Covenant Weekly Market Synopsis for December 15, 2017

December 18, 2017

Domestic stocks closed the week at record levels as likely tax reform and positive economic data (November retail sales +0.8%) propelled stocks higher. The S&P 500 tacked on gains of 0.9%, while the tech-heavy Nasdaq rose another 1.4%. International stocks, on the whole, gained 0.6% even as European and Japanese regional stock indices declined (-0.3% and -1.7%, respectively). Interest rates on the front-end of the U.S. Treasury curve rose, while those on the back-end fell, resulting in additional curve flattening. For the first time in nearly a decade, the yield on the 2-year US Treasury now exceeds the S&P 500’s dividend yield (source: Liz Ann Sonders, Charles Schwab). Precious metals gained (gold +0.6%, silver +1.2%) and copper (an important industrial commodity) rose 5.2%. WTI Crude declined a modest -0.1% to close the week at $57.30 per barrel.

It’s also worth noting that the Fed increased its Federal Funds Target rate by 0.25% (to 1.25% – 1.50%) as expected last week. In response, China’s central bank (the People’s Bank of China) raised their short-term money market rates by 0.05%, ostensibly to discourage investors from seeking to export their capital (if they can get around China’s strict capital controls) to the U.S.

For more detail on weekly, month-to-date and year-to-date asset class performance please click here.

Saint Nick – Tis’ the season for ugly sweaters, family gatherings, eating too much, and….higher equity prices. Since 1896 the Dow Jones Industrial Average has risen 76% of the time between the day after Christmas and the first two trading days in January gaining an average 1.5% (source: Hulbert Financial Digest). This compares to stocks rising only 55% of the time during all rolling six-day periods throughout the year. While stocks failed to rally over this timeframe in 2 of the last 3 years, current momentum makes it a good bet that the Santa Claus rally will be part of the 2017 stock market story.

Great Expectations – Expectations are a funny thing. By definition, expectations are related to some event or outcome in the unknowable future. And they are shaped by previous experiences, with the most recent experiences having an outsized impact on one’s perspective. The process by which expectations are formed is the basis for a well-documented behavioral phenomenon called recency bias. Recency bias is why people believe that an NBA player who has made several shots in a row should be fed the ball continually… because he has the “hot hand”. In investing, recency bias leads one to believe that the recent market action is predictive of the future. This can lead to poor investment decisions when the actual market action diverges from the expected market action. Recency bias can be addressed by studying the past (be it basketball or stock markets) to understand when recent events are an anomaly relative to history. With that in mind, the chart below highlights the unique character of the 2017 financial markets when viewed through the lens of risk-adjusted performance. It has been a year of solid gains with incredibly low volatility. In fact, unless something changes in the next two weeks, 2017 will be the least volatile year in the history of stock markets. To put this chart in perspective, the long-term Sharpe Ratio of the S&P 500 is approximately 0.3, meaning that in 2017 the S&P 500’s risk-adjusted performance is 10x better than its long run average. [Note: the Sharpe Ratio is calculated from the average return of an asset less the risk-free rate divided by the standard deviation of returns for that asset.]


This chart does not imply stocks will decline in value next year. While falling stock market prices is always a possibility, it is a surer bet that the volatility of stock prices will be higher. The bottom line is that investors should not be lulled into complacency by the market’s tranquility in 2017, nor should they overreact in response to more normalized volatility levels.

Is Santa real? – So began the conversation with our 9-year old boy.  It was the beginning of the same conversation we had last year, only then we sidestepped the question and he got distracted and moved onto playing with his Legos.  But this year he was insistent.  At first, we played dumb…  feigning ignorance and acting bewildered by his question.  But he was relentless.  Finally, we showed weakness and asked “Why do you want to know?”  He sensed blood and went in for the kill “For two reasons”, he responded:

  • “First, it’s a good idea for parents to say Santa is real because it forces kids to be good, or not get presents.  So that makes me wonder.”
  • “Second, if Santa is real, I’ll ask for really expensive stuff [darn Internet feeding his brain with ideas and $-signs] because Santa and his elves can make them for free.  If Santa’s not real, I don’t want my family to buy me expensive gifts.”

His first point was logical and insightful.  It’s true, Santa is a great trump card for parents to play with mischievous children as Christmas draws near and suddenly he understood that.  His second point exhibited financial awareness. My wife and I looked at each other and, without exchanging words, we knew it was time. Clearly, he is beginning to see the world through a more mature lens. So, we told him the truth… reluctantly sacrificing another little bit of his childhood wonder (the Easter Bunny and the Tooth Fairy are long dead and buried).  Our admission came with a warning. We told him how special this information is and that he should never share it with another child because they might believe and the importance of not robbing them of that belief.  

We’ll see how Christmas goes this year.  We thought that by revealing the Santa truth he and his sister might sleep in a bit on Christmas. But our own little Christmas wish probably won’t come true as he’s already asking if 4am is too early to get up on Christmas morning to open presents. So, as we turn the page on a new type of Christmas in our home, one without Santa, we wish you a heartfelt Happy Holidays.

See you again in 2018. Until then, be well.