2017 will be a year that will likely be remembered for strong returns and an extraordinary lack of market volatility. Despite the day-to-day news flow on health care, tax reform, political uncertainty, and elevated market valuations, investors largely shrugged off these concerns and asset classes rose based upon supportive fundamental growth and strong corporate earnings. In the last market reflection of 2017, we will discuss what we believe were some of the most important stories of the year.

1) Asset class returns were strong

2017 performance has been mostly positive across asset classes. This performance was driven by several factors: GDP growth, both in the US and overseas, has been positive and accelerating. Jobs and wages have grown in the US throughout 2017. Federal Reserve rate hikes have been measured and well communicated in the US and monetary policy remains mostly stimulative outside the US. Global interest rates have remained relatively low and inflation has been controlled in most major markets. Tax reform that aims to significantly reduce the corporate tax rate has passed the House and Senate. Lastly, corporate earnings have grown at double digit rates in 2017 and expectations for continued growth have propelled markets across the globe. As a result, US stock markets were strong again in 2017 while international markets had a significant rebound after several years of underperformance. The below chart reflects performance of several of the Gradient investment portfolios across the risk spectrum. The data shows that investors had largely positive returns and were generally rewarded for taking risk in their investment allocations.

2) Volatility was historically low

By several different measurements, 2017 markets have had strong returns with extremely low volatility. Credit spreads, the premium paid to take on risk in bond markets, are near 10 year lows. The CBOE Volatility Index (VIX), a measurement of stock market volatility, is at levels that rank near the lowest in its history. Lastly, the below chart reflects annual returns (blue bar) and maximum drawdown (red dot) of the S&P 500. In 2017, the maximum intra-year decline has been 3%. This low level of decline is rare as it has only happened one other time in the past 25 years.

To expand on these Market Reflections or to discuss any of our investment portfolios, please do not hesitate to reach out to us at 775-674-2222.

A federal tax reform bill was passed in the House of Representatives and a separate version was approved by the Senate. Now the two are undergoing a joint committee review and compromise with the hope of putting a final version to a full Congressional agreement by Christmas. The compromise is likely to get swift approval by the president.

This may seem to be a rushed process, but in fact tax reform has been debated in both chambers for several years. If the changes are indeed enacted, it will be the first major tax reform in 30 years.

For corporations:

A significant reduction in the corporate income tax rate has been proposed, from 35% to 20% by the House and Senate. Such a reduction has the potential to boost earnings for many companies in the S&P 500 by 6% on average according to Citibank* with some benefiting much more.

Further, both the House and the Senate plan to reduce the tax on cash repatriated from overseas which should benefit many of the companies in our G50 and G33 portfolios. Repatriated cash is expected to be used to invest for growth, buy back shares and increase dividends.

For non-service pass-through income companies (partnerships, S corporations and sole proprietorships) the tax reform bill is likely to contain a provision for a reduction in the tax rate.

The prospects for permitting companies to write off capital expenditures 100% in each of the next five years before gradually declining holds promise for a dramatic rise in machinery sales in the coming years along with higher after-tax profits for the machinery buyers.

For individuals:

Individual tax brackets are going to change. The top individual tax rate is reduced in the proposals, with the threshold for top rates nearly doubles for married filing jointly. See the current tax brackets with the proposed House and Senate tax brackets in the chart below.

In the Senate bill the standard deduction will be doubled while the majority of itemized deductions will be eliminated. This alone will dramatically simplify tax filings. Child tax credits are also doubled as are the estate tax exemptions, to $22 million for married taxpayers.

Both the House and Senate bills would limit property tax deductions on a primary home to $10,000 and would eliminate state and local tax deductions on federal tax returns. A variety of other itemized deductions and exemptions are on the table for elimination.

The majority of middle-income taxpayers will experience an immediate tax cut, according to the Urban-Brookings Tax Policy Center, an independent analytical group. However, they estimate that 15% to 20% of those earning between $86,000 and $300,000 will experience an immediate tax increase.

The final bill on its own is expected to add to the deficit over the next ten years when the bill will expire (a mandated limit). However, that is expected to be offset by accelerated economic growth and thus added tax income anticipated under the plan.

In summary, the proposed tax bill should benefit the profitability of many of the US companies in which we invest as lower corporate taxes benefit earnings growth. Also, lower individual rates should benefit our consumer-driven economy.

To expand on these Market Reflections or to discuss any of our investment portfolios, please do not hesitate to reach out to us at 775-674-2222.

Source:
* https://www.cnbc.com/2017/09/28/tax-cut-prospects-are-set-to-fire-up-earnings-growth-and-the-markets.html

As the markets hit the final stretch run in full stride, there are only 20 trading days left to reach the 2017 finish line unscathed. It has been a remarkable year and another remarkable month for the financial markets. All asset classes are producing positive returns through November, and the stock markets refuse to pull back from this aggressive pace. Let’s take a quick look at the year to date performance on some key indices.

The Gradient Investment portfolios are also looking for a strong finish to the year. Our portfolios are managed to deliver a targeted risk level. So far in 2017, our higher risk portfolios are outperforming lower risk portfolios. This is not a surprise in a year rewarding risk takers. Remember, our advice is to never chase performance. It’s better to maintain a proper mix of portfolios, weighted to an appropriate risk level for each individual investor.

The Gradient Tactical Rotation and the G33 are our best year-to-date performers with returns running north of 20% through November. So far this year, growth companies have been well rewarded and value companies have trailed their growth counterparts. This fact has been well documented in our past communications. Our G50 and G40i portfolios are well positive through November, but lagging pure growth portfolios. Our fixed income expectations coming into this year were for low single digit returns. The Absolute Yield and Fixed Income Portfolios are on pace to deliver on this forecast.

December will be a key month in determining the setup for 2018. With third quarter corporate earnings season successfully in the books, market attention will turn to a handful of key policy and political factors. Let’s take a look at what is ahead for the markets;

Tax Reform – Does a tax reform bill come out of the senate and will it become law? Your educated guess is as good as mine, but I believe the stock market has priced in the expectation for lower corporate and personal tax rates. If this does not get passed, the stock market (especially small cap stocks) will be disappointed and ripe for an overdue correction. If passed, this should be good news for the U.S. economy helping both consumers and businesses. The stock market should smoothly sail into 2018 should Washington create a more competitive tax environment.

Government Shutdown – We have been down this road before, and experience tells us the stock market is not fond of government shutdowns. Today’s national politically charged environment does not make funding the government any easier. Complex issues ranging from immigration, repeal of Obamacare, funding the wall, and hurricane relief will provide every side with a reason to disagree. This may prove to be a tough hurdle to clear by the fast approaching deadline.

Federal Reserve – Jerome Powell has been nominated to be the next Chairman of the Federal Reserve replacing Janet Yellen when her term expires in early 2018. The partisan confirmation process will be in full force in December. Also the Fed has a December meeting where expectations are set for a 25 basis point fed funds rate hike. Higher short-term rates and yield curve flattening likely continue into 2018.

Geopolitical Risks – The market lives with these risks every day and has yet to be shaken by the events of 2017. Unfortunately, it only takes one event to send shock waves through the markets. Let’s hope the markets don’t have to deal with any irrational acts of violence.

If the markets can avoid these potential December pitfalls, we can get to January and make corporate revenues and earnings the focus again. A new earnings season and revised forecasts for fiscal year 2018 could once again give this bull market more room to run, as revenues are expected to grow at 5% and earnings to grow at 11%. Before we project 5-11% growth in the stock market next year, let’s see how the financial world handles these critical December events.

To expand on these Market Commentaries or to discuss any of our investment portfolios, please do not hesitate to reach out to us at 775-674-2222