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We closed the 2016 year having experienced some of the most significant political changes to our country, and the world, we have observed in recent decades. It will be interesting to watch as the signaled changes unfold and impact our economy, markets and tax structure.
In terms of last year, the major asset classes results were: Stocks: the benchmark S&P 500 index achieved a total return, with dividends reinvested, of 11.96%. For most of the year the index was positive. Bonds: Barclays US Aggregate Index 2.65%1. The broader market’s technology heavy NASDAQ Composite index's total return returned 7.50% for 2016 and the measure of the world markets, the MSCI All Country World ex USA Index rose 4.50%.1 Interest rates are likely to continue their slow climb in 2017 and we continue to believe we are in a long term period of relatively low interest rates which should continue to benefit equity markets.
Last January, the US equity market got off to its worst two-week start ever, resulting in a 10 percent decline in the first two weeks of trading. While the stock market plunged, so did oil prices. Both ultimately recovered from the early stumble, but that wasn't an obvious outcome at the time. The biggest news affecting global markets? It wasn't the federal presidential election results. While we experienced a so called Trump rally after November 7th, the most market moving news was Brexit. On Brexit election night, stock markets fell quickly and then rapidly rallied to regain their losses. Last year, rising interest rates were not as significant as many had predicted and small business optimism skyrocketed in December after the election. With small business accounting for almost 50% of jobs in the US, this optimism may bode well for the US economy.2
The two major world events last year, as mentioned above, combined with the current question of 'what will our government do next' creates a degree of uncertainty. But is uncertainty bad? Not always, hypothesizes Brian S. Wesbury – Chief Economist for First Trust, "If you listen to elite policymakers around the globe, they all seem to agree on one thing: the need to avoid "uncertainty." In their thinking the battle against uncertainty is a never-ending struggle, and if only the world were more certain the economy would be doing much better. Which is kind of odd when you think about it, because if you really want certainty you couldn't get much more of it than in the old Soviet Union or present day North Korea. Those economies minimize flexibility, choice, and freedom, while maximizing certainty. It's the certainty of the prison cell, but it's certainty nonetheless. By contrast, free-market capitalism is the opposite of a system built on certainty. No one knows what will be invented or discovered next - otherwise it already would have been invented or discovered - or how consumer appetites will change in the future. In free-market capitalism, uncertainty is a feature, not a bug. Obviously, not all certainty is bad. People are more industrious and more inventive when they can rely on the certainty that their property rights will be respected by both the government and their fellow countrymen. That kind of certainty is good, and governments that respect the rule of law, while minimizing corruption and the impact of political correctness, help maximize the risk-taking that boosts standards of living. In the end, it's really about 'faith' more than 'certainty.' If investors, entrepreneurs, and workers can operate with justifiable faith that the government will protect their freedom, they will always attempt to boost economic growth."3 For economic growth to get a boost from its current 2% annual rate, we need increases from some combination of 1) personal consumption, 2) capital spending on housing and by corporations, 3) government purchases and 4) trade. So what will it be for 2017?
Repeating what we wrote last year, investors should continue to plan for lower rates of return than have occurred in prior decades. We continue to maintain last years opinion on investment returns, for the foreseeable future. For investors this is a very important concept to embrace and consider. One can invest in a riskless U.S Government guaranteed investment (10-year US Treasury Bonds) and earn a fixed interest rate of 2.45% on 12/30/16 (which interestingly was 2.27% at the end 2015).4
To earn more than the 10-year Treasury yield, investors must commit to risking their investment principal in fluctuating value (gain or loss) investments such as stock, real estate or commodity market assets. The risk reward, over time, for stock market based assets is typically a margin over the U.S Treasury yield. For example, the typical risk reward formula is the 10-year U.S. Treasury yield of 2.45% + risk reward margin of 4.0%, equaling a 6.45% in total return result, over an extended period of time. 6.5% for a 100% stock allocation (which no prudent investor should have) is below the historical average, but this view should be dialed into present day investor forecasting and be accepted as a forward expectation for risk asset returns. If you are depending on investment return averages greater than the above formula displays, you may be disappointed.
Our outlook, continues to be more of the same in 2017, but we could be surprised (in either direction) with the political changes and resulting proposed federal law changes, which have been proposed. Diversification will be important, diversification seeks to avoid divergent returns from different asset classes and in doing so, protects against downside loss. Understanding this concept means investors will not own only the winning asset class and avoid the losing asset classes. Accordingly, investors will not take home a rate of return that matches the best market return. When we experience long periods of market optimism, noting the current bull market dates to March 9, 2009, which is the second-longest on record, it is easy to forget the market does cycle and at sometime will enter a bear market period. Historically, market declines have varied in intensity and frequency and they have been regular events. It may also be reassuring to know that the market has always recovered from declines. Volatility is not a recent phenomenon. Investors can expect the market to experience significant corrections with regularity. Over the last three decades corrections have averaged approximately 14%.5 History has shown that those who chose to stay the course, and remain invested, were rewarded for their patience more often than not. Investors often think they are more comfortable accepting risk when stocks are at an all-time high only to turn their stocks to cash after a plunge. If you have that concept in your current thinking, you may have too much risk in your allocation. Take a look at your investment account statements from October 2008 to March 2009 and try to remember how you felt during that time. Did you sell your stock positions when the 'half-off' sale was going on. Embrace the pain and anxiety you felt back then and set your overall allocation between stocks, bonds, real estate and cash, accordingly. We can help you with your allocation. If you believe your current investment allocation is not appropriate for you and your objectives, please let us know. And realize that we always suggest a prudent approach is to think long-term and to maintain a steady focus on your longer term investment objectives.
Annually we gather data in preparation of assembling a comprehensive report including your Personal Financial History. We are currently working toward completion of these reports, please help us by sending the necessary data to our office for any accounts for which we do not receive statements or other personal information. The assumptions we use in these reports are reasonable approaches in an attempt to estimate when a client should reach their individual level of financial independence or in the case of those that are currently retired, how long their investment assets will be available to support their targeted lifestyle.
Once you receive your report, please review and call us to schedule a mutually convenient time to review your goals, objectives, review your current savings rate and your accumulated investment assets together with an asset allocation review, and together we can determine if any changes might be in order to address your tolerance for volatility and your long-term wealth accumulation objectives as reflected on the annual report “Estimate of Retirement Needs”.
1 Capital Group
2 Hartford Funds Management Group, Inc
3 First Trust Advisors L.P. 06/27/16 regarding Brexit
4 Source: WSJ Markets
5 First Trust Advisors L.P., Bloomberg.