At the end of each year, we find value in reviewing what we got right and what we got wrong. Postmortems can help us learn from our missteps and reinforce the processes that led to our successful recommendations. So here are our equity hits and misses in 2017:
Emerging markets. Our bullish call on emerging markets (EM) equities was one of our biggest hits in 2017 as the MSCI EM Index returned 38% for the year. EM equities benefited from the synchronized global economic expansion, commodity stability, a weak U.S. dollar, and relative political stability. We maintain this recommendation for 2018.
Technology. Throughout 2017 we favored technology, the year’s top performing sector, with a 39% return. The sector benefited from strong earnings growth and several powerful trends, such as mobility, cloud computing, and artificial intelligence. We maintain this recommendation as 2018 begins, although outperformance may moderate. More broadly, our preference for economically sensitive sectors over defensives proved accurate.
Healthcare. We favored healthcare throughout most of the year, which outperformed the S&P 500 Index during the period it was recommended. (We tempered our enthusiasm for the sector in November.) We correctly predicted the spending from the Affordable Care Act would remain intact, although uncertainty remains as 2018 begins.
Risk positioning. We maintained sufficient portfolio risk in 2017 for the majority of our model portfolios to mostly outperform their benchmarks (gross of fees). A good year for active managers also contributed to broad outperformance as more than half of U.S. active managers outperformed their benchmarks in 2017 based on Morningstar data.
Stock market forecast. We started 2017 with a mid-single digit total return forecast for the S&P 500, which we then slightly raised to 6–9% midyear. While directionally correct, the increase still fell well short of the stellar 22% return the S&P 500 produced last year. Our high-single digit earnings forecast for 2017 was accurate (consensus is currently 10%), but we did not anticipate the degree that valuations would expand.
Small caps. We warmed up to small cap stocks during the year due to potential policy benefits. Our catalyst (tax reform) came through, but small caps did not react as favorably as we anticipated. We have maintained this recommendation for 2018 on the potential that small caps would eventually benefit from the new tax law.
Master limited partnerships. Our biggest miss in 2017 was master limited partnerships (MLP). The primary reason for the underperformance was weakness in the energy sector itself, as the sector lost 1% for the year. MLP performance was particularly disappointing given that market interest rates remained low. However, we maintain this recommendation due to strong U.S. energy production, deregulation, and rich yields.
Growth/Value. We came into 2017 recommending a balanced position between growth and value. The macroeconomic backdrop was favorable for value in terms of accelerating economic growth and conditions were poised to improve for the value-heavy financials sector. But growth continued its decade-long run of outperformance. Most of our model portfolios were tilted toward growth throughout much of the year, but clearly we left some gains on the table by not more strongly favoring growth over value. We expect the market to increasingly favor value in 2018.
So there you have it—some hits and some misses from LPL Research in 2017. Look for our hits and misses in fixed income coming soon.