Q4 2017 Rising Tide Lifts All Boats
COMMENTARY FROM THE INVESTMENT COMMITTEE OF CORAL GABLES TRUST COMPANY
Q4 2017 - Rising Tide Lifts All Boats
Markets continued on their furious pace in the fourth quarter as positive sentiment continued to build around tax reform in the U.S. and a global recovery that seemed to pick up speed. The S&P 500 notched another positive quarter making it nine consecutive quarterly gains. By some measures investor bullishness is the highest since 1986 and market volatility is at an all-time low signaling little appreciation for risk. The S&P 500 returned a solid 6.64% for the quarter and made over 62 record highs in 2017. The Federal Reserve raised rates in December as expected bringing the Fed Funds range to 1.25% - 1.50%. Expectations are for an additional three rate hikes in 2018 assuming the economy continues at a relatively healthy pace. The tax reform debate has become a legislative reality as the statutory corporate tax rate was lowered to 21% and personal tax brackets got revamped. Time will tell just how much tax reform will affect the bottom line of corporate America. Economists and investors are left wondering if this is the event that will finally spark inflation to levels worthy of attention.
In the fourth quarter, market gains were broad across all major asset type categories. Looking closer, a large performance difference remains between growth and value. Large cap growth outperformed large cap value by 17% on the year which is the widest margin since 2009. Technology certainly had a lot to do with the outperformance as the sector returned 38% on the year. The high flying FANG (Facebook, Amazon, Netflix, Google) group continues to garner attention and they hold sizeable market cap positions in the most common of ETF vehicles. Energy and Telecommunications were the only two sectors that finished in the red for the year. U.S. economic data remains strong with GDP projections expected to follow a strong pattern similar to Q3 2017. Earnings season has started and the reports so far have been encouraging with earnings growth expected to be in the upper single digit range. Tension in North Korea and the Middle East cannot be overlooked but is clearly being ignored by the markets as of now. Market valuations are considered elevated compared to 10 and 15 year historical averages making corporate earnings increasingly more important to future performance.
This year has been more than a U.S. story. We are seeing a synchronized global recovery with Europe, Emerging Markets and Japan all performing in-line or ahead of the U.S. A weaker USD served as a tailwind to U.S. investors that participated in foreign markets. The MSCI EAFE index returned 4.27% for the quarter taking YTD gains to 25.62%. The MSCI Emerging Markets index fared better with a 7.50% return for the quarter resulting in YTD gains of over 37%. There are several reasons for the revival of international equities. Positive GDP results, lowered unemployment, favorable valuations and accommodative monetary policy were the primary drivers behind the outperformance.
Regarding fixed income, the 10-year treasury yield finished the year right where it started. At 2.45%, some skepticism remains that the economy has the all clear signal. High yield had a strong year returning in the mid-single digits as spreads tightened further. The Fed being active on the shorter end of the yield curve has caused the shape of the yield curve to flatten. Strong growth prospects have overshadowed this typical recession indicator but it will be interesting to see if inflation expectations increase causing the curve to have a more positive slope. Expectations are for equity to outperform bonds and cash in 2018, however, we continue to argue that fixed income will continue to serve as a vital component in a diversified portfolio and will act as a buffer against unexpected equity volatility.
THOUGHTS ON ASSET ALLOCATION
Equity returns in 2017 certainly surprised to the upside. The Trust Investment Committee has had several discussions recently about how to rebalance for 2018. With the understanding that valuations are rising, particularly in the U.S., the Committee elected to trim the U.S. domestic large-cap exposure in favor of a slightly higher weight in International. Increasing international equity will allow us to position the model towards geographies that possess better valuations and stronger growth prospects. After much research and discussion we decided to initiate a small position in emerging markets. The region is benefiting from synchronized global growth, commodity stabilization and a stable political backdrop. Valuations are notably lower in emerging markets when compared to the United States and developed international regions making a compelling case for investment over the next few years.
A number of our managers beat their benchmark by significant margins in 2017 as active managers generally outperformed vs. their passive counterparts. All our equity and fixed income managers had a positive absolute return in 2017 while some had exceptional results compared to their benchmarks.
Investment Manager / * 2017 Return / Manager Benchmark
T. Rowe Price Inst. LC Growth Fund / +37.82% / +30.21% Russell 1000 Growth
Oakmark Fund / +21.14% / +13.66% Russell 1000 Value
AB Discovery Value / +12.71% / +10.36% Russell 2500 Value
Dana Large Cap Core / +27.42% / +21.83% S&P 500
Schafer Cullen Div Value / +17.12% / +13.66% Russell 1000 Value
*Returns are expressed as composite returns. Results may vary. Past performance is no guarantee of future returns
We look forward to speaking with all of you regarding our views and the performance of your respective portfolios. For additional information or questions please contact Mason Williams, Chief Investment Officer, at 786-497-1214 or Gerardo Rodriguez, Investment Officer, at 786-292-0310.