Many records were broken in 2017: the costliest hurricane season in recorded history, the most collective major league baseball home runs in a regular season and the highest price paid for a wrist watch ($17.8 million for Paul Newman’s Rolex).
Stocks in the U.S. broke records in 2017 as well. The Dow Jones Industrial Average reached five 1,000-point milestones, more than double the previous record for a year. The Standard and Poor’s 500 Index closed at new all-time highs 62 times for the year while posting positive returns for every month, the first time ever for this to occur. While all major U.S. stock markets enjoyed strong double-digit gains, developed international equities as measured by the MSCI EAFE Index did even better and out-performed domestics for the first time since 2012.
As 2018 began, stocks continued a steady rise in January, then February’s economic and investor cross-currents resulted in volatility measures not witnessed in a few years. First quarter market swings included a retracement of January gains, an official market correction reading at 10% down from peak, and a jump in the VIX (volatility) Index to the highest level in over two years.
The 2017 upward trajectory was partly due to realized and anticipated earnings growth resulting from fiscal stimulus promised by the new administration. Uncertainty about policy details and the likelihood of success provided hiccups along the way, yet those were largely overcome quickly and culminated with the passage of the Tax Cuts and Jobs Act in December. The continued accommodative low interest rate policy also contributed to this performance and helped the U.S. economy (GDP) run at a solid annual pace of 2.5%.
The Federal Reserve seeks to sustain this economic growth by bringing interest rates up to a less stimulative level of 2.9% by 2019, well below its 50-year average of 5.0%. However, these same factors that promoted such strong 2017 market returns are now viewed with uncertainty. Could low unemployment and long-awaited rising wages lead to a more aggressive Fed and higher than forecast interest rates?
Adding to the discussion, economic growth is not limited to the U.S. for the first time in a decade and is in fact synchronized globally. Forty-five countries tracked by the OECD are experiencing some level of positive economic activity, both last year and projected for 2018. This uniform growth pattern results from multiple years of low interest rates set by central banks world-wide. Even though the U.S. Fed stopped its Quantitative Easing policies of buying bonds and began raising interest rates in 2015, European and Japanese central banks have continued to buy assets and maintain sub-zero percent interest rates.
At current stock valuations, new records for U.S. stocks may be less common over the near-term, and rising interest rates may dampen fixed income returns. Still, despite recent spikes in volatility, the slow and steady pace of economic growth combined with continued accommodative central bank policy, should offer solid support for global markets over the intermediate term.
Sources: S&P Dow, Bloomberg L.P., Organization for Economic Cooperation and Development, The Federal Reserve
About the Author
Senior Vice President, BB&T Retirement and Institutional Services
Jim King is a senior vice president of BB&T Retirement and Institutional Services and serves as chief investment officer for BB&T Institutional Investment Advisers.