Year In Review - 2016
After many years in which the financial crisis and its aftermath dominated sentiment – and outcomes – in the financial markets – 2016 was most noteworthy for the impact of political events. Since the mortgage meltdown of 2007-08 it had been the Federal Reserve along with other central bankers whose actions seemed all important. However, unexpected election results in Britain in late June and then in America’s November elections put politics at center stage. Brexit and the implications of the Republican triumph dominated much of the results in stock, bond, and currency markets during the latter months of the year.
Ironically, despite the discontent expressed by voters, most national economic statistics were relatively strong. The year was, in fact, a quite respectable one for the American economy and consumer. Moderate growth continued, purchasing power gathered strength due to low inflation, and wages rose a bit faster than in previous years as the employment market continued to expand and participation increased.
The prevalent view in recent years has been that interest rates had nowhere to go but up. That sentiment abruptly turned in mid-February, when the Fed signaled its reluctance to raise rates in the face of global economic distress. From that point on, beaten up assets such as emerging market bonds and stocks, as well as natural resource stocks, surged. The decision by British voters to exit the European Union was a shock to the financial system and seemed to ensure that the period of record low interest rates will continue indefinitely. However, in contrast to the consensus opinion, economies and markets remained steady. Later, the shock US election result produced an instant reversal in interest rate sentiments, as the prospect of potential tax cuts and increased government spending led to a surge in optimism concerning economic growth, and also raised the specter of inflation, causing interest rates to spike.
Major Economic Events
Growth in the US was moderate, although the path was bumpy. Employment expanded at an increased clip, inflation remained under control, and housing prices rose. Consumer confidence and spending remained fairly high. Manufacturing struggled, depressed by reduced energy production and the effects of the high US dollar. The anti-business and anti-trade tenor of the election had no discernible economic or financial impact.
Growth slowed in China, although various government stimulus measures provided some relief. Debt rose and the Chinese stock market was highly erratic. Resource-based economies – and individual companies – suffered from the slowdown in Chinese demand. Australia, Brazil, Russia, and Indonesia were among the nations that were negatively impacted.
Europe’s economy slowly recovered, and it seemed that the worst had passed. The European Central Bank embarked on a massive easing program. That sense of optimism was crushed in 2016 by the refugee crisis, which soon exposed the fault lines in European “unity”. Contrary to what most expected, Brexit had little effect on British and European economies, although it is still unclear how the European situation will evolve.
Oil prices touched bottom in mid-February, 2016, then rebounded sharply. American shale producers have proved quite resilient and it seems that low energy prices are likely to continue, despite the fact that demand for oil has exceeded expectations. OPEC continues to try and reassert its power over the market.
The Equity Markets
US stocks rose in each quarter and have risen for five straight quarters. The broad US equity market ended 2016 with gains of roughly 12%. Small and mid cap stocks did particularly well, particularly in the last two months of the year. Healthcare fell, as concerns over drug pricing weighed on the sector. Financial stocks surged in the post-election rally. Value stocks significantly outgained growth.
International stocks were mixed. The EAFE Index (predominantly Europe, Australia, and Japan) ended the year up just 1.0%. The various stimulative measures taken by central banks in Europe and Japan have not produced a robust turnaround. Large European banks, in particular, are being hurt by the negative interest rate policies. In emerging markets, the story was much more favorable, albeit with volatility and a large dispersion of returns. Despite poor economic statistics, equity investors are looking forward and countries such as Russia and Brazil, having been written off by many investors, turned in strong gains during 2016. Italy and Mexico were the worst performers of 2016.
Energy stocks profited from the rapid recovery in energy prices; natural resource stocks ended the year as the top asset class. American REIT prices did reasonably well, although the prospect of higher interest rates pulled them down during the last half of the year. International REITs struggled with sluggish consumer spending.
Overall, the effects of diversification from the traditional S&P 500 index were mixed. Small and mid cap stocks made significant positive contributions, as did energy stocks. International investments detracted overall, although the gains in emerging markets were not far below the American market.
The Fixed Income Markets
Bond returns were weak in the fourth quarter and this drop negated much of the gains of 2016. Nevertheless, bonds ended the year with positive results. US taxable bonds ended with a return of just under 3%. The Federal Reserve increased interest rates just once. International bonds also had a poor fourth quarter (a rising dollar inflicted much of the damage) and ended the year with only small gains. Cash and similar investments continue to languish.
