Undoubtedly, the biggest story during the final quarter of 2016 was the unexpected election of Donald Trump as President of the United States. That result, which surprised most poll-watchers, coupled with Republicans maintaining majorities in Congress, has led to a general belief among investors that the business environment and corporate profitability may show improvement.
The US economy has already shown signs of life. The final reading of third quarter GDP checked in at 3.5%, showing the fastest growth in two years. While most economists expect growth in the US to return to the “new normal” of 2.0%-2.5% growth going forward, there has been a notable uptick in optimism. First, consumer confidence and sentiment surveys increased markedly towards the end of the year, with the Conference Board’s consumer confidence release showing its strongest reading since 2001. Additionally, most expectations-based economic surveys have also been trending upward. The labor market remains strong and now appears to be reaching levels that most economists would consider to represent full-employment. At the end of November, the headline unemployment rate stood at 4.6%, its lowest level since mid-2007. To date in 2016, the economy has added approximately 180,000 jobs per month, down from 229,000 per month in 2015. As the economy nears full employment, wage growth is showing signs of materializing, which may be a harbinger of inflation concerns. The consumer side of the economy remains in relatively good shape. According to the Census Bureau, retail sales continue to advance at a modest pace. Housing statistics generally remain strong, with the S&P/Case-Shiller Housing Index continuing to show gains. However, the rising mortgage rates experienced toward the end of the year may threaten the sustainability of housing market strength and will be closely monitored going forward.The industrial side of the US economy showed signs of improvement throughout 2016, in part due to a rebound in energy-related commodities. The price of crude oil jumped 45% during the year, with WTI crude oil ending the year just under $54 per barrel. Manufacturing followed suit, as the Institute for Supply Management’s Purchasing Managers Index (PMI) came in at 54.7 for December, its highest level of the year, buoyed by strong new orders, production, and employment figures. Additional recent releases from regional manufacturing surveys have also strengthened into year-end.
In-line with market expectations, the Federal Open Market Committee raised the federal funds rate by 0.25%, to a range of 0.50%-0.75% at its December meeting. This move was the Fed’s first hike for calendar year 2016, and only its second hike since moving to virtually 0% rates in 2009. Also of note during the December meeting was the Fed’s projections for 2017 included three projected rate hikes, up from previously expected two hikes. The primary reasons given for the rate hike and projections include a stronger labor market and an expected gradual rise of inflation.
The yields on longer-term bonds also rose during the fourth quarter, pushing bond prices lower. Expectations for stronger growth and inflation helped move the benchmark 10-year treasury note from 1.60% where it began the quarter to its year-end closing yield of 2.45%. In fact, the month of November saw the largest one-month increase in the 10-year Treasury note in nearly seven years, while during late December the 10-year nearly reached 2.6%, its highest yield in over two years. The rise in yields caused losses in many bond funds, with the Barclays Aggregate bond benchmark losing 3% for the fourth quarter.Globally, interest rates remain stuck near historic lows. While the overall level of sovereign debt at negative yields declined during the quarter, it was estimated there was still significant amounts of global debt carrying negative interest rates as of the end of November. While rates in most developed nations have increased, major world economies such as Germany and Japan have their 10-year government securities yielding less than 0.25% at year-end, while the UK crossed above the 1% market during December. Furthermore, most central banks are still stuck in an accommodative phase, versus the tightening being experienced in the US.
Treasury yields of selected maturities for recent time periods are displayed below.
|Treasury Bill||Treasury Notes & Bonds|
|3 mo.||2 yr.||5 yr.||10 yr.||30 yr.|
The total return numbers for various fixed income indices over the last twelve months are displayed below (data from Bloomberg).
|12 Month Returns (as of 12/31/16)|
|Barclay Capital US Aggregate||2.65%||Merrill Lunch US High-Yield||17.49%|
|Barclays Intermediate Government||1.05%||Merrill Lynch US Municipal Index||0.44%|
|Dow Jones Corporate||2.49%||JP Morgan Embi Global||10.19%|
As the year came to an end, investors watched the Dow Jones Industrial Average flirt with the 20,000 level on the heels of the “Trump Rally.” Although the Dow ultimately fell short of the 20,000 in 2016, shares of stocks within financial and industrial sectors were bid up strongly following the election, which propelled the Dow to an outsized gain relative to other widely followed large-cap indices during the quarter. Another notable characteristic of 2016 was the outperformance of value stocks versus growth, which reversed a trend seen in previous years. Meanwhile, smaller-capitalization stocks experienced a dramatic run-up in the final quarter of 2016, gaining over 11% in the month of November alone. In general, higher-yielding stocks in more defensive areas of the market were the laggards for the quarter, as investors rotated out of those sectors due to a rising rate environment and began looking for stronger earnings growth potential.
International equities failed to fully participate in the late-year rally, and had mixed results for the full year. Developed foreign markets showed a modest decline for the quarter, and ended just slightly positive for the year. Although these foreign markets have lagged their US counterparts for some time and appear to becoming more attractively valued, most foreign economies are still stuck in a very low growth environment and are grappling with political uncertainty of their own. Emerging market equities experienced a volatile 2016, gaining over 10% for the full year as higher commodity prices generally benefit these economies, but had a rather sharp pullback during the fourth quarter, dropping over 4%.
Below is a table which displays various equity index returns for the past quarter.
|Equity Indices||4th Quarter 2016|
|Dow Jones Industrial||8.66%|
|S&P 500 Growth||0.48%|
|S&P 500 Value||7.34%|
|Russell 2000 (small-cap)||8.82%|
|MSCI/EAFE (developed international)||-0.62%|
|MSCI/EM (emerging markets)||-4.31%|
Looking at sector performance within the S&P 500, there was once again a wide dispersion of returns. A major reversal in leadership continued during the quarter, with Financials gaining over 20%, followed by strong gains in the Industrials and Energy sectors. Conversely, interest-rate sensitive sectors including the newly created Real Estate sector and Utilities were among the biggest laggards, as interest rates moved markedly higher in the period. Health Care was also a laggard, as political uncertainty remains heightened due to uncertainty regarding the future of the Affordable Care Act.
The following table details S&P 500 sector returns for the quarter (price only).
|Return by Stock Sector||4th Quarter 2016|
|6. Consumer Discretionary||1.9%|
|9. Consumer Staples||-2.7%|
|10. Health Care||-4.4%|
|11. Real Estate||-5.3%|