The Year of the Positive Outcome

At the beginning of 2017, no one could have predicted what would be in store for markets, politics, and even football.  The Bostonians and the Atlantans are aware of expecting something is going to happen and then the unthinkable occurs.  The Patriots, who were favored to win the Superbowl, were losing 28 – 3 with 8:36 left in the 3rd quarter of against the Falcons.  The Patriots would end up coming back epically and winning 34 – 28.

The stock market was expected to go up in 2017 which is not outlandish call as markets tend to go up over time because economic growth is positive over time.  The challenge is that we don’t  know with certainty that markets will go up.  Like the viewers of the football game, we do not know the outcome until the game is over.  Moreover, what we think will happen, probably won’t happen or at least the way we thought it would.  Yes, I predicted the Patriots would win the game, but the path to victory was different in my head.  Yes, I thought the markets would be up on the year, but I never envisioned them being up over 20% without a 3% pullback.  I have already come to terms that I cannot predict the future, but I can diversify, plan for the worst and hope for the best.

2017 is a year in which we witnessed (at least for markets) the positive dispersion around the average.  At my firm, we help our clients plan for years like this; we just don’t know when they will show up.

Asset Allocation 

Global asset allocation strategies have been on a roll.   Last year, was the first time since 2012 that the MSCI All Country World Index outperformed the US Total Stock Market. Emerging Markets indices continued their uptrend from 2016 to 2017 and were up over 30% for the year.  2018 has started off with a positive first week for all major asset classes.  Caveat, the Dow Jones Industrial Average had a remarkable year up 25% in 2017.

We completely blew through the year-end price targets for the S&P 500 as most research shops were not predicting double digits returns in the S&P 500.  We also blew through some analysts 2018 year-end price targets.  Go figure.

For the moment, advisers can hold their heads up high for recommending globally diversified portfolios.   First quarter reviews should go rather smoothly as investor portfolios that invested 50% in global funds were up double digits.  Stock market volatility was low throughout the year making it easier to stay invested.

2017 was also a significant year from a financial planning standpoint for people at all ages and stages.  If your plan was projecting a 5% linear growth rate over the next three years, it is possible that you are well ahead of your 2020 objective.   For people withdrawing on their assets, your withdrawal rate on your portfolio for 2018 has been reduced, assuming your expenses stay the same.

Staying patient is an underrated behavioral characteristic in investing.  For instance, a pre-retiree invested in 60% stocks, 35% bonds, and 5% in a commodities index.  The hypothetical portfolio is rebalanced annually at the beginning of the year.  As a percentage of the stock, 67% was invested in US stocks, 25% in international developed markets, and little over 8% in emerging markets.  The portfolio is not subject to any fees or trading costs.

JPM GTM - return quilt 2018

Ok, so the returns in the asset allocation portfolio, indicated by the light grey square, were up 5.2% in 2014, down 2.0% in 2015, and up 8.3% 2016 which comes out to a 3.67% compounded return over the 3-year period.  When you include the 14.6% from 2017, the compound return for the four-year period is now 6.35%.  The cliché “ it is not about timing the market, but more about time in the market” fits perfectly for this four-year period.  The returns in 2017 turned a below average 3-year period to a well-respected 4-year return.  The weekend golfer would say “three bad shots and one good shot still makes par.”

Things I find interesting when looking at the return quilt

  1. All the equity asset classes shown in the chart have beaten the asset allocation strategy since 2003 though with more volatility.  The equity risk premium (the return of US Stocks minus US Bonds) was 5.8% over the 15 year period.
  2. Low interest and savings rates have hurt savers since the dotcom bust. Cash and bond yields are low.  The real return (inflation adjusted) on cash has been negative for quite some time.
  3. US Large Caps have outperformed an asset allocation strategy every year since the Global Financial Crisis (“GFC”) which could be why the Great Bull Market is also the “most hated” bull market, as investors looked elsewhere for return coming out of the 2009 recession.
  4. Fixed Income has only had one year where it was the best performer. Fixed Income in bull markets can be a significant drag on performance when the equity markets are doing well.
  5. The commodity index was the worst performer of the group; however, it was the fourth highest in volatility measured by standard deviation. Commodities did not get the memo about the adage: higher risk, higher return.

The S&P 500 has yet to give up the Iron Throne since the GFC, and though the tide has been turning, the other assets classes have some catching up to do. At the start of the year, I like to try and predict which asset class will be the top performer each year and my bet this year will be Emerging Markets (same as last), on the flip side, I would be surprised if REITs were top dog.

Source:  JPMorgan Guide to the Markets – Quarter 1 – 2018