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2017 Year in Review

| January 30, 2018

In Chinese philosophy, Yin and Yang are described as opposite forces that may actually be complementary and interdependent. Dark and light, fire and water, fear and greed are all part of Yin and Yang. One cannot exist without the other. Let’s focus on the last one – fear and greed – since that seems to be most apropos. The equity markets had another good year with the S&P 500 leading the US markets, up 21.8% on a total return basis. These returns were mainly dominated by large cap growth companies like Facebook, Amazon, Google etc. Most of the “high flyers” also had very high valuations, but that didn’t seem to slow their appreciation. Small-cap stocks only returned 13.2%, while mid-cap stocks returned 16.2%. International stocks were up roughly 25% and emerging markets stocks were up 37.4% for 2017, while Bitcoin was up 1,318% for 2017. The Barclays aggregate bond index was up 3.55%, while Real Estate Investment Trusts returned 4.9% and energy stocks were down almost 2% for last year. It was certainly a good year for most asset allocations, but for those trying to “keep up with the market,” it was very difficult to do last year. Besides, we would argue that not only would you have to keep up on the upside, but you would also expect to “keep up” on the downside as well. Which brings us to Fear and Greed.

We remember 2008/2009 very well, as most of you do as well. If you go back to that time, it was full of fear. Fear of losing more money, fear of the entire system imploding, fear of where some might be living as people were getting laid off and many were spending their 401(k)s just to pay their mortgage. Today, employment is very good, people are making more money (in some cases a lot more money), housing prices have recovered and, depending on where you live, have exceeded the previous highs. With this new optimism comes the beginning of the greed cycle. Put another way, FOMO, Fear of Missing Out.  Missing out on what, though?

There have been many investors sitting on the sidelines, just waiting for a “good time” to put their money to work, people waiting for the system to implode for various reasons, the simplest being that the market seems high. And yet now we are starting to see people who have been somewhat risk averse get some courage and are investing in ways that only a year or two ago would have been unthinkable. As humans, one of the greatest biases we face is ‘recency bias,’ meaning what has happened (or what one has experienced recently) is what will keep going on. For instance, the S&P 500 index has had lower volatility than the US bond market, even though it is a much riskier investment. Because that is our recent experience, investors are believing that it will continue to act that same way.

We have written about Bitcoin and cryptocurrencies many times and we still get a lot of questions regarding them. Mostly it’s questions about what is it and then, because they have appreciated so much recently, should we be buying some? This is FOMO. Not really understanding what an investment is, but “feeling” stupid for not investing in it, because who hasn’t read about the 19 year old that is a multi-millionaire because he bought Bitcoin several years ago. Of course, we have heard these stories all over the place and yes, we all would have liked to get in early. If you are reading stories in Time or USA Today, it’s likely that the easy money has been made…at least in the short-run. If you had bought a month ago, you would have already lost 43% of your money in that short time period.

Getting back to Yin and Yang, always remember that there is balance in life, and while fear and greed are natural emotions, they are very destructive in the investment world. Our job as advisors is to keep you from getting too fearful or too greedy so that you can stay on course for your goals. We have definitely moved from the fear cycle to the greed cycle, and just as we manage the economic cycle, we must also manage the emotional cycle of investing.

Wrapping up our commentary, what do we see for 2018? It’s already off to a good start, but more importantly we are in a synchronized global expansion that we think is early in it’s cycle. Not since the mid-2000’s have we seen a world that is growing together. We see that continuing for the foreseeable future and we would expect the markets to reflect that good economy. The Federal Reserve is expected to raise short term interest rates 3-4 times in 2018, but other global central banks are not as far along in that process as the US is and therefore you should see some differentiation between some global markets. We would expect that the US Dollar will continue to sell off, which should be good for international equities, not to mention their valuations are much lower than the US equity market. Short term rates will move higher, but we think longer term rates will not go up nearly as much and we could be facing a flatter yield curve (difference between short- and long-term rates get closer together). What are the risks?  The world could go into recession (not likely at this point), the Fed could raise rates too much (quite likely, but maybe an issue more for 2019 or 2020) and we could have a geopolitical issue from the likes of North Korea or Russia (below 50% probability in our view). We continue to stay overweight equities, especially International equities, and underweight bonds, especially traditional bonds. Commodities, cash, and currencies will likely have minimal exposures for 2018. If the FOMO trade continues and gets more intense, it is likely we will see some kind of ‘melt up’ in the markets, but keep in mind that does not preclude a decent correction in the markets along the way. Last year our biggest drawdown in the markets was 2% or 3%. That’s not normal, nor would we expect that to repeat itself in 2018. Just when you think it’s safe to go back in the water…

As always, we encourage you to call or email if you wish to have a longer discussion surrounding these or any topics – and certainly we look forward to speaking with you. If you have friends or family that you would like to pass this along to, please do.