In 2017, we were again reminded of the importance of following an investment approach based on discipline and diversification vs. prediction and timing. As we gear up for the new year, we can look at several examples during 2017 that provide perspective on what guidance investors may want to follow, or not follow, in order to achieve the long-term return the capital markets offer.
Each January, a well-known financial publication invites a group of experienced investment professionals to New York for a lengthy roundtable discussion of the investment outlook for the year ahead. The nine panelists have spent their careers studying companies and poring over economic statistics to find the most rewarding investment opportunities around the globe.
Ahead of 2017, the authors of the publication’s report were struck by the “remarkably cohesive consensus” among the members of the group, who often find much to disagree about. Not one pro expressed strong enthusiasm for US stocks in the year ahead, two expected returns to be negative for the year, and the most optimistic forecast was for a total return of 7%. They also found little to like in global markets, citing “gigantic geopolitical issues,” including a Chinese “debt bubble” and a “crisis” in the Italian banking system.
The excerpts below summarizing the panel’s outlook presented a less than optimistic view of the year ahead in January 2017.
“This could be the year when the movie runs backwards: Inflation awakens. Bond yields reboot. Stocks stumble. Active management rules. And we haven’t even touched on the coming regime change in Washington.”1
The outcome of these predictions: Zero-for-four, although some might point out that at least they got the direction right regarding the inflation rate.
- Inflation barely budged, moving to 2.17% for the January - November 2017 period, up from 2.07% for the year in 2016.2
- The yield on the 10-year US Treasury note did not move up but instead slipped from 2.45% to 2.40%.
- Stocks moved broadly higher around the world, in some cases dramactically. Twenty out of 47 countries tracked by the MSCI achieved total returns in excess of 30%.3
- According to Morningstar, the average large blend investment underperformed the S&P 500 index by 1.39 percentage points, and the average small company investment underperformed the S&P 600 index by 1.35 percentage points.
The above-mentioned panel was no aberration. Among 15 prominent investment strategists polled by USA TODAY, the average prediction for US stocks for 2017 was 4.4%, while the most optimistic was 10.4%.4 Expert or not, there is little evidence that accurate predictions about future events, as well as how the market will react to those events, can be achieved on a consistent basis.
- What do you get when you combine a tumultuous year for a new US president and divisive political trends in many global markets? Answer: a new record. For the first time since 1897, the total return for the US stock market (the CRSP 1-10 Index and, prior to 1926, the Dow Jones Industrial Average) was positive in every single month of the year. During the year, a great deal of media coverage was focused on markets at all-time highs, and some investors braced themselves for a sharp drop in stock prices. Not only did the much anticipated “correction” never occur, financial markets remained remarkably calm. Out of 254 trading days in 2017, the total return of the S&P 500 Index rose or fell over 1% only eight times. By comparison, in a more rambunctious year such as 1999, it did so 92 times.5
- North Korea issued threats of a nuclear missile strike throughout the year and boasted that even mainland US cities were vulnerable to its newest warheads. Next-door neighbor South Korea would seem to have the most to lose if such a catastrophe occurred, but Korean stocks were among the top performers in 2017, with a total return of 29.5% in local currency and 46.0% in US dollar terms.6
- To many experienced researchers, Chinese stocks appeared alarmingly vulnerable. A gloomy November 2016 article7 warned that “China’s debt addiction could lead to a financial crisis.” In the article, a prominent Wall Street strategist observed: “It’s scary that China seems to be continuing its debt binge to achieve its unrealistic growth targets.” And a global investment manager noted: “We are the most underweight China we have been since launching the investment five years ago.” The outcome: China was the third best-performing stock market in 2017 with a total return of 51.6% in local currency and 50.7% in US dollar terms.8
- The seven-year string of increasing US auto sales finally ended in 2017. Domestic sales fell 1.0% at Ford Motor, 1.3% at General Motors, and 10.7% at Fiat Chrysler.9 Anticipating the sales slump, a Wall Street Journal columnist warned investors in January 2017 to avoid the stocks.10 Good advice? Ford Motor had a total return of 8.7%, which was in fact below the 21.8% return of the S&P 500 Index. However, General Motors returned 22.5%, and Fiat Chrysler’s total return came in at an impressive 96.3%, even with more than a 10% drop in sales.11
While some of these examples may seem counterintuitive, the above “surprises” from 2017 reinforce the challenge of drawing a direct link between positive or negative events in the world and positive or negative returns in the stock market.
Expect the Unexpected
Financial markets surprised many investors in 2017, but then again they have a long history of surprising investors. For example, from 1926–2017, the annualized return for the S&P 500 Index was 10.2%. But returns in any single year were seldom close to this figure. They fell in a range between 8% and 12% only six times in the last 92 years but experienced gains or losses greater than 20% 40 times (34 gains, six losses). Investors should appreciate that many times realized returns may be far different from expected returns.
For a number of investors, 2017 was a paradox. The harder they tried to enhance their results by paying close attention to current events, the more likely they failed to capture the rate of return the capital markets offered.
New Year’s resolution: Keep informed on current events as a responsible citizen. Let the capital markets decide where returns will be generated.
- Lauren R. Rublin, “Stocks Could Post Limited Gains in 2017 as Yields Rise,” Barron’s, January 14, 2017.
- Inflation data © 2018 and earlier, Morningstar. All rights reserved. Underlying data provided by Ibbotson Associates via Morningstar Direct.
- As measured by the MSCI All Country World IMI Index (net dividends).
- Adam Shell, “How Will Stocks Make Out in 2017?” USA TODAY, December 24, 2016.
- S&P data © 2018 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved.
- As measured by the MSCI Korea IMI Index (net dividends). MSCI data © MSCI 2018, all rights reserved.
- Jonathan R. Laing, “China’s Debt Addiction Could Lead to Financial Crisis,” Barron’s, November 5, 2016.
- As measured by the MSCI China IMI Index (net dividends). MSCI data © MSCI 2018, all rights reserved.
- Neal E. Boudette, “Car Sales End a 7 Year Upswing, With More Challenges Ahead,” New York Times, January 3, 2018.
- Steven Russolillo, “Yellow Flag Waves Over Auto Stocks,” Wall Street Journal, January 4, 2017.
- Ford Motor, General Motors, and Fiat Chrysler returns provided by Bloomberg Finance LP.
Article by Weston Wellington, Vice President, Dimensional Fund Advisors