Market Watch - January 2017
Written by Rick Welch on January 2, 2017
We are pleased to provide you with our quarterly newsletter featuring the status of our investment class weightings, our interpretation of recent data and our outlook for the future. If you have any questions about any topic, we hope you will not hesitate to contact us.
Status of our Investment Class Weightings
Changes from our October 2016 Market Watch are noted in italic.
US Large Cap Sectors –
Overweight – Financials (↑) and Technology
Neutral – Consumer Discretionary, Consumer Staples, Energy, Health Care (↓), Industrial (↑), Materials (↑) and Real Estate
Underweight – None
No Weighting - Utilities
US Mid and Small Cap – Increase all weightings. (↑)
International Developed Markets – Decrease all weightings. (↓)
Emerging Markets – Maintain all weightings.
Alternative Strategies – Maintain all weightings.
Multi-sector Bond Funds – Maintain all weightings.
Investment Grade US Corporate Bonds – Maintain all weightings.
High Yield US Corporate Bonds – Maintain all weightings.
Investment Grade Municipal Bonds – Maintain all weightings.
Data – After falling in October and the first week of November, the markets began a rally the day after the US Presidential election and continued rising in November and for much of December. For 2016, we see the following equity benchmark returns: US Large Cap – DJIA (+13.41%) and S&P 500 (+9.53%), US Small Cap - Russell 2000 (+19.33%) and International - ACWX (+1.66%). Much of the credit for this rally has been given to the victory of Donald Trump – but there is more to this story. We think that the recent improvement in economic growth and corporate earnings is what is really driving the market higher. For Q3, the earnings growth rate for the S&P 500 was 4.2%, making this the first quarter since Q1 2015 that the index has seen a year-over-year growth in earnings. The sectors making the most improvement in earnings from Q1 to Q4E are energy, financials, materials and technology. GDP, the broadest measure of economic output, for Q3 showed an annualized growth rate of 3.5%, significantly above the 1.4% in Q2 and 0.8% in Q1. Volatility (as measured by VIX) peaked on November 4th at 22.51, only to fall back to 14.35 at quarter end, below the long run average of 20.0. Domestic economic data for Q4 was generally quite good. During Q4, the yield on the benchmark 10-year US Treasury surged from 1.60% to 2.44%. After a strong first-half of 2016, the Barclays US Aggregate Bond Index fell in Q4 leaving a 2016 return of just +0.04%. Monthly job growth averaged 175,000 in September, October and November as the national unemployment rate fell to 4.6%. New weekly unemployment claims averaged a low 256,500 in Q4 (compared to 259,500 in Q3) providing a positive outlook for the domestic job picture. Consumer confidence, as measured by the Conference Board, rose to a 13-year high mark in November as consumers grew more optimistic about prospects for the US economy going into 2017. The December Manufacturing Business Outlook Survey by the Federal Reserve Bank of Philadelphia “reported that the indexes for general activity, shipments and employment were all positive and that manufacturers were much more optimistic about growth over the next six months” as the six-month index rose to its highest reading since January 2015. Retail sales data was good, though uninspiring in September (+1.0%), October (+0.6%) and November (+0.1%). Surging online orders and last-minute shopping data suggest that December retail sales will be strong. Data from the housing sector was mixed in October and November with new home sales (-1.4% and +5.2%) and housing starts (+27.4% and -18.7%) unable to create positive momentum. CPI rose 0.2% in November and over the last 12 months the all items index increased 1.7%, a level not seen since Q4 of 2014, yet still below the Fed target of 2.0%.
Outlook – As the cloud of election uncertainty clears, we expect a Trump presidency will be built on his campaign themes of pro-growth, pro-business and America-first. President-elect Trump desires more prudent monetary policy and will look to encourage economic growth with fiscal rather than monetary stimulus. If this sounds like a reversal of economic policy (from easy money to fiscal stimulus), that is exactly what it is. His promised transportation infrastructure spending plan could add 0.5% to GDP and act as a broad economic stimulus creating new jobs and encouraging corporate investment. Another form of economic stimulus could come from promised tax cuts (for both personal and corporate taxpayers) and an overhaul of the federal tax code. It is estimated that the Trump tax plan could add 1.2% to GDP. Deregulation advocates hope that President Trump will push to roll back a broad list of costly regulatory measures in banking (in particular, the dismantling of the Dodd-Frank Wall Street Reform and Consumer Protection Act), environmental protection and labor. Possible obstacles await including a well-defined path of the Fed to normalize interest rates and Mr. Trumps’ populist stands on immigration and free trade.
On page 1 of this report, you will notice the six investment class weighting changes (↑) or (↓) we have made since the October 2016 edition of Market Watch, which is the largest number of weighting changes made in any quarter over the last five years. Recent surging share prices in the Financials and Industrial sectors suggest that an early stage sector rotation (from high growth to low growth) may be underway. We are not convinced, however, and will be watchful of any sentiment changes as the Trump administration takes office in early 2017. Upgrading the Financials sector to overweight was not difficult. A tightening Fed (we see 2 or 3 rate hikes in 2017) will finally give this sector some long needed relief. The Industrial sector could benefit nicely from any corporate tax cut and use the savings to increase investment in both ongoing operations and product development. We have downgraded Health Care until we see what happens to the Affordable Care Act – will it be repealed and replaced or just amended, leaving behind popular provisions like coverage for pre-existing conditions? Falling short of the required 60-vote Republican supermajority in the Senate needed to repeal, we think an amendment or partial repeal is more likely and that any consequential action on health care reform will wait until the Trump tax plan has been legislated. Materials should benefit from a stronger US dollar and domestic inflation that rises closer to the Fed target of 2.0%. US small caps have surged since Election Day and have outperformed most equity benchmarks during that period – we think this trend could continue if economic growth here at home continues to improve. We think international stocks will continue to lag behind US stocks as the EU faces a growing populist movement (key elections are scheduled in France and Germany), below trend economic growth and a strong dollar.
