The 2016 Year in Review


In January 2016, we projected that the S&P 500 would gain 5% for the year, but we noted we would revisit that estimate in July.  In July, noting that an earnings recession among US corporations was coming to an end, we elevated our forecast to 10%.  For the full year, the S&P 500 rose 12.0%, so close enough.  Full details of US and world Indexes are here:

Within the major categories, Energy stocks rallied 27.4%, as oil rose from a mid January low of $26/barrel to a year end high of $54.  On January 23rd, we wrote:

We would like to think that financial markets are "rational" but every once in a while, markets fixate on ONE particular indicator. In the last three weeks, price direction in stocks became entirely correlated with the price direction in oil.  Nothing else - earnings, interest rates, labor markets, industrial production, housing markets - seemed to matter.  Last August, investors fixated on the Chinese markets, which dragged down US stocks 11% in a month.  When the fixation dissipated, US stocks gained back the entire loss in 2 ½ months.  We expect the same will happen over the next few months, so starting Monday we are putting all our spare cash to work.

Indeed, we nailed the low for 2016.

Telecommunications gained 23.5% on the year, which is hard to explain for a sector that investors traditionally buy for the reliable income stream.  In a rising interest rate environment, we'd expect this sector to do poorly.  However, even the Utility sector gained 16.4% for the year.

Financial Services did third best, rallying 22.7% for the year, and 21.0% for the 4th quarter.  We're not necessarily happy about this.  Investors presume that the banks will be able to throw off the "shackles" of the Dodd-Frank regulations, resume the go-go trading activities that led to the 2008-9 financial melt-down.

Healthcare stocks were clobbered, the only losing sector on the year, with a loss of 2.7%.  Investors worry that the probable demise of Obamacare will knock 24 million Americans off the insurance rolls, massively disrupting the health care system.  According to CNBC, "More than 80 percent of those losing coverage would be in working families, and about 66 percent would have a just a high school degree or less. About half of the people who would lose coverage would be white, and 40 percent would be young adults."  As these Americans were more likely to vote Republican in the recent election, Congressional leaders now find themselves in a very uncomfortable position.

US Mid Cap and Small Cap stocks gained 21.3% in 2017, substantially outpacing the Large Caps (up 12.0%.) This divergence in return generally becomes apparent in the late stages of an economic expansion (and bull markets.)  The smaller companies can grow revenues and earnings faster than behemoths like General Electric and Microsoft, but are more vulnerable to economic contraction triggered by rising interest rates (our current scenario.)

Among international markets, the Russian stock market topped world tables, gaining 52%, benefitting from a rebound in oil prices and the expectation of a compliant relationship with President-elect Trump.

Commodity focused economies including Brazil (up 39%,) Canada (up 18%,) Norway (up 18%) did well with rising oil and commodity prices. 

The UK FSTE index gained 19.2% on the year, surprising economists who expected a recession following Britain's vote to exit the EU.  That recession may yet appear in 2017.

Chinese markets fell sharply in January, regained losses through the year, but slumped in December over fears of how Trump will handle trade.  For the year, China's Shanghai index closed down 11.3% for the year, while the Shenzhen index closed down 13.5%.

The Trump Rally?  What about the Obama Bull!

Many observers pointed to the 5.0% rally ($959 billion in market cap) in the S&P 500 since Election Day as "proof" that Mr. Trump's policies will be good for the country.  If we're going to play that game, we should also note that the bond market fell between 3.5-7.4% depending on sector over the same time frame for a loss of about $1.1 trillion.

We like to track the impact of Presidential policies from inauguration day to inauguration day, though you could argue that tracking from the April following inauguration is the best way to calculate presidential influence (the time frame that a particular President's policies are actually in effect.)

People believe reflexively that Republican presidents are better for the economy and the stock market than Democratic presidents. 

The average annual return of the S&P 500 under 28 years of Democratic presidents was 13.1%, while exactly half at 6.6% for the 36 years that a Republican occupied the White House.  William Clinton presided over total returns of 264.7%, while Kenyan born Muslim socialist Barrack Obama (gains so far of 221.1%) may yet edge Ronald Reagan (full term - 223.2%.) 

George W. Bush and Richard Nixon saw declines of 30.0%, though Nixon only served 5.5 years, so produced the worst annualized return of -6.3%.  However, Nixon took office during the turmoil of the 1960's just as the nation was losing the Vietnam war and during a period of soaring inflation with stagnant economic growth. 

For worst steward of the economy, the booby award goes to George W. Bush, who took office with unemployment at 3.5%, record levels in the stock and real estate markets, and an annual budget surplus of $124 billion.  8 years later, unemployment was at 7.8% on the way to 9.9% while the stock market and real estate markets were in free-fall, and the budget deficit was $459 billion (and $1.4 trillion in 2009.) 

The Bush tax cuts and the expense of the Afghanistan and Iraq wars grew the US national debt from $5.7 trillion to $11.1 trillion in eight years.  Additional borrowing to relieve the US economy from the Great Recession of 2009 added another $7 trillion in debt over eight years.  As a percent of the economy (104% of GDP) the only time the national debt was worse was in 1946 (126% at the conclusion of World War II.)  As much as borrowing to rebuild infrastructure is a good idea, once a country's debt exceeds its annual GDP (think Japan, Zimbabwe, Greece, Italy, Iceland), the risk of economic stagnation soars.

When we think about how Donald Trump combines the cluelessness of George W. Bush with the paranoia of Richard Nixon, we're not exactly filled with confidence about the next 4 years.

Our stock market forecast for 2017

No forecast now, no forecast until April.  We can't recall another time in the last 30 years that we were so uncertain about what to expect from the US government, and how that would affect the key drivers of stock market returns - revenues, earnings and interest rates.

Other analysts have put out price targets for the S&P 500 of 2300-2450, which would imply gains of 3-9.5% from the current level of the S&P 500 at 2239.  The consensus for 2017 is that:

  • Inflation will rise from the current 2% annualized
  • Interest rates will continue to rise, with the Fed raising rates perhaps 3 times this year
  • The dollar will remain strong, depressing the value of overseas earnings and promoting imports over exports
  • A combination of deficit spending and new spending on infrastructure COULD enable the US economy to grow faster than the 2% annually of the last 8 years.
  • Wages will rise as labor markets tighten
  • Earnings in general will rise, particularly if corporate taxes are lowered

Better earnings increase stock prices, but higher interest rates depress stock prices.  Which driver will come out on top in 2017?  We don't know yet.  However, we do know that stocks generally fare better than bonds in an inflationary environment.  The bond exposure we do have is focused on short maturities (3-5 years on average.)  As yields rise, bond prices fall, but bonds of short maturity are less sensitive.  Further as these bonds mature, the proceeds can be rolled over to new bonds with higher current coupons.  We're happy with our clients' current asset allocations, and we will continue to adjust our strategy as policies of the new administration become more apparent.