As winter weather settles over the U.S., the drama from the presidential election has turned cold, and today we inaugurated our 45th president. Below are our reviews of recent market conditions and forecasts for the first few quarters of 2017.
4Q2016 DRIVING FACTORS
Market interest rates rose sharply after the election, while the Federal Reserve raised key rates by 0.25%1 as planned in December. With projected economic growth from President-elect Trump’s policies (tax cuts and infrastructure spending), expectations are high for two increases in 2017. Economic strength will determine the pace of hikes.
We’ve seen improvements in energy. Earnings rebounded from their 2015 bottoms, a result of stabilized cash flows from prices sticking near $50 per barrel. However, chronic weak demand has led to oil prices not yet settling into a tight trading range. Production cuts from OPEC nations may lead to some price increases, but the real key is global demand, which needs to move significantly higher to boost prices.
Preliminary holiday retail sales numbers are mixed—several major discounters show poor sales while many internet and high-end sales figures look relatively strong. Unemployment remains low, and job creation continues above 150,000 jobs2 per month. The small rate increase likely won’t affect growth substantially, but future increases in rapid succession would slow the economy.
EFFECTS ON THE MARKET
The so-called market "Trump rally" spurred stock prices in November and drove major indices in December to record highs. Financial equities, which will benefit from higher interest rates, rallied strong. Other industries’ reactions hung on their regulatory outlook under the new president. Let's review the numbers3. Large-cap funds were up but mixed: Growth funds lost 1.2% on average and value funds gained 7.0%. Mid-cap funds were alike, with growth at break-even and value gaining an average 6.65%. Small-company funds performed very well for the second quarter in a row, gaining near 3% for growth and 12% for value. Foreign stocks were mixed: Europeans gained 1-2%, while emerging-market and Pacific funds lost 4-8%. Natural resources were positive again, gaining 4-5% in Q4 and 28% for the year. REITs continued to fall and performed more like bonds during a rate rise, losing 2-3%.
Bond markets’ reaction to the election was negative and immediate, and the sentiment continued into December after the Fed rate hike. Short-term bonds3, down slightly during the quarter, protected portfolio principal. Mid-long positions fell slightly on average. Foreign bonds fell 1% and emerging-market debt dropped 4-5% on average. High-yield bonds had another good quarter with gains over 1%. Municipal bonds remained the laggards, with losses of 5-6% in the face of the rate increases and speculation that lower tax rates may curb demand.
Economy: U.S. economic growth will sustain our equity market rally and temper the rate-increase effects in bonds. Too much growth would spur inflation fear and result in rapid rate hikes. Too slow, and we spark a recession—stopping rate increases but killing the nearly eight-year bull market rally. Trump’s proposed tax cuts and spending will favor growth. Our outlook continues to favor a full allocation to both stocks and bonds while minimizing cash and holding fewer foreign stocks and bonds than our target.
Equities: Lacking Chinese demand and continued European doubt will influence our positions in foreign and emerging-market equities. Commodities remain weak—better to hold natural resources (energy) positions.
Bonds: We appear to have a floor on the super low interest rates and are not likely to return to mortgages near 3% or 10-year Treasurys below 2%. The focus is now on 2017 rates. Our current allocation is built for slow rate increases. A run of hikes in rapid sequence, however, would dictate we use a more conservative bond approach, focusing on principal protection and reinvestment opportunities. This would lower bond income levels short term, but keeping the balance between income and safety is critical in our risk-management approach, especially when stock-market volatility returns.
Other: REIT prices fell, rebounded a tad early in 2017, and are now mostly at or below values of two years ago. We expect REITs to fall slightly further in the next rate increase. The demand for high-quality, inflation-protected income will fuel REIT demand in a high-growth, rate-hike environment. Conversely, slow rate hikes will help stabilize values and benefit REITs and preferred stocks. Both are viewed as bond substitutes and have a negative response to rate step-ups in the short term.
We publish these insights quarterly for our clients, with further detail on specific asset classes. Our personalized investment management strategy is built around each client’s personal Financial Plan and Investment Policy Statement. We review both as we make changes to each client’s portfolio, working to ensure their investments match their personal risk tolerance, return goals, and tax picture.
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1 The Federal Reserve raised key interest rates by 0.25%. Reported in the Wall Street Journal, December 15, 2016, "Fed Raises Rates for First Time in 2016, Anticipates 3 Increases in 2017.”
2 Job creation averaged 165,000 for Q4. U.S. Bureau of Labor Statistics: https://www.bls.gov/web/empsit/ceshighlights.pdf
3 All asset-class quarterly data pulled from Barron's Lipper Quarterly Performance Report, dated 1/4/17.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results.
All indices are unmanaged and may not be invested into directly. There is no assurance that the techniques and strategies discussed are suitable for all investors or will yield positive outcomes. The purchase of certain securities may be required to affect some of the strategies.
The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful. Investing in mutual funds and ETFs involves risk, including possible loss of principal. Investments in specialized industry sectors have additional risks, which are outlined in the prospectus.
Bonds are subject to market and interest rate risk if sold prior to maturity. Bond and bond mutual fund values and yields will decline as interest rates rise and bonds are subject to availability and change in price. Government bonds and Treasury bills are guaranteed by the U.S. government as to the timely payment of principal and interest and, if held to maturity, offer a fixed rate of return and fixed principal value. However, the value of fund shares is not guaranteed and will fluctuate. International investing involves special risks such as currency fluctuation and political instability and may not be suitable for all investors. These risks are often heightened for investments in emerging markets. Investing in real estate/REITs involves special risks such as potential illiquidity and may not be suitable for all investors.