As we entered 2017, we thought conditions were ripe for positive equity returns; something on the order of 8-10%. It turned out substantially better, with all the major U.S. equity indices returning double digits for the first time since 2013, and international indexes doing even better.
Our proprietary screening models are revealing more interesting companies from a broad range of sectors.
For active managers like us, digging deeper reveals an even better story. As the year progressed and concerns of overvalution grew, we remained bullish. The economy was picking up. Jobs were still being created. Earnings were still strong and growing. And we continued to identify names whose value we felt was not fully reflected in their price. Valuations aren’t cheap, but we still define them as fair.
We did witness periodic rotations from sectors that had done well (i.e., semi-conductors and software) to sectors that had lagged (retail and financials). For example, Amazon finished the year up over 50%, beating the S&P by 30%. Yet there were points where Amazon lagged the broader indices by more than 10%. The same thing happened with banks, retailers, semi-conductors and others.
The Consumer Discretionary sector was the strongest in Q4, after posting the weakest returns in Q3, and Technology returns were among the strongest, again. Energy and Telecommunications, two sectors struggling with volatile commodity prices and intense competition respectively, were the only sectors to post negative returns for the year, despite turning positive in the second half.
The widespread reach of automated trading programs and passive investors contributed to a general reduction in volatility in equity markets. Underneath, however, correlations between specific sectors, industries and companies are dropping from the high levels seen during the Quantitative Easing programs from the Federal Reserve. It is in markets like this where fundamental analysis is rewarded.
This expansion is unique as one of the slowest developing on record; nine years averaging 2% economic growth. The passage of time, a flattening yield curve, and peaking merger and acquisition activity suggest we are in the late part of the business cycle. Yet, high growth and consumer businesses are doing better than defensive names, while manufacturing indices and economic growth are accelerating. Along with fiscal policy boosts like tax reform and regulatory relief, these are all early cycle characteristics, which makes marking our place in the business cycle complex.
On balance, we see a business cycle that still has room to run. Better still, we have moved to a higher cruising speed.