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2018 Q1 Economic Update from Transition Financial Advisors, Inc.

At the start of 2017, a common view among market strategists and analysts was that financial markets would not repeat the favorable returns of 2016. An uncertain global economy, political turmoil in the U.S., implementation of Brexit, and North Korean nuclear weapons buildup were all cited as reasons to expect modest returns. The global markets defied all these predictions, with major equity indices in the U.S. as well as overseas posting very strong returns.

This broad global advance underscores the importance of following an investment approach based on diversification and discipline rather than prediction and timing. Attempting to predict markets requires investors to not only accurately forecast future events, but also predict how markets will react to those events. 2017 was a good reminder that there is little evidence suggesting either of these objectives can be accomplished on a consistent basis.

Many broad-based stock market indices returned over 20% in 2017 with international stock markets leading the way, an event we have been waiting for a while now. As the S&P 500 and other indices reached all-time highs, the media has inserted their usual fear-mongering commentary; are markets now poised for a major downturn. The answer to this question is a definitive “we don’t know.” History tells us that a market index being at an all-time high generally does not provide actionable information to investors.

For evidence, we can look at the S&P 500 Index for the better part of the last century. From 1926 through 2017, the frequency of positive 12-month returns following a new index high was no different from the frequency following the market being at any level. In fact, over this time period, almost a third of the monthly observations taken after a market has achieved a new high show the market going on to make another new high. The data show that new index highs have historically not been useful predictors of future returns or market tops.

For several years now, the equity markets have been in a period of historically low volatility. In fact, 2017 is the first year in history (going back to 1926) that all 12 months of the year showed positive returns. U.S. markets have now achieved positive returns for 14 consecutive months, going back to October of 2016 (when we lost -1.82%). The longest monthly winning streak ever is 15-months which occurred from March 1958 through May 1959. And if we go back to March 2016, the last 21 out of 22 months have been positive. Yes, volatility has been exceptionally low.

For those of you who have thought about doing your own research and buying individual stocks, you might want to know that one-third of all individual U.S. stocks lost money over the last 10 years. Less than 0.02% of U.S. stock mutual funds and ETF’s lost money over the same period. And only 62% of U.S. stocks outpaced inflation (1.7%) over this 10 year period while 99.4% of all U.S. stock mutual funds and ETF’s beat this inflation benchmark. Picking individual stocks can sound like fun, but comes with significant risks. Diversification through buying a large basket of stocks has demonstrated to be a better strategy as proven in the investment research.

For a number of years, it seems there has always been some pending catastrophe weighing on foreign economies and markets. From Brexit, to Greek bankruptcy, to a hard economic landing in China, there always seems to be some economic storm cloud hovering over the global landscape depending on who you talk to. But going into 2018, investors can see blue skies just about anywhere they look. From reduced political tensions in Europe to reform initiatives in India, to a more stable China, underlying conditions are decidedly upbeat. Indeed, the synchronized global economic recovery is gaining momentum.

To a large extent, this economic momentum has led to a broad-based recovery from the global profits recession that began in the second half of 2014. In Europe, earnings revisions turned positive for the first time since 2012. Earnings momentum in the U.S. is also accelerating supported by new tax legislation and reduced regulation. Japanese companies are generating higher profits despite a stronger yen. Barring unpredictable political or economic shocks, we expect the global earnings recovery to continue in 2018. Even if earnings are not as strong as many expect, we believe markets will weather this as long as there is the perception that underlying growth trends are positive and can be sustained as the economic cycle continues to mature. Eventually, the global economies will become “overheated,” governments will raise interest rates to “cool things down” and bonds will start looking better with higher yields. It is all just part of the normal economic cycle that follows predictable patterns, but is completely unpredictable as to when they will occur.

The S&P 500 is off to a strong start in 2018 as the index has already returned over 6% at the time of this writing. During this time, U.S. stocks have posted higher levels despite concerns about trade comments by the Trump administration. Uncertainties around the President’s “America First” policy have put pressure on the dollar since he took office. The President eased some fears in his speech last week at the World Economic Forum in Davos, Switzerland. We shall see how this all plays out.

It looks to us that the synchronized global expansion is entering a period of sustainability. Global GDP estimates are climbing and unemployment is falling. Even at current valuations, we believe equities still have excellent prospects for the year, but portfolios must stay positioned for resilience in the inevitable periods of volatility that will occur.

Sincerely,

Transition Financial Advisors Group, Inc.

Mitch Marenus, Chief Investment Officer
MBA, CFP® (US), CFA®

Brian Wruk, President
MBA, CFP® (US), CFP® (Canada), CIM, TEP