The Legacy Perspective January 2018

By Steve Wachs, CFP®                                                  

The Perfect Season

• Miami Dolphins – NFL Football - 1972 - 17-0
• Indiana Hoosiers – NCAA Basketball – 1976 – 32-0
• Florida St. Seminoles – NCAA Football – 2013 – 14-0

 Being perfect in anything is difficult. In competitive team sports, it is particularly challenging. The list above are the last teams in their respective sports to be “perfect” and be national champions. Since the 1970’s were my prime sports years (yes, my kids are still shocked by my pictures in those short basketball shorts), I know it has been a long time since perfection was attained in professional football and college basketball.2017 was the closest year we have to witnessing a “perfect season” in the investment markets. All the major asset classes had positive returns. The S&P 500 Index did not have a single month in which the return was negative. In fact, October 2016 was the last month with a negative return which is an unprecedented run. The S&P 500 also had historically low volatility as the index did not experience a daily move, up or down, of 1% or more in 2017. In each of the previous 4 years, there was an average of almost 22 such days. World stocks rebounded and generated higher returns than the U.S. equity indices.My father was a Hall of Fame basketball coach in South Dakota. That is an important job because when it is 20° below zero in January with 2 feet of snow on the ground, people need a distraction. As a new season was approaching following a particularly good year, he would say “it is a short trip from the penthouse to the outhouse.” So, are we in for an “outhouse” season in the investment markets in 2018? Here are some of our thoughts for this year.Statistically, we are due for a stock market correction.A correction is defined as a 10% or more decline. Over the last 50 years, the S&P 500 has declined on average at least 10% every 24 months. The last one of these drops was February 11, 2016, almost 2 years ago. It is important to note that a 10% correction does not mean a negative return for the calendar year which is illustrated in the following graph.We anticipate higher levels of volatility in the equity markets.We wouldn’t be surprised to see a return of increased volatility following the historically low level in 2017. As equity valuations increase with the rise in equity prices, any hint of bad news can have more pronounced effects on the fluctuation of prices. Bad news can exist in the form of earning expectations not being met, higher inflation than anticipated, interest rates moving up more than expected, and obviously unexpected global/political unrest. International equities may continue to outperform U.S. equities.The following chart provides some interesting insights. Although international equities had a banner year in 2017, you can see international returns following the 2008-09 downturn have significantly trailed the US equity markets. As economic recovery has solidified in many of these countries, equity valuations are attractive. In addition, many experts believe the US dollar may weaken which is positive for international returns. Asset allocation is important in both up and down equity markets.It intuitively makes sense that diversifying your assets among different kinds of investments is the right thing to do when equities go through difficult times. It may not be as clear to the benefit of diversification when the equity markets soar as they did in 2017. The bottom line is that we don’t know when the equity markets will go up or go down. An interesting statistic we came across recently showed that there was more cash held in checking, savings, and money market accounts than the total of either consumer spending or mortgage debt. Obviously, some of the cash is being used for short-term needs, but we believe a good portion has been sitting on the sidelines out of the equity markets waiting for the “right time” to invest. Unfortunately, no one rings a bell signaling that time. Our philosophy of diversification allows you to participate in the equity markets with an allocation that is customized to both the timeframe of your goals and your ability to tolerate risk. The “Perfect Season” is hard to repeat. None of the teams referenced previously did. We don’t anticipate a repeat in the investment markets from what we experienced in 2017. However, we don’t expect having a trip to the “outhouse” either. Whatever the season holds in store, we will be providing our best coaching along the way.