While the year hasn’t officially wrapped up as of this writing, we’re close enough to be able to form some opinions and offer some perspective on 2016. If nothing else, this year could be characterized as unexpected. Despite a steep stock sell-off in January, which weighed on investors’ outlooks early in 2016, U.S. stock returns are poised to close up over 10 percent through December. On the other hand, bond returns, while on target to gain about 2 percent for the year, are finally starting to come under pressure after a bull market of over 30 years.
Looking back, the S&P 500 Index fell over 6 percent in January after U.S. GDP growth came in below expectations, corporate earnings continued to fall, and recession fears spiked. Despite investor concerns, most economic data at home were relatively healthy, driven primarily by steady gains in employment and disposable personal income. Additionally, many investors were concerned that slowing global growth would ultimately weigh on a resilient U.S. economy. Specifically, the International Monetary Fund (IMF) lowered its global growth rate predictions several times, China delivered GDP growth below expectations, and commodity prices remained depressed.
Stocks turned a corner in March, however, surging almost 7 percent at home and over 13 percent in developing countries. The state-side rally came amid falling U.S. corporate earnings that were driven by lower energy prices, depressed commodity prices, and a strong dollar. Although declining earnings growth usually leads to lower stock prices, the Federal Open Market Committee’s (FOMC) announcement that it would reduce the number of interest rate hikes for the year buoyed stock valuations. As a result, stock price-to-earnings multiples (a common valuation metric) expanded while underlying fundamentals remained weak.
After several years of underperformance, emerging markets stocks and bonds reversed course in 2016 as depressed commodity prices started to recover. The FOMC’s plan for fewer interest rate hikes was also a boost for emerging markets countries, many of which owe significant amounts of U.S. dollar-denominated debt. Likewise, economic data out of China were better than expected, although growing debt levels and excessive government stimulus there could prove to be longer-term risks.
In another unexpected development, low-growth telecom and utilities sectors led U.S. stocks in the first half of the year. Utilities and telecom stocks typically carry higher debt levels and the FOMC’s move to keep interest rates lower for longer was viewed favorably by the markets. Both sectors were up over 20 percent through June, although they have since given back almost half of those gains.
In between tragic terrorist attacks, the U.K. shocked the world in June when it voted to exit the European Union, a development known as “BREXIT.” Markets tumbled on the news but quickly bounced back and reached new highs. While shocking headlines dominated the popular press, global economic growth was quietly stabilizing around the globe and accelerating at home.
The summer brought a much-needed reprieve from the barrage of grim headlines earlier in the year. It also ushered in new confidence in the U.S. expansion as jobs growth continued, wage growth perked up, and housing data improved. As the Presidential election drew near, corporate spending started to pick up, oil prices rallied, and company earnings improved.
Following a relatively calm summer, the U.S. surprised the world in November with the election of Donald Trump to the presidency, while Republicans maintained their majorities in the House and Senate. Despite concerns of a global shift towards populism, markets soared on hopes of tax cuts and better growth at home. After the election and following months of healthy economic data – – including a meaningful pick-up in 3rd quarter U.S. GDP growth and signs that inflation was heating up – – the FOMC raised rates in December, as expected.
Clearly, 2016 was an eventful year for markets, governments, and citizens alike. While several unknowns have become known, many of this year’s developments have sowed the seeds for more uncertainty ahead. In terms of markets, although a divide still exists between stock valuation levels and underlying fundamentals, we’re encouraged by improving corporate earnings growth. On the other hand, bonds have benefited from over thirty years of falling yields (and thus rising prices). A steeper FOMC rate hike trajectory is clearly a headwind for fixed income, but the central bank’s stance is supported by strong economic growth and signs of inflation. The end result may mean stagnant fixed income returns, but a healthy economy – a trade-off we’re willing to take.
Overall, we view stocks as most likely to outpace growing inflation expectations over the long term. While equity prices may be due for a pullback in the near term, evidence suggests that the longer-term secular bull market remains intact.
The Parsec Team