Q4 Letter: Optimism
Over the holiday season, most people enjoyed time with family and friends and, hopefully, counted their many blessings. However, I encountered a few people at holiday parties who expressed a very pessimistic outlook on our society. Their outlook generally was the result of the constant barrage of negative news and seemed most often related to racism, the prevalence of sexual harassment, violence, income inequality, political polarization (and the daily presidential tweets), health care, poverty, and immigration. While there are certainly many societal ills, we must all remember that such large-scale issues take a very long time to solve. Prior to 1920, women did not have the right to vote in the United States, and did not flock to the polls in the same numbers as men until 1980. Slavery was officially abolished in our country in 1865, yet the Civil Rights Act was not passed for nearly 100 years. Many aspects of our society are far better today than they were 50, 100 or 200 years ago.
Sustainable, responsible and impact (SRI) investing reflects the power of private capital to deliver positive change, and I write about some aspect of SRI investing each quarter. From a broader investment and economic perspective, there is plenty to be optimistic about as we head into a new year. As you’ll read below, the investment markets soared in 2017. The US economy continued its recovery/expansion (now in its ninth year) and our unemployment rate may reach a record low this year. Synchronized global economic growth was achieved in the past year, which set the stage for rising stock prices and innovation. Congress passed a tax bill that should be a boost to the US economy in the short-term (the long-term effect is far more nebulous). Outside of geopolitical issues and unexpected shocks to the system, there seems to be little that could derail the economy in 2018.
It is during this time of year that investment “experts” are often asked to make predictions about the stock market for the next 12 months. Of course, nearly all these so-called experts get it wrong. Investors must gauge their return expectations to their own time horizon and purpose of their money. In general, investing (as opposed to speculating) in the stock market has to be done with a very long-term view. So, here is my most statistically accurate “prediction” of future returns for 2018 (sorry for the bit of sarcasm):
US Stocks -39% to +47% US Bonds -8% to +43% Balanced Portfolio -15% to +33%
Please see the chart below (courtesy of JPMorgan) which illustrates that the longer an investment is held, the more narrow the range of expected returns. The chart also highlights the benefits of a balanced and diversified portfolio.
I learned first-hand last year that none of us is promised tomorrow, so we must live in the moment and be the best we can be each day. Bit by bit, good people are helping to make a positive difference in the world every day…often simply in the lives of only one other person that they touch that day. While there are so many things out of our control, we can prepare our hearts, minds and finances for what may lie ahead. We can prepare ourselves with optimism and hope for the future (humor and humility also help!).
2017 Q4 Review
Yet another strong quarter, and remarkable year, for investment performance! For the quarter and the year, large cap stocks earned more than small cap stocks and the growth style dominated the value style. The best performing sectors in the S&P 500 Index in 2017 included Technology (+38.8%), Materials (+23.8%), and Consumer Discretionary (+23.0%). The worst performing sectors during the year included Telecom (-1.3%), Energy (-1.0%) and Real Estate (+10.8%).
Non-U.S. stocks, in both developed and emerging markets, really surged in 2017. During the year, the best performing countries included China (+54.3%), India (+38.8%), and France (+29.9%). Only Russia (+6.1%) delivered single-digit returns for US investors. The U.S. Dollar generally fell relative to most other currencies in 2017, increasing returns for U.S. investors in international stocks.
The fixed income markets also delivered positive returns for the year as lower credit quality and emerging markets bonds led the way, consistent with an optimistic stock market. Cash (money market funds) yields remained low and steady during the quarter.
Hedging strategies generally delivered positive returns in 2017, with the HFRI Composite earning +7.6%.
Here are the returns for select market indices for Q4 and calendar year 2017 (as stated in US Dollars):
Responsible Investing Corner
In yet another example of how the global society has improved over time, Domini Impact Investments issued a paper describing their work in the area of protecting migrant workers around the world. Domini, along with other responsible investors, civil society organizations, corporations and public institutions have made great strides addressing working conditions in global supply chains. Domini states that: “Twenty years ago, companies argued that they carried no responsibility for working conditions in factories they did not own. We no longer hear that argument.” In an estimate by the International Labor Organization, nearly 21 million people work as forced labor, mostly within private sector industries such as manufacturing, construction and agriculture. Many workers are exploited by unethical recruiting agencies, who often charge fees to the worker in excess of months’ worth of wages earned.
Businesses can have a powerful impact on protecting the rights of workers. Domini sites a case study about Apple, who back in 2004 was silent about working conditions in its supply chain. After much dialog with responsible investors, Apple has adopted and implemented a strong code of conduct for its suppliers. Apple now actively works on human rights problems in its supply chain. You can read success stories and their progress report highlighting Apple’s measurement of suppliers in three main categories: labor and human rights, environmental responsibility, and health and safety at www.apple.com/supplier-responsibility. The advocacy efforts of Domini and other responsible investors have resulted in similar successes at Adidas, Motorola, and Ralph Lauren, among other companies around the world.
On a separate note, GMO is a large institutional investment firm that is very environmentally conscious, reflecting the values of its founder, Jeremy Grantham. For many years, there has been an industry debate about the investment merits of “divesting” portfolios of certain companies or industries (there is less debate about the power of divestment movements to induce positive social change). Many investors have assumed that divesting from a specific industry, such as oil (fossil fuel producers), would necessarily result in reduced portfolio returns. GMO conducted a study that concluded over the past 28, 60 and 92 years (since the inception of the S&P Composite Index), one could divest from oil – or any other sector – without much consequence. Eliminating any sector would have resulted in a return spread of only 0.54% over this time period (-0.16% to +0.38% relative to the total return of the full index). Investors who feel strongly about the negative effects of fossil-fuels could divest from the sector and still have a chance for a reasonable investment outcome.
This and That
I was recently given the 2017 Edition of The Economist Pocket World in Figures, and here are some random statistics from that booklet:
The U.S. has the world’s largest economy, with a GDP over $17.3 trillion. China has the second largest economy at $10.4 trillion…more than double the #3 economy, Japan.
A quality of life metric, the Human Development Index, shows Norway on top, with the U.S. ranking 8th. A variation, the Inequality-Adjusted HDI, shows the U.S. falling to the 27th ranking.
The highest divorce rate belongs to Guam (the U.S. is ranked 13th) and the country with the lowest divorce rate is Chile.
The U.S. ranks 2nd (tied with New Zealand) in the World Giving Index, which is a survey of people who either give money to charity, give time to those in need, or helped a stranger.
The most polluted capital city in the world is Delhi, India…by a wide margin. Fortunately, no U.S. cities are in the top twenty on this list.
In the “Species Under Threat” category, Indonesia leads the world in threatened mammals and the U.S. leads the world in threatened fish.
The world’s highest life expectancy is in Monaco and the lowest life expectancy is in Swaziland. The U.S. ranks 48th in this category.
Here is this quarter’s closing quote: “It is a great danger if inequality becomes so extreme that it can threaten democracy.” – Angus Dalton, Princeton University economist and 2015 Nobel Prize winner in Economics.
Thank you for all your support during a very interesting 2017!
Gregory D. Wait, President
Prophecy Impact Investments, LLC