posted on January 11, 2018 11:53
There was certainly no shortage of potential market shocks in 2017. To start the year, the U.S. ushered in new leadership. The year also saw presidential elections in South Korea, India, Iran, Germany, and France – each of which had potential to impact markets. In March, the U.K. invoked Article 50 commencing Brexit negotiations that may last up to 730 days. Just months after major hurricanes pounded the Caribbean and southeastern United States, the largest wildfires in California history raged out west. Cryptocurrencies, or digital currencies, staged a rally greater than almost any asset in human history despite being backed only by a digital ledger and belief (by some) that it may be the future of currency. North Korea tested nuclear weapons and intercontinental ballistic missiles on several occasions and even threatened nuclear war.
Now take a deep breath. Despite all of these (and more) potential shocks, the U.S. and international markets proved unshakable in 2017. In fact, not only did markets dodge all of these bullets as if a character from ‘The Matrix’, but around the globe stocks generated robust returns with historically low volatility.
The Sharpe Ratio
The Sharpe Ratio, developed by Nobel Laureate William Sharpe, is a common measure used to compare risk-adjusted return for different assets. Since its inception in 1994, the MSCI All Country World Stock Index has returned 7.2% with a 15.1% standard deviation (volatility) – producing a historical Sharpe Ratio of 0.32 once the risk-free rate (the rate of return an investor could expect with absolutely zero risk – 30 Day U.S. T-Bills are used here) is backed out. But in 2017, a return of 24.0% with a 2.7% standard deviation generated an incredible Sharpe Ratio of 8.5 – the highest in the index’s history! To put this in perspective, the index’s second best calendar year Sharpe Ratio was only 2.8. Focusing on the S&P 500 Index, we have an even longer data history. Since 1926, the S&P 500 Index has had a Sharpe Ratio of 0.36. In 2017, a 21.8% return in combination with a 3.9% standard deviation generated a Sharpe Ratio of 5.3 – the 3rd highest for the S&P 500 since 1926!
In terms of risk-adjusted returns, 2017 was undoubtedly one of the best years of all time for stocks around the globe. But as we forge into 2018, we must not forget that geopolitical and macroeconomic risks remain which could add to volatility – making it as important as ever to maintain a portfolio globally diversified across stocks, bonds, and alternatives.
Read our complete December 2017 Economic & Market Commentary for Market Returns Year-To-Date as of 12/31/2017, Market Returns Longer Term Annualized as of 12/31/2017, Economic Indicators, and an Appendix.
Sources: Bureau of Economic Analysis (BEA), Federal Reserve, Morningstar Direct, Standard and Poor's
This is intended for informational purposes only and should not be construed as legal, investment or financial advice. Please consult your legal, investment and financial professionals regarding your specific circumstances.