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Fourth Quarter 2016

Happy New Year!

In 2016, the notion that anyone can predict the future has been completely dispelled. Even those that were in the business of interpreting polls lost all credibility this election year. Despite all predictions to the contrary, Donald Trump is president-elect and Republicans control Congress. The market initially reacted negatively the night of the election, but has turned positive ever since. Since the election, the S&P is up approximately 6%.

The Markets

2016 began with the worst two months for the S&P performance ever, but went on to recover and now is near new, all-time highs. As we have mentioned many times, this illustrates that short-term market performance is not a predictor of what will happen even later in the year. The year ended on a very positive note for equities, but a negative trend for bonds - most likely a reaction to perceived fiscal stimulus like infrastructure investment and lower taxes, as well as higher interest rates and potentially higher inflation. Bonds reversed their gains after decades of appreciation, as interest rates have come down steadily since the 1980s. It may take some time before rates are normalized. Especially hard hit were municipal bonds, since higher interest rates and lower taxes were a double whammy for them. We would not sell them now, but assure diversification in different types of bonds to protect against further declines. This is a process we have embraced for some time. The biggest winners were small company stocks.

If you missed the best three days in the market last year, your S&P return was reduced to 4.4%. After large declines, oil prices rebounded as well closing at $53.72 a barrel. However, our national debt is now $19.879 trillion compared to $11.2 trillion just 10 years ago.

All of this market reaction to events yet undetermined has created questions from some clients. The top three questions I get are:

  1. Is the market overvalued, should I get out?
  2. Am I missing too much, should I get more aggressive?
  3. Should my accounts look like the S&P 500?

It reminds me a little bit of what it was like in the mid-1990s when we had many of the same questions. You may recall Greenspan famously declared the markets’ “irrational exuberance” in 1996, but it was 1999 before markets peaked. The decline was significant from 2000-2002, with the dot-com bubble bursting and 9/11 and the subsequent recession.

Consider the following: One measure of market valuation is price-earnings ratio or “P/E” ratio. The historical P/E (25-year forward P/E average) of the market averages 15.9. At the peak, in 2000 it was 27.2. The current P/E ratio is 16.9. We are somewhat above average, which means caution is in order. What we know historically is that markets can run up for some time before corrections happen. International stocks are less expensive as measured by PE as are emerging markets, which had a very good year in 2016. Historically, it is a buying opportunity when PE’s are historically low. Bonds are still a type of insurance policy in a portfolio against significant loss, even though they might not perform as well when interest rates are rising. While we never know what the future brings, we are not anticipating sharp increases and The Federal Reserve has not signaled significant increases, but rather slower, more pragmatic change. With a diversified portfolio, it is important to balance risk. The bottom line is if you try to match stock market returns, without the benefit of diversification, you take on significant risk (which was more than 50% declines in the corrections of 2001-2002 and 2008-2009).

The first few months of 2017 will help us determine what policies will actually be enacted and how to take advantage of what may be significant trends. While much is written about what is likely to happen and how investments will react, we know that flexibility and diversification are paramount, as no one can predict short-term events. We will always stay focused on the goal and prepare for the unpredictable.

We hope you had a wonderful holiday season and wish you a healthy and happy 2017!


Financial Market Update* Year-to-date change as of December 31, 2016
S&P 500 Index 11.96%
Morningstar Commodities
Broad Basket Category 12.16%
MSCI EAFE US$ (International) 1.00%
Barclay US Aggregate Bond 2.65%
*Indexes are for illustrative purposes only. One cannot invest directly in any index. Assumes dividends are reinvested.
Source: Morningstar

The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market. The Morningstar Commodities Broad Basket Category is a composite of returns of all funds in this category. The MSCI EAFE is a free float-adjusted market capitalization index that is designed to measure developed market equity performance, excluding the United States & Canada. The EAFE consists of the country indices of 21 developed nations. The Barclays US Aggregate Index is an unmanaged market value weighted performance benchmark for investment-grade fixed rate debt issues, including government, corporate, asset backed, mortgage backed securities with a maturity of at least 1 year.

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