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Market Commentary

Year-End 2016 Market Commentary and 2017 Market Outlook – Renormalizing the New Normal

Data Source: Bloomberg

4Q2016 Highlights:

• U.S. stocks turned in a strong quarter led by financials and pro-cyclical sectors such as energy.  This move accelerated following the November election results.  Markets outside the U.S. lagged as foreign currencies came under pressure versus the U.S. dollar. 
• The quarter also saw a resurgence in small cap value style of investing as investors interpreted the electoral results as favoring smaller/domestic-oriented companies that could benefit from a strong U.S. dollar. 
• Commodities, rallied led by oil prices, as OPEC agreed upon production cuts, despite a strong rally in the U.S. dollar.  Oil settled in the $50-$55.  Earlier in the year, oil had dropped to the mid-$20s as part of the global market sell-off. 
• Fixed income came under pressure as investor expectations of higher inflation rose following the U.S. election.  The 10-Year Treasury spiked above 2.60% before settling at 2.44%. Municipal bonds came under greater pressure as investors priced in expectations of lower taxes going forward that would make tax-free munis less attractive. 
• Although equities appeared to pause towards the end of December, investor sentiment has turned bullish on a renormalization of the “New Normal” where cyclical growth, led by fiscal stimulus, will help put the U.S. (and perhaps the world) out of its post-2008 deflationary doldrums. 
• With the S&P 500 trading near 19x next year’s earnings, valuations appear to be stretched; however, high valuations can be supported by a strong cycle of revenue and earnings growth, as corporate America rides the wave of cyclical reflation. 

YTD 2016 Highlights:

• U.S. stocks turned in another year of positive performance, extending the current bull market to almost eight years.  The S&P 500 returned 12% leading all other major regions helping to cement U.S. equity dominance over global markets. 
• Emerging markets had led all regions up until the November election where they experienced weakness over concerns that global trade would be restricted under the new U.S. administration. Japan and Europe continue to face structural issues of low nominal growth with the latter now experiencing a surge in populist sentiment following the Brexit referendum vote and ongoing migrant crisis. 
• Investors expressed a thirst for yield and defensive (low volatility) assets during the first half of the year as the macro environment remained highly uncertain following China’s January devaluation of its currency and renewed capital concerns of Eurozone banks.
• However, central banks, which had been pursuing negative rates, shifted policies to engineer steeper yield curves (longer rates higher than shorter rates) to support profitability of lending institutions. This started the reflationary trade that steepened global yield curves and accelerated following the U.S. election in November leading to one of the worst monthly returns for global bonds. 
• The markets have now priced in high expectations that the new regime in Washington will produce a more business-friendly environment through deregulation and lower taxes.  This renewed demand could drive labor costs higher which would feed into final prices prompting the Federal Reserve to become more aggressive in its rate tightening.
• Whether the cyclical reflationary forces can overwhelm the structure disinflationary environment caused by aging demographics and high debt levels will determine the longer-term course of equity and fixed income valuations. 

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To view 4Q2016 and YTD 2016 exhibits and supplemental charts, click here.