Q MARKETS REVIEW
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1 Stock markets around the world continued their ascent during the quarter as investors took solace in continuing corporate earnings growth, fueled by strong global economic growth, and U.S. tax cuts. Overview Global stock markets delivered another strong quarter on the back of global economic expansion, increasing corporate earnings, and U.S. individual and corporate tax cuts. In November, President Trump nominated Jerome Powell to chair the Federal Reserve (Fed) and lead the unprecedented task of normalizing the U.S. monetary policy of the past decade by increasing the Fed funds rate and reducing Fed bond holdings. In December, the Fed voted to raise the federal funds rate by 25 basis points (0.25%), to a high end of 1.50%, citing labor market strength and better-than-expected economic growth. The global economic expansion continues to gain momentum with the United States, Europe, and Japan leading the charge. The global aggregate purchasing manufacturers index reach a six-year high in December. The increase in activity has helped fuel a rebound in the demand for commodities. China s contribution to global economic growth, while solid for the quarter, was somewhat muted as China took measures aimed at cooling their overheated stock and real estate markets. U.S. companies delivered a stellar quarter of earnings growth. Third quarter data indicated that three out of four companies in the S&P 500 beat their average earnings estimates and that two out of three companies beat their revenue estimates. Actual earnings growth was 6.4% for the quarter and revenue growth was 5.8%. The fourth quarter is looking even better with earnings estimates compiled by Factset forecasting an earnings growth rate of 10.5%. (estimates are subject to change). The depreciation of the U.S. dollar took a pause in the fourth quarter. The U.S. tax cut and a Fed rate hike offset optimism that the economic outlook in the rest of the world was improving at least as quickly as the U.S DXY: Dollar Index Spot As of: 12/31/2017 Source: Bloomberg S&P 500 is a registered trademark of Standard & Poor s Financial Services LLC
2 Change in Thousands of Persons Q Job growth rebounded after falling off in September in the wake of hurricanes in Texas and Florida. Despite signs of a tight labor market, strong economic growth and positive consumer and business sentiment continue to support payroll growth. The U.S. Economy The gross domestic product (GDP) grew by 3.2% in the third quarter. Economic growth was broad-based with participation from consumer spending and services, as well as growth in durable and non-durable goods. The December global Purchasing Managers Index (PMI) for the U.S. remained firmly in positive territory, signaling continued growth. The University of Michigan U.S. consumer sentiment survey rose to a 13- year high in December. This shift upward was unexpected though understandable given record stock market highs, low unemployment, and economic activity driven by post hurricane recovery efforts. Sentiment also remains high across businesses which generally translates into near-term economic activity. U.S. hiring levels rebounded from September s hurricane-related weakness though they came in below expectations. Falling employment in retail tempered employment gains in health care, contractors, manufacturing, and hospitality. As the labor market continues to tighten wage growth, which has been sluggish, could accelerate. Change in Total Non-Farm Payrolls Sources: St. Louis Fed, U.S. Bureau of Labor Statistics As of: December The Fed continued to follow through on the unprecedented task of normalizing a decade of U.S. monetary policy by beginning to reduce Fed bond holdings in October and by increasing the Fed funds rate by another ¼ percent in December. Inflation & Monetary Policy Headline Consumer Price Index (CPI) inflation moved up to 2.2% yearover-year in November. Rising energy prices were the primary contributor while apparel and new and used vehicle prices were down. Other measures of inflation such as the Core Personal Consumption Expenditures (PCE) deflator preferred by the Fed showed less rapid price gains. Despite tepid inflation, the Fed still decided to raise the Fed funds rate in December by 25 basis points, with a new target of 1.50%. The Fed cited labor market strength and better-than-expected economic growth and also signaled further rate hikes in A weaker dollar over the past twelve months, higher oil prices, low unemployment, and a strong housing market could shift inflation higher. 2
3 Europe and Japan showed signs of economic momentum while China s Party Congress was held against the backdrop of less rapid growth. The Global Economy Improvements in the global economy continued in the fourth quarter with Europe and Japan leading the pack. Europe grew by 2.6% year-over-year through the third quarter, the highest level of growth since the first quarter of This was primarily due to greater household consumption, fixed investment, and exports. Japan s economy expanded at an annualized rate of 2.5% in the third quarter. This was in addition to improved market expectations in business spending and exports. Despite the positive economic data, the European Central Bank and Bank of Japan each maintained monetary stimulus. The momentum of global growth is powerful as manufacturing experiences a strong rebound. The global manufacturing purchasing managers' index (PMI), a measurement of manufacturing's health, rose to 54 in November, its highest reading since March 2011 (readings over 50 represent growth). China s ruling Communist Party held its quinquennial congress in October and appointed current President Xi Jinping to his second five-year term as President. This congress consolidated President Xi s power and enshrined his principles in place as China seeks to move from an economy led by fixed investment to one more balanced by consumer demand and business innovation. Investors continued to bid up U.S. stock prices in the fourth quarter fueled by a tax cut, economic momentum and strength in corporate earnings. U.S. Stocks U.S. stocks finished off the year with rapid gains due to a near goldilocks environment characterized by an accelerating global economy, improving corporate earnings, and delivery on the promised U.S. individual and corporate tax cuts combined with only modest inflation. Geopolitics and natural disasters remained background noise to investors. Most valuation measures show the U.S. equity market as expensive but bond yields are also low, underscoring the importance of diversification outside of U.S. Stocks and bonds. S&P 500 -Trailing Twelve Months Sources: Bloomberg As of: 12/29/ Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
4 Growth outpaced value again in the quarter, while small cap stocks reacted positively to President Trump s tax proposals. Market Cap & Style Gains were broadly positive during the quarter. Growth stocks had another strong quarter. Pessimism towards old economy companies whose costs are sensitive to rising energy prices weighed on the value and small cap indexes. U.S. Large Cap Stocks S&P 500 Composite U.S. Mid Cap Stocks Russell Mid Cap U.S. Small Cap Stocks Russell 2000 U.S. Value Stocks Russell 3000 Value U.S. Growth Stocks Russell 3000 Growth Source: Morningstar Direct as of 12/31/2017 Global economic strength and a weaker U.S. dollar in 2017 drove information technology stock prices to even higher prices while rising rates supported financial services stocks. Sector Investors bid stocks in the information technology sector up during the quarter partly due to the lower corporate taxes and the benefit of a lower U.S. dollar for the large component of sales outside the United States. Stocks in the financials sector benefited from rising interest rates which generally translate into higher profit margins. S&P 500 Index Sectors Weights (%) QTD (%) Consumer Discretionary Consumer Staples Energy Financials Health Care Industrials Information Technology Materials Real Estate Telecommunication Services Utilities Attribution Total 4.48 Source: Morningstar Direct as of 12/31/2017 International stocks outpaced U.S. stocks with emerging markets leading the way. International Stocks Continued signs of solid economic activity across Europe and Japan helped international stocks during the quarter and the year. The purchasing manufacturers index (PMI) in Europe achieved an all-time high of 60.6 in December and the PMI In Japan achieved a 4-year high of 54 in December. Investors reacted to these signals by bidding up the price of both international stocks and commodities. The falling U.S. dollar, which benefited international stocks for most of the year, was less of a factor in the fourth quarter. 4
5 Further signs of improving economic conditions and expectations for the Fed to continue to be dovish as they hike the Fed funds rate helped emerging markets to a strong quarter. Stronger global growth and modest inflation supported emerging market stocks for the quarter and the year. Faster growth supports earnings while low inflation allows local central banks to maintain lower interest rates. Investor confidence that the Fed will not hit the brakes too hard as they remove monetary stimulus also supported capital flows into emerging markets. Developed Market Stocks (USD) MSCI EAFE (net) Developed Market Stocks (LCL) MSCI EAFE (net) LCL Currency Impact Emerging Market Stocks (USD) MSCI EM (net) European Stocks (USD) MSCI Europe (net) Japanese Stocks (USD) MSCI Japan (net) The U.S. Treasury yield curve flattened as the Fed raised the Fed Funds rate on the short-end while yields on longer-dated Treasury bonds did not follow suit. Historically yield flattening has often occurred near economic slowdowns. However, nearly a decade of unprecedented monetary and fiscal stimulus is making it more difficult to predict. Pacific Country Stocks (USD) MSCI Pacific Ex Japan (net) Source: Morningstar Direct as of 12/31/17 Fixed Income The yield on the 10-year U.S. Treasury bond moved higher for the quarter, peaking in late December before falling at year-end. The yield curve flattened in the quarter, as the spread between 10-year and 30-year Treasury bonds fell to 0.34% from over 0.60% a year ago. A flattening yield curve often accompanies the late stages of a credit cycle though this time may different given unprecedented monetary policy. The Fed raised the Fed funds rate three times in 2017, including at the December meeting. This brought the target for the Federal Funds rate to between 1.25% and 1.50%. Fed projections suggest three more rate hikes in 2018, though market prices suggest only two for the year. Rising rates make fixed income investing more challenging and investors should remember that losses are possible in bonds. 10-Year U.S. Treasury Yield -Trailing Twelve Months Sources: St. Louis Fed, Board of Governors of the Federal Reserve System (US) As of: 12/29/ Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec 2 5
6 U.S. long duration treasuries delivered strong returns in the fourth quarter as bond investors curtailed their expectations for long-term economic growth in the face of Fed rate hikes. Regions International and emerging markets bonds delivered positive returns for the quarter. Continued confidence in global economic fundamentals provided support to non-u.s. bond returns. Emerging market bond prices lost ground in the first half of the fourth quarter but rallied in the second half with the passing of U.S. tax cuts. Credit High yield bond prices had a tepid quarter as spreads (difference in yield versus U.S. Treasury bonds) spiked up in mid-november before coming back in by quarter end. Duration Even as the Fed Funds rate moved higher at the end the quarter, bond prices generally held steady. Long government bonds, as measured by the Bloomberg Barclays US Treasury 20+ Year Index, outperformed both corporate and high yield bonds as the yield curve flattened during the quarter. U.S. Bonds BBgBarc US Agg Bond Developed Market Bonds BBgBarc Gbl Agg Ex US Emerging Market Bonds JPM EMBI Global U.S. Corporate Bonds BBgBarc US Corp IG U.S. High Yield Corporate Bonds BBgBarc US Corp High Yield U.S. TIPS BBgBarc US Treasury US TIPS U.S. Long Duration Treasuries BBgBarc US Treasury 20+ Yr Source: Morningstar Direct as of 12/31/17 Higher prices for oil and copper supported the Bloomberg Commodity Index during the quarter. Real Estate & Commodities Real Estate Investment Trusts (REITs) delivered positive returns for the quarter despite the Fed rate hike as strong holiday sales overcame concerns about the disruption in brick and mortar retail. Falling inventories and global economic strength pushed commodity prices higher. West Texas Intermediate oil prices ended the quarter at $60.46, up $14.50 from the end of September. U.S. Real Estate DJ US Real Estate Commodities Bloomberg Commodity Gold Bloomberg Sub Gold Source: Morningstar Direct as of 12/31/17 6
7 Conclusion The passage of a tax bill that many doubted could happen added fuel to stock markets at quarter end as near goldilocks conditions were already supporting prices. Low inflation and surging earnings growth provided a powerful combination to support stock prices. Optimism is elevated for consumers, businesses, and stock investors which reinforces the trend. The results for 2017 were positive total returns for the S&P 500 Index in every month of the year. Despite the feel good atmosphere, risks remain, including geopolitical hotspots such as the Middle East and on the Korean peninsula. The political and policy atmosphere in Washington D.C. also remains uncertain. Two of the biggest questions in 2018 will be whether inflation finally spikes higher and whether stock prices can continue to rise in the face of high valuations which could degrade future returns even if the real economy delivers growth. As investors fall back in love with stocks, the current price trend is higher, but the risk of an eventual stock market sell-off looms larger. After years of gains in both stocks and bonds, it is worth remembering that it is possible for both to decline. We believe that investors who stick with a disciplined, diversified plan are best positioned to capture the benefits of shifting trends in the markets. The performance data cited in this document represents past performance and should not be considered indicative of future results. Current performance may be lower or higher than return data quoted herein. Investors should carefully consider investment objectives, risks, charges and expenses. These materials and the platform of investments made available by MassMutual are offered without regard to the individualized needs of any plan, its participants, or beneficiaries. These materials are not intended as impartial investment advice or to give advice in a fiduciary capacity to any plan. This and other important information about the platform of investments made available by MassMutual is contained in fund prospectuses and summary prospectuses, which can be obtained from and should be read carefully before investing. These investments are not FDIC-insured, may lose value and are not guaranteed by a bank or other financial institution. The information provided is the opinion of MassMutual Funds Investment Management as of 1/15/2018 and is subject to change without notice. It is not to be construed as tax, legal or investment advice. Past performance does not guarantee future results Massachusetts Mutual Life Insurance Company (MassMutual), Springfield, MA All rights reserved. RS
Q MARKETS REVIEW
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