The year 2016 is now in the books and what a year it was for both the U.S. bond and stock markets. The year was progressing in rather calm fashion through November 4 with the stock market (S&P 500) up just over 2% and interest rates sliding throughout the year from 2.25% (10 year US Treasury bond) to 1.35% around the start of the summer. There was more concern about the economy slipping into recession and mild deflation than anything else. Economic growth was anemic and interest rates around the world were falling, in some countries to 0% or below. Then wham!
It happened. The November 4 election changed everything when every major poll had the results going the other way. We talked in our newsletter dated December 2015 about the stock market being fully valued based on earnings and fundamentals and how we expected 2016 to be a tepid year for stock market returns. We were looking fairly prescient until November 4! Since then the stock market has gained about 10% and interest rates have gone up by a full percentage point. Whether any of us liked the candidates in the race or how the results panned out a few things are abundantly clear. The upturn in interest rates that started in July was an indication the Wall Street and the markets were beginning to anticipate a strengthening in the economy above and beyond what we have been witnessing since the economy bottomed in 2009. The election results threw fuel on the fire.
The incoming administration campaigned on cutting corporate and personal income taxes, easing red tape and regulations, reversing or retooling Obamacare, and investing billions in our country’s neglected and crumbling infrastructure. This is music to the market’s ears. Anything that reduces taxes and amps up the country’s growth rate will lead to increases in corporate earnings. Over longer periods of time corporate earnings growth drives stock prices. The downside of the surprising election result is that we are all flying blind to some degree until enough time passes to determine if all of these new initiatives actually get passed and if so, what the ramifications will actually look like. The stock market is acting like everything mentioned above is a done deal when the President elect hasn’t even moved into the White House yet.
Certain industry groups have appreciated strongly in the past 2 months while others have been left completely behind. The banks have performed particularly well closely followed by industrial stocks, the former because of potentially reduced regulation and the latter due to potentially stronger economic growth. Utilities, health care and consumer staples stocks have largely been left behind. You go to the doctor and go grocery shopping irrespective of what the economy is doing or where interest rates are at any given minute. Actually, that is what has made these industry groups such good performers over many years. These groups don’t rely on the economy to grow their earnings. As long as the population grows and folks continue to live longer, these guys should do just fine.
On the contrary, recent year’s tepid economic growth has been a good back drop for the financial markets. Corporate earnings have grown enough to keep stocks on an upward trajectory while interest rates have remained at historically low levels. Low interest rates have made houses and automobiles more affordable while providing little to no competition for stocks. Going into your bank to find you can only get a percent or so interest on a CD is not likely to make you go out and sell your stocks. Bump that CD Rate up to 5% or 6% and things start to get interesting. In conclusion, we don’t want the economy to accelerate too quickly, at the risk of pushing inflation and interest rates up faster than anticipated. That would be the recipe for the Federal Reserve to clamp down on the money flow in turn potentially causing the next economic downturn and bear market in common stocks.
Given the aforementioned lack of visibility regarding government policy and the incoming administration, GSB Wealth’s affliction for high quality investments should serve us well in the months to come. We are currently looking, on the margin, to rotate out or reduce exposure to those investments that have logged strong gains since November 4 and reallocate to some of the sectors that have been left behind. The market is expecting corporate earnings growth to accelerate to 12% to 13% in 2017 and 2018. This would be a tall task and if it does pan out we might expect the stock market to do reasonably well in 2017. Should some of the policies of the new administration get watered down or strung out to future years, we may see a stock market pull back as a lot of positive expectations seem to already be built in. GSB Wealth will be closely assessing government policy as 2017 unfolds and will be making adjustments to client portfolios as necessary.
Sincerely, the GSB Wealth Management Team
"Wisdom is not a product of schooling but of the lifetime attempt to acquire it." ~ Albert Einstein