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Market Commentary 12/31/2016

Winds of Change…

The election of the 45th US president on November 8 introduced a wave of speculation here and across the globe about economic policies for 2017 and beyond. Investors’ hopes for a new, pro-business attitude in Washington drove the S&P 500 to record highs, yet there have also been concerns about the economic impact of changes proposed by the incoming administration. Historical trends caution us against taking the post-election market rally as an indication of what the future holds for this presidency. Nevertheless, many of President-elect Trump’s proposals have the potential to propel the economy forward, though, as always, there is by no means certainty for the road ahead.

Looking back at 2016, US markets generally remained upbeat from November 9th through year end, with the S&P 500 recording a quarterly return of 3.8%. While the markets rallied post-election, they first had to erase the losses sustained in October. Much of this turnaround was driven by financials. Rising rates and a bet that the new administration will lighten the sector’s regulatory environment drove financial stocks up 21.1% for the quarter. The markets also saw continued gains in energy and industrials, rising 7.3% and 7.2% for the quarter respectively. Even more than large companies, smaller US company stocks had big wins with a total return for the quarter of 8.8% as measured by the Russell 2000.

By contrast, European equities did not perform well. An aggressive monetary stimulus program wasn’t enough to turn around Europe’s weak economic growth, and an increasing sense of populism and anti-establishment politics created additional uncertainty for European markets. US investors saw their already modest international returns cut even further after the sharp November spike in the US dollar.

2016 ended relatively well across the board for fixed income despite gyrations along the way. The benchmark 10 year Treasury yield started the year at 2.27% before hitting a bottom of 1.36% in early July. Post-election, the yield shot up again in anticipation of Fed rate hikes and inflation, closing 2016 at 2.45%. Even with a sharp rise in yield and the consequent drop in price for bonds, there were still plenty of strong returns to be found across the fixed income market in 2016. After 35 years, though, we believe the bull market for bonds has finally come to an end, meaning that going forward, successful bond investing may require more skill to attain the kind of returns investors are used to seeing.

Looking to the future, will the upward trend that started on November 9th continue into 2017? On the one hand, history suggests that markets aren’t good at judging presidents. A recent Wall Street Journal article discussed market returns between election and inauguration for the past 13 presidents, from 1928 through 2008. Seven out of thirteen time periods saw election-to-inauguration returns that starkly differed from the overall direction of the market during each president’s term. This held true across both Democratic and Republican administrations, including that of one of Trump’s most lauded predecessors, Ronald Reagan. After Reagan was elected, stocks rose by about 10%, nearly identical to the gains heralded by Trump’s win. Yet while Reagan’s presidency was characterized by tremendous economic success, the initial rally didn’t hold and stocks lost those early gains over the next couple of years. Here history would suggest that the recent market rally may not be a good indicator of what 2017 has in store.

That said, when one considers our nation’s already-improving corporate environment combined with a perceived ‘pro-business’ attitude within the new administration, it seems possible that the US market may have legs to continue its run. Investment managers point to Trump’s call for substantial corporate and individual tax cuts, job creation and infrastructure projects, and the rolling back of regulation as policies that may have a positive impact on market performance. Trump has promised to put more investment into job creation projects such as transportation, clean water, telecommunications, security and energy infrastructure. Of course, as with any presidency, it is difficult to know which initiatives will actually be implemented. With the Republican majority in congress, the proposed tax cuts may well be achievable. Whether the other initiatives, many of them carrying enormous costs, will be successfully navigated through Congress is less clear. Yet if the new president can build on the current environment with a combination of fiscal and other policy decisions, we may continue to see stock market strength in the US.

While US corporate earnings and the economic environment is in generally good shape, there are still significant hurdles to overcome. Market valuation remains one big concern. Investors should question whether corporate earnings will grow enough to support stock valuations, which are higher than their historical averages. Of concern, too, is the fact that many of Trump’s proposed investments in infrastructure would likely come at the cost of increasing the budget deficit. Inflation could become an issue if government spending on infrastructure starts to drive prices up. The current inflation rate is in line with the Federal Reserve target and is low by historical standards but, if it rises rapidly, could put a damper on market growth. Lastly, the diverging policies of the Fed and central banks around the world have caused a strong dollar relative to many foreign currencies, including the Euro, at its lowest level to the dollar since 2003. A further strengthening of US currency could threaten the recovery in US corporate earnings by making US exports more expensive to foreign buyers and reducing the value of companies’ overseas revenue.

As we enter 2017, there are reasons to be optimistic. Yet whether early gains will translate into long-term results remains to be seen. New forces at work in our markets, such as the rise of inflation and an increasing populist sentiment, will affect investors now and going forward. We may or may not agree with the direction of these winds of change, but we shouldn’t disregard them. We believe that we have entered a new phase of the market cycle that will require more care in selecting investments here and across the globe. Valuations are not cheap overall, but our belief is that opportunities remain. We will continue to be vigilant in finding opportunities that help our clients achieve their goals.

We look forward to working with you to achieve your goals in the years ahead.

Thomas L. Menzel, CFP®                                             Shawn J. Jacobson, CFP®, ChFC, MBA
Asset Manager                                                            Asset Manager


JP Morgan Guide to the Markets 1Q 2017; Forester Value Fund Quarterly Update, January 2017; Charles Schwab, Luminous Times: Looking Ahead with Optimism about 2017, January 2017; Raymond James, Investment Strategy Quarterly, January 2017; Weitz Investment Partners, Value Matters, January 3, 2017; Wall Street Journal, Dow Ends Strong After Poor Start, December 31, 2016; Wall Street Journal, Can All the Markets be Wrong on Trump?, November 29, 2016

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