2017 is certainly off to a more encouraging start for stocks than last year. Investors may painfully recall that stocks in 2016 experienced what was reportedly the worst start to a new year in history. The weakness persisted into mid-February, dashing many investors' hopes in the process. The remainder of the year fared much better, punctuated by an impressive rally following the Presidential election in early November. Small company U.S. stocks really shined, with the Russell 2000 index up 21.3% for the year.
Large company U.S. stocks also did very well in 2016, with the Standard & Poor's 500 up 12.0%. After a dazzling performance through the first 3 quarters of the year, emerging market stocks went the opposite direction following the election. This weakness was largely attributed to renewed concerns of continued strength in the U.S. Dollar, and concerns about what President-elect Trump's trade policies will be. Despite the sell-off, emerging market stocks as measured by the MSCI Emerging Market index were up 11.2% for the year. Taking the bronze medal last year was the MSCI EAFE index of established foreign stocks, which finished the year up 1.0%. The two foreign stock indexes are leading the charge thus far in 2017, perhaps on the expectation that the U.S. Dollar and interest rates will ease back following this Friday's Presidential inauguration.
The 35 year bull market in U.S. government bonds hit a speed bump following the election. The interest rate on the 10-year Treasury had hit its lowest level ever last summer, hitting a low of 1.34% on July 6th. Yields climbed from there, and really spiked following the election, which means bond prices weakened (due to the inverse relationship between prices and yields). As of the end of 2016, the 10 year Treasury yield was up to 2.45%, its highest level in almost 1 1/2 years. While some market observers may declare the end of the bull market for government bonds, it is premature to do so. The very long-term trend of falling interest rates on this closely watched benchmark remains intact. For the year, bonds as measured by the Barclays Capital U.S. Intermediate Government/Credit index were up 2.1% on a total return basis, which factors in the interest received on the bonds as well as their change in price.
So where do we go from here? The turning of the calendar is always accompanied by great fanfare as investment companies and their market strategists roll out their expectations for the coming year. While I enjoy and value the opinions of others, it is also with a small dose of skepticism that I review these. Opinions often seem to change like the wind. An important lesson I've learned over the years is that investors are best served keeping their end-goal in mind, and not be swayed by gyrations in the financial markets and the opinions of others. Investors can also be vulnerable to holding onto their own opinions too tightly, which can prove costly.
Regardless of who won the election, it has been my view that our economy is doing better than people were willing to believe, and that rebounding profits — and low interest rates — made stocks more attractive than their present valuations may indicate. Add to this the improved odds of corporate tax reform in the U.S., and I think we have the explanation for the recent rally in stocks. While equity valuations have become less favorable due to the rise in prices and interest rates, I believe they remain attractive.
Tempering my enthusiasm in the near-term is the sharp rise in investor sentiment. Despite stock prices holding up well, investors were down in the dumps just prior to the election, which was cause for contrarian investors to be optimistic. Since then, investors' hopes have risen along with stock prices. When volatility returns — as it surely will — sentiment will undoubtedly follow suit. One possible source of volatility could be a return of inflation, which would prompt the Federal Reserve to raise interest rates. Interest rate increases can cause trepidation in the financial markets due to the resultant increase in borrowing costs, as well as their impact on stock and bond valuations. Volatility could also arise from some of the usual suspects, namely Europe (elections in France and Germany later this year), and ongoing concerns about China's slowing growth and rising debt. I believe any volatility we see will be within the confines of a longer-term uptrending market.
May you and your family have a healthy and prosperous 2017.
Glenn S. Rank, CIMA®
Certified Investment Management Analyst®
President, GSR Capital Management
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- The Russell 2000 index is comprised of approximately 2,000 of the smaller securities from the Russell 3000. Representing approximately 10% of the Russell 3000, the index is created to provide a full and unbiased indicator of the small cap segment. The S&P 500 is an unmanaged index of 500 widely held stocks that’s generally considered representative of the U.S. stock market. The MSCI EAFE index and the MSCI Emerging Markets index are unmanaged indexes compiled by Morgan Stanley Capital International that are generally considered representative of the developed international stock market and emerging international stock market, respectively. International securities involve additional risks including currency fluctuations, differing financial accounting standards, and possible political and economic volatility, and may not be suitable for all investors. Investing in emerging markets can be riskier than investing in well-established foreign markets. Investing in small cap stocks generally involves greater risks, and therefore, may not be appropriate for every investor. The Barclays Capital U.S. Intermediate Government/Credit Bond Index measures the performance of U.S. Dollar denominated U.S. Treasuries, government-related and investment grade U.S. corporate securities that have a remaining maturity of greater than one year and less than ten years. Inclusion of these indexes is for illustrative purposes only. Keep in mind that individuals cannot invest directly in any index and index performance does not include transaction costs or other fees, which will affect actual investment performance. Individual investor’s results will vary.
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