Dow, S&P 500, Nasdaq Had Best Year Since 2013

In this issue:

THE U.S., ECONOMYGlobal ExpansionReal EstateStock Market

GLOBAL ECONOMYOverseas MarketsChinese Economy

COMMODOTIESRising Prices

U.S., Economic News Global Equities Post Stellar Gains in 2017

BCJ Market Commentary

W W W. B C J F I N A N C I A L. C O M 1

Global equity markets produced stronger returns in terms of price than we’ve seen in several years during 2017. Underpinning the strong year for U.S. stocks, in particular, were strong corporate earnings, low volatility and the global economic expansion from which the U.S. and other countries have benefitted.

Only the Dow Jones Industrial Average (DJIA) posted double-digit gains during the fourth quarter. Yet, that index as well as the S&P 500 and the Nasdaq Composite recorded their best annual performance since 2013. (For full-year 2017 results, please see the chart below.)

In contrast to historically-low volatility in U.S. equity markets, the Treasury market experienced

several periods of significant price swings. The yield on the 10-year Treasury note ended 2017 at 2.41%, down marginally from 2.44% at year-end 2016. As of early September, the yield on the 10-year note was trading as low as about 2.07%, but subsequently rose in the following weeks with the so-called “reflation trade,” after the release of the tax reform framework and a temporary debt-ceiling agreement.

Meanwhile during the fourth quarter, the spread between the two-year Treasury note and the 10-year Treasury note compressed to 53 basis points at year-end, its flattest level since before the 2008-2009 financial

Life is a journey. Let’s plan for it.

crisis, according to Morningstar Credit Ratings. Short-term rates have been rising rapidly as the Federal Reserve raised interest rates three times during the course of 2017. The two-year note’s yield rose by 69 basis points in 2017, while demand for longer-dated Treasurys from insurance and pension funds helped drive down the yield on the 30-year bond by about 25 basis points during the year.

For 2018, the U.S. Treasury market faces more potential supply, which could lead to higher yields. On the one hand, the Federal Reserve is beginning to

unwind its more than $4 trillion balance sheet following quantitative easing. The U.S. government also may have to issue more debt because of an expanding budget deficit.

Interest rates are also forecast to increase for 2018 and rising inflationary trends – already beginning to emerge in oil and commodity prices – would place further upward pressure on Treasury yields. Concerns about inflation during early January 2018 have already pushed the yield on the 10-year note above 2.50%, its highest level in 10 months.

Real Estate — Low Inventory, Sales Increases Helped Lift Home Prices in 2017

Higher 10-year Treasury yields are already having some impact on mortgage rates. As tracked by Mortgage News Daily (MND), 30-year fixed-rate mortgages recently reached an eight-month high at 4.15%. MND’s methodology involves tracking lenders’ raw prices which tend to be higher than rates provided by Freddie Mac’s primary mortgage market survey.

The $1.5 trillion tax package signed by President Donald Trump in late December may also be a factor in how the nation’s housing market fares in 2018. The legislation caps the deduction homeowners can take on mortgage loans at up to $750,000, down from $1 million. It also caps deductions for state and local income and property taxes, or state and local property and sales taxes at $10,000.

Housing did experience strong performance in 2017, with price gains in major metropolitan markets regaining most of the depreciation experienced

following the financial crisis of a decade ago. The combination – at least during 2017 – of economic growth, low interest rates and tight labor markets helped boost home prices.

The S&P CoreLogic Case-Shiller U.S. National Home Price NSA Index posted a 6.2% annual gain in October (the most recent figures available), while the 20-City Composite was up 6.4% year-over-year. Other measures of home prices also displayed appreciation with the National Association of Realtors (NAR) reporting that median existing home prices for all housing types rose by 5.8% in November compared to a year ago – the 69th straight month of year-over-year gains.

W W W. B C J F I N A N C I A L. C O M 2

Freddie MacPrimary Mortgage Market Survey

Average Rates

30-Year FRM

15-Year FRM

5/1-Year ARM

Source: Freddie Mac. http://www.freddiemac.com/pmms/

Week of 1/4/18

3.95%

3.38%

3.45%

Week of 12/28/17

3.99%

3.44%

3.47%

Week of 1/5/17

4.20%

3.44%

3.33%

Existing home sales rose 5.6% in November compared to the previous month’s upwardly-revised figures, to a seasonally-adjusted annual rate of 5.81 million. The NAR said sales were 3.8% higher than the prior year, and at their strongest pace since December 2016.

Total housing inventory at the end of November was 7.2% lower than the previous month and 9.7% lower than a year ago. Inventory has fallen for 30 consecutive months and is now only at a 3.4-month supply at the current sales pace. The anticipated rise in mortgage rates in 2018 could further cut into affordability if these “staggeringly low” supply levels persist, Lawrence Yun, NAR’s chief economist, said.

Tax Reform, Earnings and Economy Key Themes For Stocks in 2018

To put the U.S. stock market’s performance during 2017 into perspective: The S&P 500 posted total return gains every month (albeit down 0.04%, but up 0.12% with dividends), and now stands at a new record of 14 consecutive months of gains. The index also had 62 new closing highs (equal to 1964), compared to 18 in 2016, and behind the record of 77 in 1995. The DJIA posted 71 new closing highs versus 26 in 2016, setting a new record dating back to 1896, according to S&P Dow Jones Indices, a division of S&P Global.

While the U.S. economy may be further along than other nations in expansion and in its business cycle, U.S. companies’ earnings are still expected to get a boost in 2018 from lower corporate tax rates as part of the recently signed tax package.

U.S. gross domestic product (GDP) growth increased at an annual rate of 3.2% in the third quarter. Forecasts for the fourth quarter range from about 2.8% to as high as 4.0% based on the Atlanta Federal Reserve’s GDPNow model and the New York Federal Reserve’s Nowcast GDP projection model, respectively. The Nowcast GDP model also forecasts 3.4% economic growth for the first quarter of 2018.

One provision of tax reform does require companies to repatriate earnings from overseas subsidiaries (at

reduced rates as low as 8%) and more companies have been disclosing possible one-time charges and other earnings hits in recent weeks due, in part, to this provision. Yet, a portion of these repatriated earnings may also be used to repurchase shares and increase dividends, further supporting the stocks of those companies which choose to do so.

In addition, corporate earnings could benefit if companies continue to invest in further productivity gains. That trend began to emerge during 2017 as stronger revenue growth resulted in more companies reinvesting in their own businesses, and may, to some extent, justify higher valuations for those companies pursuing organic growth through investments in property, plants and equipment. On that note, some of the repatriated cash may likely be used for acquisitions, investment and research and development.

As the research from S&P Dow Jones Indices indicates, expectations are high for 2018, with more analysts calling for the S&P 500 to cross 3,000 – the so-called “S&P 3,000 Club.” That would result in the index gaining slightly more than 12.0% from its 2017 close. Those expectations include predictions of more money in corporate accounts, via lower taxes, as companies spend more money on buybacks and add to the upward buying pressure of stocks. In addition, consumer spending may stimulate the economy with higher paychecks from lower withholding taxes.

To get another future gauge on corporate earnings and how it may impact stock prices in 2018, S&P Dow Jones Indices notes that the upcoming earnings season may be an indicator, as companies provide guidance on the potential impact of the tax package on income and the amount of repatriated cash.

W W W. B C J F I N A N C I A L. C O M 3

versus 26 in 2016According to S&P Dow Jones Indices, a division of S&P Global

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71DJIANEW CLOSING HIGHS IN 2017

W W W. B C J F I N A N C I A L. C O M 4

While the performance in U.S. stock market indexes in 2017 was impressive, equity markets elsewhere also posted strong gains. Lower valuations overseas compared to those for U.S. equities drove inflows into developed and emerging markets. The MSCI ACWI ex-USA index, which tracks companies outside the U.S. in developed and emerging markets, rose by 24.08% for the year, while the AC Asia Pacific ex-Japan index gained 33.5% in 2017.

Elsewhere, Japan’s Nikkei 225 gained 19.1% in 2017. Several factors have been underpinning the performance of the country’s equity market. The Bank of Japan continues to support the overall economy through expansionary monetary policy.

The country’s labor market continues to tighten with the unemployment rate at 2.7% in November 2017 and the number of unemployed people down 9.6% from the previous year, according to Japan’s Statistics Bureau. November’s unemployment rate was the lowest since December 1993. The jobs-to-applicants ratio rose slightly to 1.56 in November, the highest since January 1974, indicating there were 156 applicants for every 100 workers.

According to the Japan Center for Economic Research, the July-September quarter represented the seventh consecutive quarter of growth with annualized GDP up by 1.4%. The continued global expansion has favored export growth. Overall, the country’s current recovery phase has been sustained since December 2012 and has surpassed the so-called “Izanagi Boom” of 57 consecutive months of economic growth from November 1965 to July 1970.

In Europe, the MSCI AC Europe index rose by 21.9% in 2017. Business and consumer confidence were steady in 2017. For example, the sentix Economic Index, an indicator of investor sentiment, was 32.9 in January, its highest since August 2007, reversing a slight loss of momentum in December.

Labor markets in the eurozone are also strengthening, with the unemployment rate at 8.7% in November, the lowest rate since January 2009. The unemployment rate for the EU28 fell to 7.3% in November and was the lowest since October 2008, according to Eurostat.

The eurozone’s economy continued to strengthen during 2017. Seasonally-adjusted GDP rose by 2.6% in the eurozone and the EU28 in the third quarter of 2017, according to Eurostat. That followed year-over-year GDP growth of 2.4% in both zones in the second quarter.

Despite the pickup in growth and reduced slack in labor markets, inflationary pressures have yet to emerge and remain below the European Central Bank’s (ECB) 2.0% target, indicating that monetary policy may continue to favor markets during 2018. Annual inflation in the eurozone was estimated at 1.4% in December, down from 1.5% the previous month.

The ECB announced in October that it would continue its asset purchase program through September 2018 (though at a monthly pace of €30 billion, down from €60 billion previously) until a sustained adjustment in the path of inflation emerges consistent with the ECB’s intent of a rate at or near 2.0%.

Global Markets Review

In China, slower economic growth is forecast for 2018 following the government’s emphasis during 2017 on finding balance between the country’s high debt levels, reforming state-owned enterprises, curbing overcapacity in some industrial sectors and cooling the property market.

According to recent data from the National Bureau of Statistics, China’s economy posted annualized growth of 6.8% in the third quarter and 6.9% for the year through September. Consensus forecasts from economists for GDP growth for 2018 is about 6.4% to 6.5%, to as low as 6.1% in 2019, according to research from Goldman Sachs.

The nation’s manufacturing PMI (purchasing manager’s index) came in at 51.6 for December, a decrease of 0.2 percentage point from the previous month, but still at the annual average. Despite the ongoing expansion in manufacturing (indicated by a reading above 50.0), factory jobs are contracting with the employed person index at 48.5 in December – its lowest during the past 13 months.

The slowdown and restructuring the government intends for the economy appears to be starting in other recent economic figures. Fixed asset investment rose by only 7.2% in the period from January through November 2017, compared to growth of 8.3% in the same period in 2016. The floor space of commercial buildings for sale fell by 13.7% at the end of November, compared to November 2016.

Strong Equity Market Gains Overseas As Well

Chinese Economy in Transition

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W W W. B C J F I N A N C I A L. C O M 5

Strong global economic growth has already contributed, in part, to rising oil and materials prices during the past year. In 2017, commodity prices continued the steady rebound seen since their lows from mid-2014 to early 2016. Industrial metal prices such as copper rallied, given the pickup in global economic growth. Comex copper prices rose by about 33% in 2017, for example, and ended the year strongly with a two-week rally that sent prices up by more than 8%.

Meanwhile, on the final day of 2017, West Texas Intermediate

(WTI) crude prices broke through $60 a barrel, closing on the New York Mercantile Exchange at $60.42 – its highest since June 2015. This marked the first time that the front-month WTI contract in the U.S. settled above $60 since June 2015.

For 2017, WTI crude climbed by about 12.5%, and ended the year 42.0% higher from the low it hit in June. Brent Crude, a global benchmark for oil prices, had previously broken through the $60 a barrel level and ended the year at $66.87, up 17.7%. Brent has since pushed toward $70 a

barrel, closing on January 10 at $69.20 a barrel.

Some analysts are saying that oil prices could reach $80 a barrel in 2018, though others remain skeptical. Those in the higher-price camp note rising global demand, shrinking inventories and the commitment from the Organization of the Petroleum Exporting Countries and countries outside OPEC, including Russia, to limit output. Still, others say, major production from U.S. shale could limit the ability of oil prices to sustain their recent levels.

CommoditiesRising Commodity Prices May Warrant Attention In 2018

With central banks beginning to pull back on the accommodative monetary policy measures put in place several years ago, and more rate increases expected in 2018 from the Federal Reserve, inflationary pressures may begin to emerge.

Upcoming Select Economic Releases

W W W. B C J F I N A N C I A L .C O M

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W W W. B C J F I N A N C I A L. C O M 6

Life is a journey. Let’s plan for it.

W W W. B C J F I N A N C I A L. C O M 7

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U.S. Equities Market Attributes December 2017. https://www.spindices.com/https://www.frbatlanta.org/cqer/research/gdpnow.aspxhttps://www.newyorkfed.org/research/policy/nowcasthttps://www.nytimes.com/2018/01/04/business/corporate-tax-cuts.htmlhttps://www.cnbc.com/2018/01/05/apple-tech-companies-to-bring-back-400-billion.htmlhttp://www.stat.go.jp/english/data/roudou/results/month/index.htmhttps://www.japantimes.co.jp/news/2017/12/26/business/economy-business/japans-jobless-rate-improved-24-year-low-spending-rose-november/#.WlTQ_66nGpohttps://www.jcer.or.jp/eng/pdf/sa172_eng.pdfhttps://www.sentix.de/index.php/en/sentix-Economic-News/danger-of-overheating.htmlhttp://ec.europa.eu/eurostat/documents/2995521/8571046/3-09012018-AP-EN.pdf/0d35bf38-0dcc-4f3c-b3e8-5dbcdbe6908ehttp://ec.europa.eu/eurostat/documents/2995521/8515977/2-07122017-AP-EN.pdf/0ef3dfff-dcfb-4377-aa46-f55569c5b29ahttp://ec.europa.eu/eurostat/documents/2995521/8568132/2-05012018-AP-EN.pdf/57b59ffc-f626-4b1b-9547-aafd9de4e127http://www.stats.gov.cn/english/PressRelease/201710/t20171023_1545167.htmlhttp://www.goldmansachs.com/our-thinking/pages/macroeconomic-insights-folder/2018-global-economic-outlook-as-good-as-it-gets/report.pdfhttp://www.stats.gov.cn/english/PressRelease/201801/t20180103_1569401.htmlhttp://www.stats.gov.cn/english/PressRelease/201712/t20171214_1562721.htmlhttps://blogs.wsj.com/moneybeat/2018/01/10/whispers-of-80-oil-are-growing-louder/

SOURCES AND LINKS FOR STOCKS AND BONDS DATADow Jones Industrial Average:http://bigcharts.marketwatch.com/historical/default.asp?symb=DJIA&closeDate=12%2F29%2F17&x=38&y=20 http://bigcharts.marketwatch.com/historical/default.asp?symb=DJIA&closeDate=12%2F30%2F16&x=34&y=23 http://bigcharts.marketwatch.com/historical/default.asp?symb=DJIA&closeDate=12%2F31%2F12&x=34&y=28 http://bigcharts.marketwatch.com/historical/default.asp?symb=DJIA&closeDate=12%2F31%2F07&x=42&y=23 http://bigcharts.marketwatch.com/historical/default.asp?symb=DJIA&closeDate=9%2F29%2F17&x=30&y=26 S&P 500:http://bigcharts.marketwatch.com/historical/default.asp?symb=SPX&closeDate=12%2F29%2F17&x=30&y=22 http://bigcharts.marketwatch.com/historical/default.asp?symb=SPX&closeDate=12%2F30%2F16&x=42&y=24 http://bigcharts.marketwatch.com/historical/default.asp?symb=SPX&closeDate=12%2F31%2F12&x=47&y=24 http://bigcharts.marketwatch.com/historical/default.asp?symb=SPX&closeDate=12%2F31%2F07&x=31&y=26 http://bigcharts.marketwatch.com/historical/default.asp?symb=SPX&closeDate=09%2F29%2F17&x=30&y=26 Nasdaq:http://bigcharts.marketwatch.com/historical/default.asp?symb=NASDAQ&closeDate=12%2F29%2F17&x=32&y=27 http://bigcharts.marketwatch.com/historical/default.asp?symb=NASDAQ&closeDate=12%2F30%2F16&x=40&y=19 http://bigcharts.marketwatch.com/historical/default.asp?symb=NASDAQ&closeDate=12%2F31%2F12&x=38&y=20 http://bigcharts.marketwatch.com/historical/default.asp?symb=NASDAQ&closeDate=12%2F31%2F07&x=38&y=20 http://bigcharts.marketwatch.com/historical/default.asp?symb=NASDAQ&closeDate=09%2F29%2F17&x=39&y=19 10-Year TIPS:https://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=realyieldYear&year=2017 https://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=realyieldYear&year=2016 https://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=realyieldYear&year=2012 https://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=realyieldYear&year=2007 MSCI:https://www.msci.com/end-of-day-data-regional

Nikkei 225:http://bigcharts.marketwatch.com/historical/default.asp?symb=NI225&closeDate=12%2F29%2F17&x=38&y=20