Kai W. Hong, CFA
Managing Partner & Chief Investment Strategist
The quarter started with the absence of any major economic or geopolitical news. That left investors to contemplate the generally sanguine and oddly complacent nature of the markets. In the US, the Republican tax plan was the main political story as people assessed both the substance of the legislation (potential elimination of various tax preferences, permanent reduction in the corporate tax rate) and likelihood of passage. Meanwhile, US Fed policy continued along the same path of gradual reduction of its balance sheet, support for periodic and modest rate increases, and copious amounts of messaging regarding this approach. Outside of the US, Brexit negotiations continued to be halting with little progress made between the UK and the EU. Optimism propelled the markets forward as investors anticipated a continuation of steady economic growth, good corporate performance, and accommodative monetary policy. As markets pressed upwards, discussions shifted from a focus on valuations to justifications for continuing bullishness. Corporate M&A activity was robust as corporate and private equity cash supported transactions. A lot of attention was also given to the remarkable rally in bitcoin (over +1,300% this year!) as option exchanges launched futures contracts but policymakers warning of risk. With people lined up on both sides of the debate, only time will tell whether bitcoin can live up to the hype that has driven its value to such lofty levels. The US Fed raised interest rates for the third time in the year and re-iterated its guidance for further increases in 2018. As the year ended, the Republican tax plan passed the US Congress with the headline change being a decrease in the corporate tax rate from 35% to 21%.
For the quarter, the US broad market Russell 3000 Index finished at +6.3%, bringing the full year return to +21.1%. More impressively, this was all accomplished with historically low volatility and no negative monthly returns during the year. Returns in US small cap stocks were also robust for the year, but not nearly as strong as their large cap counterparts. The Russell 2000 Index returned +3.3% for the quarter and +14.7% for the year. Outside of the US, performance in developed markets rebounded from several years of lackluster performance to finally outpace the US. The MSCI World ex USA Index returned +4.2% for the quarter and +24.2% for the year. Developing market performance was even better with the MSCI Emerging Markets Index returning +7.4% for the quarter and +37.3% for the year.
Market volatility remained at the low end of historical ranges on both an implied (VIX-based) and realized basis. Trade volumes remained quite low, particularly in the second half of the year. At the factor level, Smaller Size and Value were significantly negative for the quarter and the worst performing factors for the full year period. Momentum and Quality were positive for the quarter and the best performing factors for the full year period. Equal-weighted portfolios underperformed market-cap weighted portfolios for the quarter and year, which continued to highlight the leadership of a handful of mega-cap Technology names during this period. At the sector level, Consumer Discretionary and Technology were the best performers for the quarter. The Technology sector’s +35% return for the year was well over 10% better than the return of the next best sector, Consumer Discretionary, which returned +22%.