Market View (January 2017) – A Shift in Perspective

by REDW Stanley Financial Advisors

Overview
Daniel Yu, CFA®, AIF®

For our entire history as a nation we have debated the question, “How much authority should be centralized?” This discussion is not limited to the US, but is global in nature. After the 2008 crisis, many argued that economic decision-making needed to be increasingly regulated and centralized. As the recovery that started in 2009 failed to reach historic averages, questions arose over whether or not the amount of regulation and centralization was too much. In 2016, two events demonstrated the level of discontent with the “new normal.” On June 23, 2016, Britain voted to leave the European Union in what is commonly called Brexit. The decision to leave was characterized as a blow to uniform set of laws and regulations that was the promise of the EU. On November 8, 2016, outspoken real estate mogul Donald Trump was elected President of the United States. A central theme of Trump’s campaign was the overreach of government regulation. Despite calls at the time that both events were disasters and would destroy economic growth, the more economically sensitive asset classes (equities) tended to improve after both events. We hold that markets are generally efficient and that participants should be able to easily allocate their economic resources as they see best. In that light, we further conclude that a broadly diversified portfolio is the most prudent course for investors to meet their long term goals.

Equities
Daniel Yu, CFA®, AIF®

Since the economic recovery began in 2009, US GDP growth has averaged 2.1%. In most recoveries, US GDP growth has been 3-4%. As 2016 began, equities tended to lag behind other asset classes. Throughout the year, oil prices stabilized and economic growth data continued to improve, with job creation and income growth remaining steady. With the expectation of tax and regulation reform from the next administration, equities rallied in the fourth quarter. The bellwether, S&P 500, finished the year up 11.96%, while the Russell 2000 (an index of small cap equities) finished the year up 21.31%. Compare those numbers to the +3.84% and +2.22% for the 6/30/16 readings of the S&P 500 and Russell 2000, respectively. On the international side, future growth prospects also accelerated through the year. The MSCI EAFE finished the year up 1%, which is a marked improvement from the mid-year loss of 4.42%. As the price of oil stabilized, emerging markets also improved, with a year-end gain of 10.79%

Fixed Income
Paul Madrid, CFA®, CFP®, AIF®

In 2016 the Federal Reserve (Fed) had plans to increase interest rates two or three times; however, we only saw one rate hike of 0.25% in December 2016. This was primarily due to uncertainty by the Fed that economic growth was below expectations. With this and a struggling energy sector, global fixed income markets had strong performance during the first half of 2016. As energy markets rebounded and the global economy picked up some momentum, interest rates turned to the upside, causing bond values to decline. For instance, using the 10-Year US Treasury Note as a proxy for the US fixed income market, we saw the yield begin 2016 at 2.27%, then fall to 1.49% in June, and finally increase to 2.45% to close out the year.

Throughout 2016 fixed income returns experienced some ups and downs, but nearly all fixed income markets ended with a positive total return for the year. Short Term Bonds (Barclays US/Govt 1-5 Yr Index) were up 1.56% for the year, while Intermediate Term Bonds (Barclays US Aggregate Intermediate Index) were up 1.97%. One of the best performing bond markets in 2016 was High Yield (Barclays US Corporate High Yield), which was up 17.13% for the year. Despite the large interest rate swings throughout the year, fixed income performance was in line with expectations. More importantly, the fixed income allocations contributed strongly to diversified portfolios throughout the year by balancing out some of the risk and preserving capital.

Alternatives
Paul Madrid, CFA®, CFP®, AIF® and Daniel Yu, CFA®, AIF®

After two difficult years for oil, the commodities sector had a solid return for 2016. Discussions from the Organization of Petroleum Exporting Countries (OPEC) indicated production limits to support the price of oil came to fruition in the late stages of the year. The Bloomberg Commodity index finished the year up 11.8% primarily due to the improvement in the price of oil.

Managed futures did not perform as well, as volatility declined substantially in the final quarter of the year. The AQR Managed Futures fund declined 8.43% for the year and the 361 Managed Futures Strategy declined 0.81% for 2016. Because the AQR fund is trend following and major trends shifted in the second half of 2016, the fund performed poorly. However, during the first quarter of 2016 when equity and commodity markets experienced a significant decline, the AQR fund had strong positive performance. Although we are not proud with the fund’s 2016 performance, we recognize the benefits it provides to the portfolio in distressed market situations and over the long-term.

In recent years, Real Estate Investment Trusts (REITs) have performed well versus other asset classes as economic growth fueled a recovery in real estate both in the US and globally. By midyear of 2016, the REIT index had a gain of 13.68%; however, in the fourth quarter as interest rates rose, REIT’s also declined but managed to finish the year up 8.63%.

Conclusion
Daniel Yu, CFA®, AIF®

Despite Brexit and a Trump election catching the “experts” off guard, we do not see the makings of a recession; in fact, we may see an acceleration of growth. Innovations continue to be developed, inflation is relatively tame, and with the expected political changes, we anticipate market participants to utilize their creative energies as they have in the past.

While accelerating economic growth is by no means assured, we continue hold to our core tenet that a diversified, asset allocated portfolio with a longer term view in conjunction with sound financial planning is the best way for you, our client, to reach your goals. We thank you for your continued trust in us.


Copyright 2017 REDW Stanley Financial Advisors, LLC. All Rights Reserved. This publication is intended for general informational purposes only and should not be construed as investment, financial, tax, or legal advice.