May you live in interesting times.
Ancient Chinese curse
2016 gave investors many reasons and opportunities to want to move to the sidelines and step out of equities, although in the end, it was not an unusually volatile year for world markets. Although it may seem hard to remember back so far, the year got off to a very rocky start, with markets tumbling 10% in the first few weeks of the year – the worst start to a year since 1930. You may recall from one of my early year posts, the Royal Bank of Scotland’s Andrew Roberts made a widely publicized, “Sell everything – and now!” call on January 12th, essentially predicting bad things for the year ahead. (To borrow and slightly modify a phrase from Dr. Phil, one might ask, “How’d that work out for you?”)
Then came the Brexit surprise of late June, with markets around the globe – including here in the U.S. – falling between 6% and 10% the day after. And then, of course, there were the worries about the possibility that Donald Trump might actually win the presidency and the expected impact that might have on markets. Markets appeared to indicate very clearly in the weeks leading up to the election that they would not look favorably on a Trump victory and, in fact, US stock futures did fall 850 points on election night as it became evident that – against many odds and almost all predictions, Donald Trump defeated Hillary Clinton.
And despite all of these worries, how did equity markets fare in 2016? Quite positively. One would be hard pressed to find a bad outcome around the globe for those who were fully invested for the year. US large company stocks were up 12% for the year, and US small company stocks – despite looking quite expensive at the outset – ran away with the show, posting a 21% return. Emerging Markets – up 31% for the year at one point mid-year – ended up adding 11%, and Asia was up as well, albeit a meager 2%. Europe was essentially flat, give or take, drifting down less than a half of a percent. Bond returns were anemic (again), with most high quality corporate and government categories in the 0% to 2% range – perhaps 3% if one was feeling sporty and went out as far as 10 years on the yield curve.
In addition to positive equity returns in most markets, we also saw the reemergence of something we had not seen in several years: the value premium. Historically, value-oriented stocks (i.e., those that are inexpensive compared to other stocks based on earnings or book value) have outperformed “market” and growth stocks by a few percentage points a year, but this premium had not made an appearance in the few years prior to 2016. As value-oriented holdings are a significant portion of the portfolios we construct, this had been a disappointment, but not a surprise, as styles (value vs. growth, large vs. small) suffer through cycles of their own. However, last year, the tide turned and value-based investment strategies were clearly on top, both here and abroad. In the US large cap market – and in stocks globally, we saw a value premium of about 5%, meaning value stocks outperformed the broad markets by that much. In the US small cap market, the value premium was closer to 10%. Given that such cycles often persist, it would not be surprising to see this premium persist for a few years in its own turn, but of course, only time will tell.
If there is one take-away I would suggest from 2016’s year in review, it would be this: It is very difficult to predict what will happen in the world, let alone in the markets – and even if you know what will happen in the world (and of course, that itself is unknowable), it is still impossible to fully predict what will happen in markets. Two good examples of this point include the meager but positive return the London FTSE 100 stock exchange posted in the six months following the Brexit vote (who would’ve thought?), and the US market’s surprising post-election rally, which added nearly 2,000 points to the Dow in the seven weeks following Donald Trump’s election victory. The best example, though, is one I wrote about mid-year: Brazil. Despite a host of issues which garnered wide attention, including very negative pre-Olympic preparation coverage and the year-long impeachment story of Dilma Rousseff, the country’s first female president, on charges of manipulating the federal budget, that country’s market somehow managed to be at the top of the charts this year, gaining an eye-popping 56%. These lessons will be well worth remembering as we contemplate what may lie ahead for 2017 as a soon-to-be President Trump takes office.
Trump and the Markets
On that topic, a few comments about what a Trump presidency has meant so far and may mean looking forward for markets: I’ll start with acknowledging how divisive a campaign we witnessed and how deeply and bitterly divided so much of the country is over fundamental issues. It is obvious to anyone who has picked up a newspaper in the last year that there are deep political divisions which span economic, social/welfare, and immigration-related issues, as well as what is acceptable behavior from anyone, let alone a presidential candidate. Putting aside issues of personality and temperament, which I understand are not inconsequential things in a president, I will proffer a guess as to why markets have (unexpectedly) performed so well post-election, with the acknowledgement that hindsight is closer to 20/20 than is foresight.
In essence, despite the misgivings many voters may rightfully have about issues of temperament, diplomacy, and social norms, Donald Trump has put forth an agenda that – at least in part – is pro-growth, pro-business, and pro-capital. His proposed agenda, which includes tax cuts at both the individual and corporate levels, an infrastructure spending plan, and trade reform, has ignited the hopes of many business leaders and voters, in what appears to be a rising sense of economic confidence and animal spirits[1] not seen since before the financial crisis.
One economic issue of some concern remains Trumps anti-trade position and the potential to spark a trade/tariff war with our largest trading partners. Doing so would be unequivocally bad for businesses here and abroad, as well as for the American consumer. Such a trade war would likely preserve the jobs of a few – but at the cost of many other jobs that would be lost to decreasing exports, and also at the incalculable cost to the American consumer of increased prices on everything from TVs to cars to clothing. Whatever benefits a Trump economic agenda may yield, they are not likely to be had from a trade war and imposing tariffs on imported goods. We, as consumers – and ultimately as producers – are better off as a whole when goods are manufactured and purchased at their lowest cost, wherever that may be. Said another way, while 700 Carrier employees and perhaps a larger number of Ford and GM employees may be better off by having their jobs remain here in the U.S., it is unlikely that Americans at large would see a net benefit – and indeed, it is much more likely that they see a net loss – from forcing companies to manufacture goods domestically at a higher cost. (And, in reality, any requirement / incentive to manufacture goods domestically will almost certainly lead to increased efforts to automate such jobs out of existence as Carrier is doing with $16MM of investment in its Indiana plant, which ultimately will eliminate a substantial portion of the jobs that were to be saved.) It remains to be seen how aggressively President Trump pursues a protectionist trade agenda, but let’s hope this is not at the top of the agenda and that a more pro-trade Congress prevails in limiting the scope of any such agenda.
So, just as 2016 was an “interesting” year, I have no doubt that 2017 will be equally “interesting.” I hope for you and your family, it is interesting in a positive way and that it’s a year of improving health, happiness and prosperity. As always, please let us know if there is anything we can do for you.