Adjusted for a weaker U.S. dollar, S&P 500 gains in 2017 were less impressive than meets the eye, and offer yet another reminder why portfolios should diversified globally, according to analysts at New Frontier Advisors.
The S&P 500
rose 19.4% last year, fueled by optimism over corporate tax cuts and favorable economic growth environment as well as low inflation. The stock market performance, attributed in part to a strengthening economy, stands in contrast to a flattening yield curve and a weakening U.S. dollar, both of which signal low economic growth in the long term.
The yield curve—the difference between short-dated and long-dated yields—has been flattening steadily since 2013, when it was at about 265 basis points. The spread between two-
and 10-year Treasury yields
is currently at 60 basis points.
An inverted yield curve preceded all of the past seven recessions, but a flattening yield curve does not always mean it will invert. In fact, the yield curve steepened over the past few weeks after narrowing to 48 basis points.
The ICE U.S dollar Index
which measures the greenback against six other major rivals, fell by 9.8% in 2017, despite the Federal Reserve increasing interest rates three times last year and promising three more hikes in 2018.
A weaker dollar also makes U.S. assets less attractive to foreign investors, resulting in diminished demand.
“When we adjust for the dollar weakness [by using the ICE dollar index], the actual return in 2017 was 7.4%, or below the average return since 1957, which is 8.6%,” said Robert Michaud, chief investment officer at New Frontier Advisors.
“It is true that 7.4% return is still positive, but from an international investor’s point of view, it’s mediocre,” Michaud said.
For European investors, for example, the nominal gain in the S&P 500 in euro terms, was only 4.9%, according to FactSet.
But even U.S.-based investors should consider mitigating the currency risk by diversifying their portfolios, according to Michaud.
“From a purchasing power perspective, the U.S. market peaked in at the beginning of March 2017. U.S. investors, even if they spend money only domestically cannot ignore this, because we live in a global economy,” he said.
The S&P 500 is up another 6.1% so far in January, and with only five trading days left in the month, it is shaping up to be one of the best monthly performances since March 2016. Meanwhile, the dollar weakened another 3% against its main rival euro and Japanese yen and fell 5.2% against British pound.
The dollar slumped to a three-year low on Wednesday, with the ICE dollar index falling 1% to 89.24 on Wednesday after Treasury Secretary Steven Mnuchin at the annual meeting of the World Economic Forum in Davos said he wasn’t concerned about the currency’s recent decline. “A weaker dollar is good for trade. In the longer term, a stronger dollar is a reflection of the strength of the U.S. economy,” he said.
“Euphoria in the stock market right now is pretty high. I certainly would not want investors taking out mortgages to invest in stocks right now, but it’s also not a reason to sell everything. Ideally, investors would have more global perspective all along and have a diversified portfolio,” Michaud said.