be successful. Diversification does not eliminate the risk of market loss.
Investing risks include loss of principal and fluctuating value. Small cap securities are subject to greater volatility than those in other asset categories. International investing involves special risks such as currency fluctuation and political instability. Investing in emerging markets may accentuate these risks. Sector-specific investments can also increase these risks.
Fixed income securities are subject to increased loss of principal during periods of rising interest rates. Fixed income investments are subject to various other risks, including changes in credit quality, liquidity, prepayments, and other factors. REIT risks include changes in real estate values and property taxes, interest rates, cash flow of underlying real estate assets, supply and demand, and the management skill and creditworthiness of the issuer.
Dimensional Fund Advisors LP is an investment advisor registered with the Securities and Exchange Commission.