DAWN OF A NEW ERA? MARKET OPTIMISM TRUMPS UNCERTAINTY.
Market volatility continued in the fourth quarter of 2016 amidst uncertainty about the U.S. Presidential election as well as overseas economic and geopolitical tensions. For the better part of 2016 the U.S. faced an election that was too close to call allowing mood swings to underpin economic news as time wore on. The S&P500 Index declined 4% between September 30 and the Friday before Election Day. In the early morning after the election, futures markets traded down sharply as the results became clear. Yet, by the time markets opened, in an abrupt about-face, the markets had reestablished pre-election levels and the S&P500 Index rallied over 7% through year-end.
In the fourth quarter the S&P500 Index earned a 3.8% total return rounding up the strong year-to-date return to 12% for the year ended December 31, 2016. Inspired by the results of the Presidential election in November Small Cap Stocks surged 8.8% in the fourth quarter, chalking up a 21.3% total return for the year, as represented by the Russell 2000 Index. Foreign equity returns were lackluster during the quarter as indicated by the declines MSCI EAFE Index and the MSCI EM Index, 0.7% and 4.1%, respectively. Emerging Market equities had a strong year with an 11.6% total return.
|Market Indicies (Total Return as of 12/31/2016)|
|MSCI Emerging Markets**||(4.3)||11.2||(2.3)||1.6|
|Source: Bloomberg Finance L.P; *Annualized; **USD|
Economy and Interest Rates
In December the Federal Open Market Committee voted to increase the Federal Funds rate by 0.25%, to a range of 0.50% – 0.75% range. In anticipation of this rate increase, bond yields reached 2016 highs. Chair Janet Yellen proclaimed that the Committee will enact a “measured pace” of increasing the Federal Funds rate which, in our opinion, remains supportive of future economic growth. Concerns about the potential impact of rising rates on the dollar and global financial markets are the reasons for slower rate of increases.
The U.S. economy has grown at a 2.1% annual pace over the past five years. The slow growth rate has allowed the economy to heal from the 2007-09 financial crisis. Businesses and consumers have benefitted from the low interest rate environment. Companies have refinanced debt, repurchased shares and have decent cash levels on their books. Consumers also paid down debt as evidenced by an increased savings rate. Mortgage rates remained low which encourages consumers to buy homes and consumer durables.
Other indications of the improvement in the economy are that business and consumer confidence have been rising. In December, the NFIB’s Small Business Confidence survey rose dramatically to 115.8 from 107.8 in November. Small Business owners surveyed by the NFIB reported that they intend to make capital investments, hire more people and increase wages. President Trump’s pro-growth policies such as reduced government regulation and a revamped tax code support business owners’ optimistic stance.
Strong demand for U.S. Government bonds is evidenced by the Treasury’s new issues being overbought. The Ten-year Treasury Note yields 2.36% which is above the low of 1.37% reached in the past twelve months. In fact, over the past five years the 10-year Treasury yield has traded in a 1.4% to 3.0% range. The market hints that this range may be the “new normal” implying that investment income expectations remain modest.
Stock prices reached new highs several times in 2016 and the Dow Jones Industrial Average is flirting with 20,000. Prices are relevant in determining an investment’s value. As equity investors, we consider additional measures when weighing the outlook for the market: earnings, valuation and sentiment.
2016 earnings for S&P 500 companies are expected to be $118.01, 10% above 2015. For 2017, the consensus earnings outlook is $128.23, per Zack’s Investment Survey, an 8.7% increase. The price-to-earnings ratio base upon expected earnings, known as P/E, is a useful barometer of value. Presently the future P/E of the S&P 500 Index is at 17.7 times 2017 expected earnings, slightly above the 15.9x long-term average. We believe that on a P/E basis the market is neither expensive nor cheap. Investor sentiment has risen supported by an improved outlook for the economy. Expected earnings and sentiment measures are positive, and the P/E ratio is neutral. The 8.7% expected increase in earnings for the S&P500 Index plus the 2% dividend yield signal a good year ahead in the equity market.
When Is the Right Time to Invest?
When you are an investor and take a long-term view, any time can be the right time depending in what you are investing. Therefore, it’s advisable to have access to wealth managers who actively monitor securities and markets daily. It’s also our job to keep emotions like loss avoidance from endangering your overall goals. Investing in a portfolio diversified over different types of assets and actively managing the assets are the keys to long-term success. The secret to successful investing is to remain focused on why you invest: to build wealth over time. The Wealth Management Officers at Old Second work with clients to develop and implement investment strategies that fit their objectives of growth and income. Particularly in volatile markets, ensuring clients’ exposure to risk is appropriate for their situation remains most important. Challenges in the markets will be met with diligence and care. Our team of experienced professionals is available to help guide you along the path toward achieving your financial goals.
Rich Gartelmann CFP® – (630) 844-5730 firstname.lastname@example.org
Steve Meves, CFA® – (630) 801-2217 – email@example.com
Jean Van Keppel CFA® – (630) 906-5489 firstname.lastname@example.org
Brad Johnson CFA®, CFP® – (630) 906-5545 email@example.com
Joel Binder, SVP – (630) 844-6767 firstname.lastname@example.org
Jacqueline Runnberg CFP® – (630) 966-2462 email@example.com
Ed Gorenz, VP – (630) 906-5467 firstname.lastname@example.org
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