Every January, it’s customary to look back at the year that was. What were the highlights? What were the “lowlights”? What were the events we’ll always remember? Most importantly, what did we learn?
Rather than write a long recap of the entire year, let’s first look at this chart:
This is hardly a full summary of everything that happened last year. And it doesn’t even mention any terrorist attacks, the ongoing investigations into President Trump’s campaign, the tidal wave of sexual harassment allegations that swept across Hollywood, the opioid epidemic, or any of a dozen other stories that dominated the news.
But let’s look closely at what it does mention. On the chart, you’ll see:
• National politics
• International incidents
• Natural disasters
These were all major developments, many of them affecting hundreds of countries and millions of people. Of course, some items weren’t necessarily bad, but each was significant in its own way. And month after month, the markets kept chugging up the hill. In fact, the S&P 500 rose over 19% for the year.
What Can We Learn from This?
Politically, culturally, meteorologically, 2017 was a volatile year – but not for the markets. As a result, 2017 taught us a valuable lesson about investing, which is that:
MAJOR NEWS STORIES DON’T DRIVE MARKETS.
Or at least, they’re far from the only thing that drives the markets. Time and again, pundits predicted the latest natural disaster, story about gridlock in Washington, or geopolitical incident would bring the markets down. In 2017, that never really happened. That’s not to say such events don’t ever affect the markets; just that they often don’t have the impact one would expect.
Take the Cuban Missile Crisis. The world has probably never been closer to nuclear war than during those nerve-wracking thirteen days in 1962, yet during that time, the Dow only fell 1.2%. By the end of the year, the Dow was up 10%.
More recently, look at Brexit. When the UK voted to leave the European Union, it took most analysts by surprise, and many predicted it would lead to a major drop in the markets. At first, it did. The vote took place on a Thursday. The next day, the Dow fell over 600 points, and then another 250 points the Monday after. But less than a month later, the Dow climbed to a new record high.
In 2017, the same thing occurred, with major events failing to impact the markets to any great degree.
What’s the Explanation?
In a sense, the markets are like baking a cake. If you’ve ever made a cake from scratch, you know the list of ingredients is fairly long. Flour and sugar. Baking soda and salt. Eggs and milk, oil and vanilla, and any of a half-dozen other things.
That’s complicated enough, but as any chemist would tell you, we’ve only just scratched the surface. Here’s what really goes into a cake: hydrogen, carbon, oxygen, nitrogen, sulfur, sodium, potassium, magnesium, molybdenum, manganese and more – all in the correct proportions, too, or else you just get a mess
The markets are like that cake – formed by hundreds, perhaps thousands of moving parts, decisions, stories, and most of all, people. So, in this analogy, the major news events that occur in any given year aren’t even the sugar or the salt. They’re the sulfur and selenium. Just a few elements in a giant bowl filled to the brim with them.
Why the Markets Went Up in 2017
So, what are some of the major elements that did move the markets in 2017?
Expectation is one. From the beginning of the year, the expectation of fewer regulations and lower taxes has been a major source of enthusiasm. (Both expectations were rewarded.)
Economic growth is another. The economy has been growing slowly but steadily over the past several years, and progress continued in 2017. The unemployment rate ended at 4.1% for the year, a 17-year low. Wages increased for many workers. Many corporations reported strong earnings throughout the year, causing valuations in most sectors to climb.
Sheer momentum was also likely a factor. FOMO, or the fear of missing out, is always a strong motivator, and as the markets climb, more and more people want to hop on board.
So What’s the Takeaway from All This?
2017 showed us that the markets aren’t a weather vane for any set of morals, political views, philosophies, or breaking news. History has repeatedly demonstrated that the markets are relatively unaffected by who the president is, which political party is in power, or how the winds of cultural change blow. In a more modern sense, the markets are far too large to be moved by anyone’s tweets or which YouTube video went viral. In a way, that’s a comforting thought. And it’s a further example of why we must avoid assigning narratives to the markets, and then making decisions based on those narratives.
Throughout 2017, many pundits kept trying to pick this event or that event as the straw that would break the camel’s back. I imagine many investors spent a lot of time searching for clues as to when the next correction would occur, and so missed out on opportunities for growth. That’s certainly been the case for this entire bull market, one of the longest in history. It’s a bull market that many investors have failed to take advantage of. (Per a survey by Gallup, only 52% of Americans report owning stock today, compared to 65% back in 2007.)
Of course, it’s also possible to make the opposite mistake: assume that good news, whether political or economic, will continue to drive the markets up. Nothing lasts forever, including bull markets, and it’s crucial that we avoid becoming irrationally exuberant, taking on more and more risk to chase higher returns. Investors who do that often make simplistic decisions based on specific news stories or trends that maybe aren’t as important as they appear.
Which brings us to the final part of this letter:
2018 Market Outlook
There’s no crystal ball to investing, and it’s impossible to truly know which “elements” will affect the markets most in 2018. Still, here are some of the trends we’ll be keeping an eye on:
• Will lower taxes mean corporate earnings continue to grow?
• Will the Mueller probe into President Trump’s campaign lead to any executive shakeup in the White House? (This only matters if it leads to policy changes that could impact the markets.)
• Who will control Congress after the 2018 midterm elections? (Again, this only matters so far as it affects policy down the road.)
• Many states are set to raise minimum wages in 2018. Will this lead to a rise in consumer spending?
At the moment, it seems reasonable to expect a kind of “Goldilocks economy” in 2018, in which economic growth is neither hot nor cold, but moderate. But again, we’re not going to make investment bets based on any storylines, nor are we going to react emotionally to future developments. Instead, we’ll continue to remember that the markets are large, complex institutions. We’ll continue to remember why we invest, which is to help you reach the specific goals you’ve set for your finances and your life. And we’ll continue to stick to our long-term strategy, which is designed to look beyond the headlines.
Have a Happy New Year!
As you know, there’s no better time to plan your year than now. To that end, I’d love to sit down with you and plan for the months ahead. We can review your current strategy and portfolio. Do we need to make changes? Are you still on track to reach your goals? This is the only story line that matters. So please give me a call at (212) 489-8443. We’ll set up a time to talk, and together, we’ll make 2018 exactly what you want it to be. On behalf of all of us here at C.E.A., we hope you had a great 2017! Here’s to an even better year to come.
Paul S. Reback
Capital Estate Advisors, Inc.