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Annual Report: Predictions for 2018 and Portfolio Performance for 2017

Annual Report: Predictions for 2018 and Portfolio Performance for 2017

My investment predictions for 2018

As the year comes to a close, it's time for my annual portfolio performance review, and predictions for 2018. Throughout this post, I'll be referencing my original portfolio and investment plan, so if you haven't had a chance to read it you might want to start there. 

Important note: You'll see that I make reference to my predictions from 2017, and make some fresh ones for 2018. These are mostly for fun, and to set my own expectations for the coming year. I would advise you to A) not take these predictions as advice and B) make sure you plan your investments on a long term basis, which is my plan for this portfolio. Individual years don't make much of a difference over the long run... it's mostly about making a good plan and sticking to it!

Investment Summary for 2017

In the second full year of my investment plan, my portfolio has been buoyed by exceptionally strong emerging market and large cap stocks. This was magnified by a well timed reallocation into emerging markets and stocks at the beginning of the year. Surprisingly, given the political climate, 2017 was defined by the near total absence of volatility. The portfolio (and many indices) grew for every single month of the year. It has been the most placid year in stock market history across many volatility metrics.

My investments have tracked their large cap benchmark fairly closely, although with slightly less return and slightly less volatility (as intended). I expect the portfolio to lag the benchmark in bull markets, and hopefully do much much better in bear markets. The lower volatility will be welcome in the bear markets to come.

2017 ends at an interesting crossroads. Although there aren’t many overtly negative signs in the world economy, the current expansion is nearly 10 years old, employment is at an all time high, and valuations (based on earnings) are at near all time highs. There isn’t a clear leveraged “bubble” as there was in 2000 or 2008, but there is significant froth. I am entering 2018 cautiously optimistic, with the expectation of modest gains across the portfolio, totaling around 8%. However, I expect volatility to increase significantly in the coming year due to geopolitical tension and the inevitable end of an aging bull market.

Vital Portfolio Statistics and Return (2017) 

Portfolio Performance (since 1/1): 17.2% (including 2.6% yield)

Benchmark Performance (VV): 20.12% return (including 1.97% yield)

Asset Allocation at Year End (change since 1/1/2017)

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Rebalancing Plan

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Every year, I evaluate the growth in the portfolio and see if there's anything I should do to drive the asset allocations closer to the desired "10 10's" - with each of the 10 indices evenly weighted at 10% of the total portfolio value.

This year, rebalancing will be relatively light as I intend to generally continue my slight over-allocation to stocks. However, I am decreasing that over-allocation slightly by adding a small amount of money to the long-term treasuries fund. At 7.69%, it's just way too far from 10%, and I'd like to start being a little more conservative after a banner year for stocks in 2017. With the new addition, nearly every index will be within 1% of the target allocation, which is just fine. 

Performance by Security

This is where it get's interesting. Every year I go through and review my predictions for the previous year, and then I take a look at how things actually went. After that I make some fresh predictions for the next year. Note that I don't base my investment decisions off of these predictions, it's simply a fun way to stay alert about my portfolio and aware of any potential rebalancing I may need to do to stay in line with my chosen allocation.

VWO (Emerging Markets)

  • Total Return: 29.79%

  • 2017 Predictions: Although China is a point of concern, there is reason to believe that Brazil could start to recover more strongly. Whether or not Trump rhetoric on trade will have an affect on these export driven economies is also unclear. Relative to historic values, and at a current yield of 3%, emerging markets appear to be a decent bargain at this point in time, and I remain bullish for a 5-10% gain in 2017, weighed only by Trump and continued issues in China.

  • Performance for 2017: Directionally, my thought process was accurate, but I was off by several orders of magnitude. Instead of a 5-10% jump, emerging markets surged 30% this year, with fantastic yield as well.

  • Predictions for 2018: I could almost copy what I wrote for 2017 and carry it forward for 2018. Leverage in China hasn’t become less of an issue, and some cracks are appearing in the facade of the highly leveraged corporations there (HNA group). However, strong sentiment continues to guide markets higher, and without a clear catalyst for a drop, it seems fair to predict a modest rise after this years meteoric surge.

VEA (Developed Markets Ex-US)

  • Total Return: 22.62%

  • 2017 Predictions: Although I am not bullish on Europe, the current yield of 2.85% is attractive. In a rising rate environment, that type of yield is an attractive way to maintain income without risking principle value. That being said, the structural issues with the single market and currency will restrict gains in this sleepy part of the marketplace to 2-3% in 2017. Until Europe figures out how to serve the different needs of a collection of vastly different nations under one currency, it will continue to be a backwater for investment.

  • Performance for 2017: My predictions for 2017 were laughably wrong. Europe (and the developed world in general) seemed to shake off the last vestiges of the financial crisis, with employment, consumption and sentiment all rising. Consequently, long-depressed stocks flourished.

  • Predictions for 2018: Although Europe (and Japan) had an excellent year, my long term outlook for developed markets outside of the US remains relatively subdued. Both Europe and Japan have aging populations with a historic bent against consumption. It’s difficult to know where growth may come from. This year’s outperformance rectified the low valuations in European stocks, and any further gains from here will be modest, likely under 8% for the year.

TLT (Long-term US treasuries)

  • Total Return: 8.31%

  • 2017 Predictions: With the US economy seemingly being loosed from any and all regulations, there is reason to believe the bull market in stocks will continue, rates will rise, and fixed income investments will fall in principle value. I expect long term treasuries to lose between 2-3% in the coming year.

  • Performance for 2017: Although my prediction for the US economy was quite accurate, the effect on long term treasuries was not. Despite rising rates and triumphant stocks, longer term treasuries had a strong year, with yields falling from 2.78 to 2.58% and principle balances rising accordingly.

  • Predictions for 2018: I believe the low volatility of 2017 will end in 2018, driving additional investment into the relative stability of treasuries in 2018. It is quite possible the yield curve will invert in 2018, with long term treasuries earning less than their short term equivalent. Unfortunately, that is also a bearish indicator: 6 out of the last 7 recessions were preceded by an inverted yield curve. I expect 5-6% total return for long term treasuries in 2018.

FM (Frontier Markets - Argentina, Turkey, Thailand, etc)

  • Total Return: 34.32%

  • 2017 Predictions: With an upswing underway in Argentina, the lingering doubts around the middle east are the largest drag on this index. The security has a decent yield, at 2.75%, so there is some benefit to owning it and risking the improvement in conditions in the underlying markets. I wouldn’t be surprised to see returns of 3-4% in this relatively lightly traded index.

  • Performance for 2017: 2017 was an amazing year for long depressed emerging markets, and as expected, this had an uplifting effect on “emerging” emerging markets as well. FM was by far the best investment within the portfolio in 2017.

  • Predictions for 2018: Turkey, along with the other middle eastern countries in this index, will likely be a drag on the index (unless oil prices rise significantly). However, the other countries that comprise the index, like Argentina and Thailand, will likely continue their rise as their regional economies continue the exciting growth of 2017. That being said, it is likely that the rise in this index will not be as strong as in 2017, and there is always a potential for China-driven volatility and losses in emerging markets as a whole. I am expecting 10% growth for FM in 2018.

VNQ (REIT - US)

  • Total Return: 4.52%

  • 2017 Predictions: There’s no reason to expect much of an increase, after many years of gains, but 3-4% seems reasonable given a strong US economy.

  • Performance for 2017: With the collapse of American retail, VNQ brought in the most disappointing return of 2017 across the portfolio.

  • Predictions for 2018: Across the world of real estate, there are caution bells ringing. Retail will likely continue to suffer from the Amazon effect. Apartments have been overbuilt over the past several years, and will likely suffer from lower rents in the coming year. Residential homes will suffer from lower deductions for mortgage interest from the Trump tax plan. Still, this index does return a healthy 4% yield, so in aggregate I would expect a modest 3-4% loss.

VCLT (Long term US corporate bonds)

  • Total Return: 9.62%

  • 2017 Predictions: As with treasuries, there isn’t much to look forward to here. Rising rates will lead to a 1-2% decline in this index for 2017.

  • Performance for 2017: Corporate bonds actually did quite well in 2017, with a nearly 10% rise. Rising expectations, profits and sentiment across all US markets led to a drop in yields, and a rise in principle value for corporate bonds.

  • Predictions for 2018: The rising volatility I expect in stocks will likely affect this index as well. Along with rising rates, it seems foolish to expect significant gains here. I predict a flat 2018.

VV (Large Cap US)

  

  • Total Return: 20.12%

  • 2017 Predictions: If investment increases along with sentiment, corporate profits will likely follow leading to price increases. I see 5-10% return for VV in 2017.

  • Performance for 2017: Although I was wrong about the magnitude of the increase, generally my prediction for 2017 was spot on. Large cap stocks gained over 20% over the course of the year with exceptionally low volatility and increasingly positive sentiment. By many accounts, it was the least volatile year on record.

  • Predictions for 2018: Although there aren’t many clouds on the horizon, the low volatility and steady gains of 2017 cannot continue forever. After a short period of rising expectations due to the Trump tax bill, I expect large cap stocks and the US market in general to experience more volatility. However, I do not think the economy will enter a recession in the calendar year, so returns will likely be in the range of 5-10%.

VO (Mid cap US stocks)

  • Total Return: 17.61%

  • 2017 Predictions: If investment increases along with sentiment, corporate profits will likely follow leading to price increases. I see 5-10% return for VO in 2017.

  • Performance for 2017: I was fairly close to predicting this correctly.

  • Predictions for 2018: My predictions for mid-cap stocks mirror those for large cap. However, I would expect this index to benefit slightly more from the lower corporate tax rate, with relatively  higher profits and returns compared to large-caps for the year. I could see a 12% return from mid-caps in 2018.

VB (Small cap US stocks)

  • Total Return: 15.15%

  • 2017 Predictions: If investment increases along with sentiment, corporate profits will likely follow leading to price increases. I see 3-6% return for VB in 2017. It would be higher, if it hadn’t risen so much already in 2016.

  • Performance for 2017: Small cap stocks saw a rise similar to large and mid cap stocks in 2017, although to a lesser degree. Generally, sentiment did not rise as quickly for smaller businesses who are perceived to benefit less from the legislation and tax changes being made by the Trump administration.

  • Predictions for 2018: My predictions for small cap stocks follow my predictions for large and mid caps, but to a more harsh degree. Volatility will affect them more, and any potential slow down in the economy will likely affect them first. I am looking for a small 2-5% gain in VB for 2018.

GNR (Natural resources index)

  • Total Return: 11.17%

  • 2017 Predictions: Commodities have been depressed for sometime. Beyond a drop in gold (if market conditions continue to improve), there’s no reason to believe that 2017 wouldn’t be a significant bounceback year. Anywhere from 10-20% would not surprise me.

  • Performance for 2017: I nailed my prediction on commodities for 2017, as the asset class saw a significant improvement led by metals.

  • Predictions for 2018: After last years improvement, it’s hard to imagine a huge increase for commodities in 2018. If oil supplies are decreased or disrupted due to geopolitical tension, it’s possible that a large gain in the index may occur. It’s likely that strong demand for metals will continue. I see this index returning 4-8% in 2018.

Summary

In short, I expect this to be a year of ups and downs, but I expect markets to be slightly positive from 1/1/2017 to 1/1/2018. Whether or not they are doesn't really matter to me, because I am in it for the long-long haul. I expect to hold these indices forever... or close to it. My predictions above are solely for fun... and to remind myself that my predictions are almost always wrong. As you can see from the notes above, I got a few important calls spot on this year (like Emerging Markets), but overall I am as clueless to the changes in the market as anyone.

As I see it, my job as the steward of this portfolio is simply to follow the original investment plan, only rebalancing to maintain the chosen asset allocation (with small deviations at my discretion). In three years, I will have my first allocation review period, where I can choose to change the overall allocation or securities if I want to.

What is your plan for 2018? Where do you see the markets going?

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