While 2017 will likely be remembered by historians for its devastating natural disasters and political unrest around the globe, investors will remember a year where market returns came easy for the majority of asset classes.Did we deserve it? 2017 marked the first year of consistent economic growth across the globe in a decade. Within the United States, S&P 500 corporations experienced meaningful revenue growth (6%) and double-digit earnings growth (10-11%) for the first year since the great recession. To top it off, the prospects for U.S. corporate tax reductions only added to the optimistic sentiment. The result of these positive factors coupled with low inflation and continued low interest rates was a synced global equity market rally.
As we enter 2018, the fate of global markets may rest with the U.S. dollar. Why?
The greenback just wrapped up its worst year since 2007, sliding 7.5% against a basket of 16 peers tracked by the Wall Street Journal. The dollar plays a central role in a variety of financial markets. At home, a weak dollar helps multinationals by making their products cheaper to overseas buyers and boosting the value of their international earnings. For example, if Apple sells an iPhone in Europe and the Euro has appreciated 7.5% versus the dollar, Apple’s profit margin just received a free lunch when they convert their revenues back to U.S. dollars.
Abroad, a weak dollar helps emerging markets even more by making their dollar-denominated debts cheaper to pay back. It also helps bolster commodities such as oil and gold, which are priced in the U.S. currency. As a result, a continuation in the dollar's downtrend would help global markets maintain the buoyant tone of 2017, when the S&P 500 index rose 19% and an index of emerging-market stocks gained more than 30%. A significant reversal in this U.S. dollar trend would shift the meaningful tailwind back into our face….making returns harder to come by across the globe.
Regardless, there are a number of positives:
- Economic indicators continue to improve around the globe: Most large U.S. companies generate 30-50% of revenues overseas. This is a tailwind for U.S. and foreign companies.
- Stocks maintain the best relative value: Stock prices rose in 2017 because earnings advanced AND the earnings multiple is expanded. There’s no denying that valuations are elevated, but most argue that this valuation can be justified by the low level of bond yields. As long as bond yields remain low, this should continue. (note that we published a blog in 2017 discussing this in detail)
- Tax Reform: Although earnings estimates tend to fade through the year as estimates adjust to reality, this time may be an exception because tax cuts have not yet been taken fully into account.
As we enter 2018, we certainly would not rule out a garden-variety correction in stock prices of 5% to 10% somewhere along the line. The market is overdue for one—in 2017, the S&P 500 Index didn’t even register a price correction of at least 3%. However, timing the market in anticipation of a short-term correction should be discouraged until we see a more significant deterioration in the economic and financial fundamentals that have underpinned the global bull market over the past two years.
As always, we greatly appreciate the confidence that you place in Pinnacle Trust.
Reid Davis serves as Chief Investment Officer at Pinnacle Trust. You can reach him by email at email@example.com or by calling the office at 601-957-0323.