*The video version of this report is available in your Orion portal.*
The bull market continued for another year, causing market indices to soar to new heights over and over again and—ominously—also pushing valuations further beyond the long-term averages.
A breakdown shows that just about everything gained in 2017. The widely-quoted S&P 500 index of large company stocks gained 6.12% during the year’s final quarter and overall returned a 19.42% gain in calendar 2017.
International stocks are also participating in the bull run. The broad-based EAFE index of companies in developed foreign economies gained 3.90% in the recent quarter, and ended the year up 21.78% in dollar terms. Emerging market stocks of less developed countries, as represented by the EAFE EM index, rose 7.09% in dollar terms in the fourth quarter, giving these very small components of most investment portfolios a remarkable 34.35% gain for the year. Our global equity fund, DFA Selectively Hedged Global Equity (DSHGX) finished up 6.60% for the quarter and is up 22.65% for the year.
Looking over the other investment categories, real estate, as measured by the Wilshire U.S. REIT index, posted a meager 1.70% gain during the year’s final quarter, yet finished the year up a respectable 4.18%. Our REIT fund, DFA Global Real Estate (DFGEX) really over performed the category and finished the quarter up 3.70%, and was up 9.18% for the year.
The S&P GSCI index, which measures commodities returns, gained 9.90% in the 4th quarter, to finish the year up 5.77%. Our commodity fund, DFA Commodity Strategy (DCMSX) somewhat under performed the index and finished the quarter up 4.35%, rising 2.70% for the year.
In the equity-like portion of our model portfolios we saw Ironclad Managed Risk (IRONX), a strategy that sells put options on equity indices and exchange traded funds, was down 0.03% for the quarter, but ended the year up 3.29%. AQR Style Premia Alternative Fund (QSPIX), a strategy that invests long and short across six different asset groups: stocks of major developed markets, country indices, bond futures, interest rate futures, currencies and commodities based on four investment styles: value, momentum, carry, and defensive, added 5.62% for the quarter, up 12.01% for the year. Rounding out the mix of equity-like funds, Steben Managed Futures Strategy (SKLIX), had a quarterly gain of 5.71%, making it up 3.48% for the year.
In the bond markets, coupon rates on 10-year Treasury bonds have risen incrementally to 2.41%, while 30-year government bond yields have fallen slightly to 2.74%.
Our high quality bond funds, DFA Selectively Hedged Fixed Income (DFSHX), closed the quarter down 0.45% but gained 2.61% for the year and DFA Investment Grade (DFAPX) declined 0.02% during the last quarter, but was still up 3.36% for the year. Our Treasury Inflation Protected (TIPs) fund, DFA Inflation Protected Securities (DIPSX) was up 1.23% for the quarter, making the fund up 3.28% for the year, while our high yield bond fund, Principal High Yield (PHYTX), finished up 1.02% for the quarter and ended the year up 8.13%.
This was a year when investors ignored the dire headlines, North Korean missile threats, investigations of the Presidency, hurricane devastation and a rapidly-growing national deficit to produce one of the smoothest investment rides in the past century. The VIX “fear” index has produced the lowest volatility since data has been collected starting in 1990. In October, the S&P 500 index broke its all-time record of consecutive days without a 3% drawdown. The biggest single-day drop in 2017 was just under 2%.
How long can this continue? Who knows? The S&P 500 is now trading at around 18 times forward earnings, which is above the historical average of 16—which, loosely translated, means you aren’t getting a bargain when you buy stocks today. At the same time, we are experiencing low unemployment rates and solid profits for American companies. The U.S. economy is growing at a 3% rate. And the psychology of the markets doesn’t match what you traditionally see at market tops: people still seem to be suspicious about how long the market rally will last, unlike the normal buying frenzy that often presages the next sharp downturn. (To see what a market frenzy looks like, are you hearing more about bitcoin than you have in the past?)
And indeed, not all stocks have prospered despite the rise in indices. A company called Range Resources lost 54% in 2017 due to continuing low fuel prices, and firms you’ve heard of incurred significant drawdowns, including General Electric (-43%), Mattel (-43%), Advance Auto Parts (-42%) and the Apache oil and gas company (-34%).
Eventually, there will be a broader bear market which will see most stocks lose value. It will be impossible to spot by forecasters, but will seem inevitable with the benefit of hindsight. The important thing to remember is that few people have ever become extremely wealthy by timing the market and jumping out because they think they can predict the next downturn. Many have gotten significantly wealthier by holding on whenever the raft hits the rapids. We missed the rapids in 2017, but everybody knows they’re coming—someday, though perhaps not soon. Let’s make sure we have a tight grip anyway.