Fourth Quarter 2016 Market & Economic Summary

The surprise election of Donald Trump was undoubtedly the biggest story of the fourth quarter. Futures on U.S. stock indexes fell sharply in the early morninghours after Trump’s victory became apparent, with Dow futures falling about 900 points. After Mr. Trump gave a conciliatory acceptance speech, however, the market turned around and was about even as the trading day started. Remarkably, the Dow Jones Industrial Average finished the day up over 250 points and didn’t look back for the remainder of the quarter.

The Dow gained 9% in the last two months of the year and 13.4% for the year as investors bet that the new administration will spend heavily on infrastructure, cut taxes, and reduce regulations. While the stock market surged, U.S. Treasury yields spiked higher as inflation expectations moved up. The U.S. dollar moved higher along with oil as investors became more confident about economic growth.

Domestic Equity Markets

The S&P 500 could not match the Dow but rose 3.3% in the quarter and 9.5% for the year. The NASDAQComposite Index gained 7.5% for the year but just 1.3% in the fourth quarter as investors moved from new technology stocks into old-line financial, industrial and energy stocks.

Investors sold off interest-sensitive sectors as rates rose. The Dow Jones Utility Average, which had gained 25% through July 6th, fell during the second half but retained a gain for the year of 14%. The Vanguard REIT ETF rose by 3.5% for the year after being up by double-digits earlier.

Meanwhile, financial stocks shot up after the election as stronger economic growth and a steeper yield curve favor bank profits. (Banks borrow short-term and lend long-term.) The KBW Bank Index has risen about 22% since Election Day, hitting its highest level since 2009.

International Markets

Developed international stocks, as measured by the MSCI EAFE index, were relatively flat in the fourth quarter, and finished the year down by 1.9%. It could have been much worse as the index fell by 10% in the days after the Brexit vote. Ironically Britain’s FTSE 100 was a standout performer, gaining 13% last year as about 80% of the FTSE 100 companies are exporters that benefit from the falling British pound. The pound plunged after the vote and has declined further since, now standing at a 30-year low versus the U.S. dollar.

Emerging markets went on a wild ride in 2016, being down over 13% in the early weeks of the year and up nearly 17% in September per the MSCI Emerging Markets Index. The index fell by 4.5% in the fourth quarter to end the year with a gain of 8.6% as Trump’s victory weakened the prospects for global trade and emerging –market exporters.

 

 

Bond Markets

While stocks were rallying in the fourth quarter, Treasury yields were soaring on expectations of stronger economic growth and higher inflation. The U.S. 10-Year Treasury Note began the quarter yielding 1.6% and rose to 1.86% prior to the election. Then the 10-Year shot up to 2.6% in mid-December before settling back to 2.45% by the end of the year.  Fears of deflation and zero interest rates that dominated the first half of the year have turned to expectations that rates will continue to rise in 2017.

High-yield bonds, which had faltered as the price of oil plummeted, were the star performer in the bond world in 2016, up nearly 20%. Prices of those bonds barely fell as Treasury yields rose, as high-yield fares well when economic conditions are improving.

The Economy

The U.S. economy expanded at an annual rate of 3.2% in the third quarter, a two-year high, although the growth rate likely fell in the fourth. Consumer Confidence as measured by the Conference Board and Consumer Sentiment as measured by the University of Michigan/Reuters are both near their highest levels since the early 2000s. Also, unemployment fell to 4.6% and job openings are at a 16-year high.

Nevertheless, while the report of Average Hourly Earnings from the U.S. Department of Labor shows a modest annual growth rate of 2.4%, the Hourly Wage Tracker from the Atlanta Federal Reserve, which tracks wages for workers that have been employed full-time for at least a year, is now growing at a 3.9% annual rate. This could mean that inflation will run hotter than expected and cause the Federal Reserve to increase interest rates at a faster pace, slowing the economy.

Conclusion

Based on stock market gains since the election, investors seem to assume that all of President-Elect Trump’s fiscal stimulus, tax cuts, and deregulation measures will be enacted into law immediately; however, nothing has yet been proposed nor gone through the legislative process. Investors may become more cautious as reality sets in. Also, the forward price/earnings ratio for the S&P 500 is about 17, very close to its peak for the past decade.

We are encouraged that the Global Purchasing Managers’ Index was at its highest level in five years in December, and the market looks good from a technical standpoint. As always, we will closely monitor all developments affecting your investments and keep you advised.