2017 Review: Tectonic Plates, Australian Economic Growth, and Global Innovation

Like two tectonic plates colliding, political divisiveness disrupted the normal course of business in Washington, DC, throughout 2017. The dissent was palpable, with each political party subject to President Trump’s promise to upend White House norms and “drain the swamp.”

However, if one looks past all the political wrangling and focuses on the national and global economy, along with the performance in the financial markets, it is clear that the real winners in 2017 were the investors.

Economic Review

At nearly nine years old, the bull market is now the second oldest in US history and reflects a 376% rise from its lows in early 2009. While this may indicate to many prognosticators the good times must soon be over there still may be a ways to go.

For context, and by way of example, one must keep in mind the long-term positive economic growth that Australia has experienced. Incredibly, the last time Australia suffered a recession was back in 1991, when the web browser had just been invented and Dances with Wolves won seven Academy Awards. Australia’s economy has racked up the longest stretch of growth in modern history: 104 quarters.

Top GDP Performers in %

Turkey 11.1

China 6.8

India 6.3

Spain 3.1

Canada 3

Australia 2.8

France tied US at 2.3

When one looks at the worlds top GDP performers for 2017, it becomes clear there still remains room for the US to make positive improvements in its growth trajectory. With exception of Venezuela, whose most recent GDP contracted 18.6%, most of the world’s economies are in expansion mode, which bodes well for the US as a major provider of services, and to a lesser extent goods, to the world’s economy.

Igniting growth across the world is the relentless drive to innovate. Looking at the chart (below) and the top performing economies (above) it is clear that there is a significant correlation between innovation and GDP. The US is currently at ninth-most innovative, which is also reflected in its positive, though not chart-topping, GDP.

The conclusion we draw from this here at Tidegate Capital, is that it is quite possible that the US economy has the potential for continued long-term positive economic growth. While there may be bumps in the road, including a stock market breather, at this point there are no indicators that the US is heading into a recession—as long as we have a measured Federal Reserve, with no significant exogenous shocks.

Equity Overview

20017 was an epic year for stocks. For the first time ever, the S&P went up every single month in 2017; if one includes the final two months of 2016, the S&P had 14 solid months of positive returns. The Dow raced 25% higher in 2017, getting even closer to 25,000 and making it the best year since 2013. While many pundits may argue over who can claim responsibility for the results, the booming stock market clearly was the result of resurgent economic growth and blockbuster corporate profits. Additionally, the sweeping tax cuts that made their way to the President’s desk by year-end were perhaps the biggest catalyst. Over time, these measures will save corporate America billions on what they owe Uncle Sam with the hope that the changes have a positive impact not only to the shareholders but also the American worker.

Investors who owned a diversified portfolio in 2017 had another year of solid returns. We hope you were able to enjoy the ride. Stock market volatility was near all-time lows, and whether you were in US equities, international, or EM the returns were impressive as evidenced by some of the ETF returns we follow (below):

Total US Stocks: 21.2%

International Equities: 27.5

Emerging Market: 31.4

REIT’s 5

US Bond Index (broad) 3.6

Long Treasuries 8.7

Gold 11.4

Commercial Real Estate - Multifamily

Tidegate Capital focuses on Real Estate, the fourth asset class and as of late 2016, the newest sector entrant into the S&P 500. So, how did the “newest” asset class perform in 2017, its first full year?

As expected, CRE-MF took a slight breather from the significant returns that have been experienced since the 2007/2008 housing debacle. However, looking ahead we expect more positive returns in 2018 and beyond as the moderate trend in new residential production continues. However, with banks continuing to make borrowing a challenge, we do not expect significant overbuilding to occur in most markets. While some first-tier cities exceeded expectations in their price appreciation over the past few years, with one example being Denver, the trend is for increased household formation and the need for ever more housing stock.

One challenge the CRE market will face is the potential for further interest rate hikes. We suggest investors stick with assets that can adjust upwards with inflation, such as multifamily properties that have the ability to pass along higher costs upon lease renewals.

To summarize, we like the solid global and US economic fundamentals, increased household formation, and moderate but improving rent growth. Heightened discipline on both the lending and acquisitions side after 2007-08 remains in place and is helping to keep returns more in-line with historic norms.

Some risks remain for 2018, and we are focusing on potential inflation with subsequent Fed rate hikes. We see the stock market is potentially overheated, and it has the potential for a material correction. As always the ever present geo-political risks remain on the forefront.

Though there are few signs of an impending slowdown on the horizon, we believe that there are still risks in traditional asset classes, particularly with stock prices at current levels that may be unsustainable. We believe a prudently structured, well-diversified portfolio with the inclusion of real estate can continue to provide the best return-to-risk profile.

In closing, we at Tidegate Capital hope all our readers have a very healthy and prosperous 2018. We look forward to providing you with quarterly updates and market commentary, and, as always, we welcome your feedback.