It’s A Whole New Ball Game Market Wrap - Fourth Quarter 2016

For a year that started with stocks losing over 10% right out of the gate, the ending was sweeter than expected. It was indeed a year of surprises. The Brexit vote threw the markets into a panic in June, and the stunning victory of Donald Trump on November 8 turned the bond market on its head and set off a totally unexpected rebound in stocks. Let’s take a moment to wrap up what happened in 2016, and then focus on how 2017 might unroll. 2016 investor results were strong, despite very uneven performance across sectors. Most U.S. stocks did well, especially small and value-oriented stocks, and the major indexes like the Dow and S&P 500 delivered robust performance. However, large growth stocks, including health care and biotech, were definitely out of favor. The average large growth stock fund closed the year up less than 2%, and health/pharmaceutical/biotech funds lost over 10%. International stocks faced a huge headwind from the strong dollar and ended the year up only 1%. Bonds experienced a pretty wild roller coaster ride in 2016, especially after the Trump election, as bonds suddenly fell out of favor. Despite that, interest rates ended the year not far from where they began. Some bond sectors, like high yield, corporates and inflation-protected securities, closed the year with surprisingly good returns, while ultra-safe Treasury and municipal bonds ended the year almost flat, a victim of changing sentiment and speculative selloffs after the election.

Looking ahead to a new political regime

What should we expect with a new Trump administration? We’re anticipating a more pro-business environment with regulatory rollbacks, a push to stimulate economic growth and a potentially lower tax burden that could make U.S. companies more profitable and competitive. Are personal tax cuts for you in the cards? Some personal tax simplification is possible, but Congress will need to be careful not to make the U.S. deficit bigger or overheat the economy, both moves that could push interest rates higher and boost inflation.

Interest rates are already trending upward

As expected, the Federal Reserve hiked rates 0.25 (¼ of 1%) in December, with two to three additional hikes expected for 2017. That means your floating rate debt (like credit cards, home equity and

student loans) might start costing you more. It’s time to develop a strategy to start paying off your liabilities.

We don’t know how fast or how much interest rates might drift upwards, but look at higher rates as a positive. If the Fed raise rates, it means the economy is strong enough to stand on its own two feet.

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2017 Investment Strategy

A slowly improving global economy with potentially higher interest rates and inflation favors growth assets like stocks instead of bonds or cash. The U.S. economy is stronger but valuations are better overseas, meaning a mix of U.S. and international equities is still recommended. Stocks, real estate, and natural resources are all good inflation-fighters as prices and values can rise with time and market conditions. We favor high-quality dividend growth stocks over purely high-dividend stocks or other “bond substitutes.”

Investors still need bonds to keep portfolio risk manageable. We like high yield, floating rate, international, strategic and inflation-protected bonds. Municipal bonds are also well-priced.

Avoid excessive cash holdings. Cash is guaranteed to lose money once inflation and taxes are taken into account, and misses out on the potentially higher returns of stocks and other growth assets. Sticking to cash is a recipe for losing money if inflation makes a comeback. With inflation, your motto needs to be “Keep up, or else!”

Remember that you’re in it for the long haul and short-term returns are not relevant to your long-term success. Since the election, market results have been driven by pure speculation about the Trump regime (and that euphoria may not last). When reality hits, it could favor an entirely different market result. That ’s why it’s always important to make portfolio decisions based on facts, not speculation.

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“Why Didn’t I Get The Same Results As The S&P 500?”

When the S&P 500 index performs well, as it did in 2016, you can bet your bottom dollar that financial advisers across the country are busy explaining why portfolio results didn’t keep up. The simplest answer to the question is that you should expect to get the return of the S&P 500 only if 100% of your assets are invested in the S&P 500, and that’s

almost never the case for real-life investors. Almost all real-life investors own a diversified portfolio containing different types of stocks, bonds and alternative investments. Real-life portfolios are designed to meet your specific needs for growth, income and risk, instead of matching a market index. Keep in mind, as well, that index returns assume reinvestment of all dividends and ignore the real-life flows and withdrawals of an actual portfolio. In a diversified portfolio, S&P 500-type stocks are only one slice of the pie. Your overall portfolio performance is a weighted average of all components. If the S&P 500 is 10% of your portfolio, it contributes only 10% of the overall portfolio return. If bonds are 50% of your portfolio, your bond returns will control 50% of the return, and so forth. Your overall portfolio results are a function of the averaged returns of U.S. stocks, bonds, foreign stocks and all the other diversified investments you own. When the S&P 500, or any other index, performs well, people tell themselves they should have owned more of it. But the facts don’t support that. No one index, or market sector, consistently performs “the best.” In fact, trying to buy “the best” frequently makes you “the worst.” For example, investors who overloaded on tech stocks in 1999 or financial stocks in 2007 learned why owning too much of one thing is never good. The lesson that savvy investors learn is that over the long-term, it always pays to diversify and own a portfolio appropriate to your needs, even if it doesn’t always give you market-beating results in the short-term.