Winter Letter To Clients: {Part I.}

Here is Part I of our most recent client letter sent out to them at the end of January.

Winter is a Season

 “Winter is not a season, it’s an occupation.”

-Sinclair Lewis

We’re always preparing for winter in Chicago and maybe are too preoccupied with it.  They say that we have only two seasons here, summer and construction.   In Chicago, outside work on homes only happens in the warmer months, largely to repair the ravages of snow, sleet and biting wind.  Vacation plans are made for those fortunate to be able to travel to warmer climes during this period and “snow birds” migrate to the warmer parts of the country, not returning until the trees start to bud three to four months out.  Winter in Chicago is also a time of reflection so in that vein here’s our latest report.

How did the markets do last year?

Markets around the world turned in positive returns in the top quartile of historical asset performance.  Major US indices returned on average better than 20% in 2017.  International markets staged even better results, breaking out of years of poor trading.  Developed markets returned 25.6% and emerging markets lead all asset classes with a 37.8% return.  Investors following a diversified approach to asset allocation by one measure returned 14.6% last year and a blended portfolio returned on average 16%.*  

Wall Street loves to use euphemisms, especially when it comes to sugarcoating bad news.  A classic example of this is how the word “volatility” is used in our business.  While volatility suggests movement in multiple directions, Wall Street uses the phrase almost exclusively for market declines.  Presumably most investors don’t mind when markets trade volatilely higher.  For investors who’ve over the years experienced stomach churning “volatility”, 2017 was a year when markets sailed through calm seas.  By that measure 2017 was one of the least volatile years on record.  For the first time, the S&P 500 showed a positive return in each month of the year.  From the opening bell on January 3^rd to the market close on December 29^th the market didn’t show a negative return at any point.  That means that investor portfolios never experienced a point last year where their accounts were in the red.  This has only happened ten times since 1928. This occurrence is unusual.  Understand it is unlikely to occur again this year.

What Are Your Expectations For 2018?

A common theme in my recent letters is to repeatedly urge investors to separate the political and social commentary from what is going on in the economic sphere.  Regardless of ones views on the current direction of the country, markets have responded enthusiastically to what they so far perceive as a roll back of governmental regulations, plans for economic stimulus plus the recently enacted tax cuts. The long term-implications of these initiatives should be debated. Also, if one is fair, it should be acknowledged that some credit for the current acceleration in the economy needs to be laid at the feet of the Obama Administration as well.  But so far markets like what they are seeing.

The massive tax overhaul has immediate economic benefits.  Lost in the rhetoric about the tax cuts being a gift to corporate America is that many in the middle class will see higher paychecks this year as a result of lower tax brackets.  If this extra cash isn’t gobbled up by states and local governments^, then that extra money is likely to find it’s way back into the economy.   Here are two examples of how this might work.

The median national salary in the US is currently around $59,039.^^  Estimates suggest that somebody earning that amount could see tax savings of between 8-12% and find themselves with an extra $800-1,200 this year.  Further, we are seeing corporations use some of this newfound savings into benefits for their employees in the form of wage increases or bonuses.  As an example, look at Walmart, which is the largest U.S. private, employer with over 1 million workers.  It recently announced it would be raising starting wages nearly 22%, from $9 to $11 dollars an hour and would hand out employee bonuses from $200 to $1,000**.  They acknowledged that at least some of that raise was a result of the recently passed tax plan, although a tight job market also likely influenced their decision.  Either way, Walmart is deeply embedded in many smaller towns and cities that the modern economy has passed by.  In a lot of these places a $2 an hour raise and the potential of a up to a $1,000 dollar bonus can have a significant impact in both spending and savings rates.  Don’t underestimate the stimulative effect this tax cut has the potential to produce.

Another way this may ripple through the economy is the repatriation of overseas tax dollars.  Apple recently announced they are bringing back some of their nearly $252 billion dollar cash accounts that’s invested overseas.  This includes nearly $38 billion in repatriation taxes and is resulting in a $350 billion dollar direct investment commitment by Apple in the US over the next five years, a move that CNBC’s Jim Cramer has characterized as a “modern-day Marshall Plan for the US economy”.***   Imagine the multiplier effect if other companies make similar types of commitments!

*Asset class returns taken for this report can be found at JP Morgan  “Guide to the Markets”, published quarterly J.P. Morgan Asset Management.com.  The “Asset Allocation” portfolio is a portfolio derived by JP Morgan used by us for an illustrative guide to asset allocation.  Its paramaters can be found at the link.  

^For my analysis on the tax cuts in Illinois go to my blog and read my link for  December 20, 2017.  Don’t Spend That Tax Money Yet {If You Livein Cook Co. Illinois} 

^^Source:  US Census Bureau via Wikipedia.

** Source:  Walmart to Raise Starting Hourly Wage to 11, Offer Paid Parental Leave 

***Source:  CNBC.com

Long ETFs related to the S&P 500 in client and personal accounts.  Short S&P 500 in a personal account as part of a separate individual strategy.