That is not our forte, nor our mandate. Our primary job is to protect our clients' financial assets and to earn worthwhile long-term returns on their investments. That said, 2017 was clearly a banner year. Stock prices rose nearly 20% on average, driven by solid growth of corporate earnings against a backdrop of very low inflation, which sustained low interest rates even as the Fed began to normalize monetary policy. In addition, the trade-weighted value of the US Dollar declined approximately 10% from its prior peak, which improved our export position and increased the translation back to Dollars of foreign-source earnings. Together, these factors sustained a modestly above-average valuation for equities.
Looking ahead into the new year, there are clearly reasons for optimism regarding further gains in stock prices, albeit not without recognition of some risks. On the plus side, there is clearly underway an accelerating global economic expansion, which should enable another year of solid growth of US corporate profits. The recently enacted tax legislation will augment further the rate of profit growth, although there likely will be some adverse unintended consequences. The biggest risk to the economy and the financial markets would be a significant increase in the overall rate of inflation. Unless inflation rises enough to tighten financial conditions and boost long-term bond yields significantly, the current valuation of equities should be sustained, although no general increase in P/Es should be expected this year. Ergo, the most likely outcome is that stock prices will track earnings gains.
The FOMC has indicated its preference for a cautious, go-slow approach to boosting the Federal Funds rate. Of course, this is contingent on the economy not overheating and inflation remaining tame. Fundamentally, inflation is always the major risk to equities and to the economy as a whole. Finally, there is a litany of well-known geopolitical risks, few of which are subject to high-confidence predictions, but any one of which could flare up and negatively impact economic activity.
Against this generally favorable backdrop, we approach the months ahead with optimism, tempered by a healthy measure of caution. In our investment decisions, we will not chase strength, but instead we will continue to seek out underpriced value. Should the risk factors dictate, we will not hesitate to move into a defensive position. If this involves holding well-above average amounts of cash reserves for a time, so be it. Our business is a marathon, not a one-hundred yard dash.
