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Byron, Lisa, Jerry, Tony, Darin and Ian
The year was a big winner for investors, with all major U.S. stock market averages surging to new highs. Price volatility was remarkably low in the face of a gauntlet of worrisome headlines in the news media. The Federal Reserve can declare victory, as they successfully raised short-term interest rates three times during the year without disrupting capital markets. Congress pulled a tax rabbit out of their hat at the last minute, giving a generous holiday gift to American companies. Capital markets enter 2018 on positive footing, and there is notable optimism for the year ahead.
Tax reform is providing momentum to stocks as we begin the New Year, lifting forecasts for anticipated corporate profits and overall economic activity. The new tax program was designed to energize the corporate sector, with a significant reduction in the top marginal rate and incentives to repatriate cash currently held overseas. The program’s impact on individual taxes is more ambiguous, with lower rates potentially offset by limits on the deductions for state taxes, property taxes and mortgage interest. Workers are expected to benefit, as companies will be able to afford new hiring, wage increases and capital expenditures. Some companies have already reacted to the tax bill by offering one-time bonuses, higher pay and increased 401(k) contributions for employees. Wall Street anticipates double-digit gains in corporate earnings for 2018, and shareholders will be counting on those profits to boost share values and dividends.
The bond market has weathered an important shift in monetary policy better than expected. The Federal Reserve began to back away from its historic program of monetary stimulus a couple years ago. They ended “quantitative easing” and began to nudge short-term interest rates upward. So far, the bond market has reacted calmly. Janet Yellen, who has overseen this transition, will wrap up her term as Chair of the Fed next month. Jerome Powell will take over, and he is widely expected to continue along the path of gradual monetary tightening. At their December meeting, the Fed improved its forecast for the economy and affirmed plans for three rate hikes in the coming year. While short-term rates have inched higher, the yield on the 10-Year Treasury note finished 2017 at 2.40 percent, nearly unchanged from the 2.44 percent a year earlier, and the rate on 30-year fixed mortgages remains under four percent.
Our economy added 2.1 million jobs in 2017, and the picture appears promising for workers. Hiring has increased every month for 87 consecutive months, the longest period of expansion on record. The current unemployment rate of 4.1 percent is already low, and that figure is expected to dip to around 3.9 percent this year. Wage growth has been surprisingly muted in light of new job creation, allowing inflation to remain near the Fed’s target rate of two percent. As talent becomes scarce, companies will need to increase wages to attract new employees. A tightening labor market will be good for workers, yet we will be on the lookout for hints of accelerating inflation. Inflation rates above three percent could startle the bond market and create drama for interest rates.
One of the more colorful stories of 2017 is the astounding surge in the price of bitcoin and other cryptocurrencies. Advocates cite the computer-generated currencies’ ability to discreetly transfer value outside the boundaries of traditional government surveillance and regulation. This is a valuable feature for clandestine activities. However, we do not believe the dollar’s role in our economy will be jeopardized by bitcoin or the multitude of burgeoning competitors that have attracted an intense amount of hype. It seems likely the anonymous and unregulated nature of cryptocurrencies will eventually be challenged, as the IRS takes action to tax trading profits and the federal government asserts its regulatory authority over the nation’s money supply. In the meantime, we view them as highly speculative assets.
Another interesting story concerns the steady decline of publicly-traded companies in recent decades. According to the University of Chicago’s Booth School of Business, the number of publicly-traded companies has dropped roughly in half over the recent twenty year period. Some went out of business. Others were acquired or taken private to avoid stringent regulatory listing requirements. A huge amount of capital is now available through venture capital and private equity funds, which provide a competing source of money for growing businesses. Robust capital markets have been central to the development and financing of innovation in our American economy since the start of the Industrial Revolution, but that is an advantage that cannot be taken for granted. The opportunities available to investors depend upon the most successful businesses finding it attractive to “go public,” so that investors can participate in their growth.
We are grateful for the productive year in 2017, and there are good reasons to be optimistic about the economy and capital markets for the coming year. Earnings, interest rates and employment appear to be in good shape. We wish you and your family a healthy, happy and prosperous New Year.
Past performance is not indicative of future results. The information contained in this report is based on internal research derived from various sources and does not purport to be statements of all material facts relating to the items mentioned. The information, while not guaranteed as accuracy or completeness, has been obtained from sources we believe to be reliable. Opinions expressed herein are subject to change without notice.
West Oak Capital, LLC
2801 Townsgate Road, Suite 112
Westlake Village, California 91361
Ph. 805.230.8282, Fax 805.230.8283