2016 will certainly go down as one of the more interesting years in recent memory. By far, the biggest story of the year was the presidential election results. Since the election, there have been quite a number reactions; not least of which has been in the financial markets.
As undoubtedly everyone knows, the U.S. stock market has soared since November 8th. While most of the market averages were on track for moderate gains in 2016, post-election, those indices added an additional 5 to 16 percent. The following table shows not just the returns, but also the gains relative to firm size.
Regardless of your political view, the reaction in the financial markets should be encouraging. But the question remains if these gains are justified. We’ve been asked that countless times since the election and do believe it is.
For the last several years, stocks have managed to post gains despite tepid economic growth. Those gains have been made possible through a combination of financial engineering, cost cutting and Fed monetary policy.
None of those are sustainable in the long run and have led us to wonder what would be a catalyst for growth over next few years. This has been a particular concern in light of the strengthening dollar and pressure on companies’ top line growth.
The current market momentum has been fueled by the belief that policies from the Trump administration will significantly alter the business environment in this country for the better. Based on what we’ve seen so far, we’re inclined to agree with the market’s optimism. Most notably are several of his key economic appointments and the early agenda focusing on clearing the way for growth. This is not to say everything is going to be smooth sailing in this controversial administration, but on matters effecting your portfolio, there are certainly valid reasons to be hopeful.
This year’s gains have been unique to the U.S. market. Overseas markets finished the year mostly flat in 2016, further indicating investor’s confidence specifically in U.S. growth. The MSCI EAFE Index, which is a stock market index designed to measure the equity market performance of developed markets outside of the U.S. & Canada, declined 0.7% in the 4th quarter and posted only a 1.5% gain for the whole year. We feel that the U.S. markets will continue to outperform in 2017 and have responded by reallocating our international investments to domestic shares.
The other significant reaction to the election has been in the bond market. The benchmark 10 year treasury rate rose 30 basis points immediately after the election and then added another 50 basis points by year-end. An 80 point increase in interest rates is a very big move and reflects the market’s belief that higher growth is ahead.
The improving outlook has also given the Fed a chance to finally unwind its ultra low rate policy. This is seen as critically important. The easy money policies of the Fed have been in place since the financial crisis. These policies were originally implemented to prop up home values and stabilize the debt market. They were effective in that regard but have lasted way too long. Strong market manipulations by the central bank for an extended period of time invariably lead to distortions and potential bubbles. It will be reassuring to see these programs finally put to bed and let interest rates find their true market based levels.