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Investment Outlook - Fourth Quarter 2017

The Market Keeps Going – What Can Get in its Way



By: Tyler Smith
Wednesday, January 17, 2018

Market Recap and Review
The Market Keeps Going – What Can Get in its Way
Goldilocks looks to have prevailed. The story throughout the year has been one of respectable economic expansion, low inflation, and continued accommodative monetary policy. The [“not too hot, not too cold”] combination of these factors, alongside a subdued level of volatility, worked to provide a solid backdrop for the markets in 2017. Furthermore, 4Q ended on a strong note driven by renewed optimism around the positive implications from tax reform for both corporations and individuals.
To this point, the solid underlying fundamentals of U.S. companies appear to have eased investor fears of stretched equity valuations. The United States remains an attractive place to invest as corporate earnings growth, as opposed to euphoric optimism, has been the key driving force behind increasing stock prices. Additionally, consumer confidence has reached all-time highs and the outlook for small business activity remains robust.
While we do not view a larger-scale economic contraction as imminent, it is important to remember we are in, what we would consider, the later innings of an economic cycle. It will be interesting to see how markets respond as central banks across developed economies begin to take a slightly more restrictive stance on monetary policy moving into 2018.
All three major stock market indices drove higher in 4Q with the large capDow Jones Industrial Average leading the way, up 11% for the quarter. The S&P500 and NASDAQ finished up 6.6% and 6.3% respectively. For the year, the S&P finished up 21.8%, the Dow up 28%, and the NASDAQ up 28.2% (all returns stated on a total return basis). Aside from a brief cooling late November/early December, the NASDAQ had been the notable outperformer through much of the year. High-flying, momentum names such as Facebook, Amazon, Netflix, and Google (otherwise known as “FANG”) drove much of the market strength as investors favored momentum and growth over value. We also saw similar trends in the healthcare space.
Diving a bit deeper into the individual sector performance through 4Q, we saw a potential preview of what might lie ahead in 2018. Playing to the market’s overarching appetite for growth, the tech and healthcare sectors had been one of the key driving forces behind the market’s rally in 2017. However, many of these companies would see relatively less upside from a lower corporate tax rate (one of the key changes to take effect under the new tax bill). The energy, telecommunications, financial, and consumer staples sectors, on the other hand, are said to be the primary beneficiaries of corporate tax reform. Accordingly, we did see some brief periods of rotation into these areas at the expense of tech and healthcare. If this is a sign of things to come, we could see a scenario where the quintessential momentum/growth names take a back seat to some of the prior market laggards. This is not to say areas like tech and healthcare can’t have another solid year in 2018. If these businesses continue to drive meaningful progress into the underlying fundamentals (e.g., revenue growth, market share, cash flow, etc.), they could offset their relative disadvantage on the tax front.
At the end of the day, we believe the proposed tax changes will be a net positive for both corporations and consumers. However, we would expect there to be some ongoing fluctuations in relative sector performance as investors continue to digest potential implications from the changing tax code in 2018 and beyond.

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