New Year, New Policies, and Managing the New Risks

We would like to take this opportunity to extend our warmest Holiday Wishes to all of our clients and their advisers. 2016 certainly was a year for the history books – from the Brexit surprise to the November surprise; the year certainly was not one that improved the reputation of pollsters! The global investment landscape has changed considerably in the last 30 days, and there is no shortage of pundits opining on what the Trump Administration means for the capital markets. After a hike of 25 bps on December 14th, what will the Fed do in 2017? What happens to infrastructure spending? Trade policy? Health care? Before we move to the important themes that we think will impact capital markets in 2017, we think a look back at 2016 is appropriate.

2016 – Year in Review

If there was one word we could use to describe the equity markets in 2016 it would be RESILIENCY. On three separate occasions the market experienced a material decline only to be followed by a full recovery:

Decline #1 (Jan 1st Feb 15th)

As oil declined to $26/barrel and credit spreads widened, equity markets plum- meted. As of mid-February, many equity indices had experienced declines of 10% or more, only to be followed by a strong recovery when oil prices seemed to find a floor.

By the end of the first quarter, virtually all of the damage had been reversed – investors were willing to move back into a “risk-on” mode.

Decline #2: (end of June)

A surprise referendum in the UK to leave the European Union startled world markets. The pollsters (and the bookies!) had gotten it wrong and the uncertainty caused a major level of consternation among investors. Again, global markets sold off as economists and others debated what the referendum’s impact would be on the UK and the Eurozone. But a funny thing happened on the way to the correction – markets were calmed by assurances from pundits and politicians that a smooth transition would avoid major economic dislocation – and maybe we can even get the referendum reversed!

Decline #3: (September 30th – Nov 4th)

October witnessed a pick-up in volatility – which is consistent with the historical pattern in the month preceding a Presidential election. Uncertainty is the biggest contributor to volatility as the polls ebbed and flowed and the outlook for certain sectors changed frequently. The net result was a drawdown of about -4% in the week before the election. The day before the election (Monday November 7th) witnessed a significant bounce as investors began to discount the certainty of a Democratic victory – the status quo being a bit more comfortable than the unknown accompanying a Trump Administration.

As the results came in on Election night, and the media coverage went from the possibility to the likelihood to the certainty that Trump had pulled off the upset victory, equity markets around the world and the US futures market sold off precipitously. Again, fear of the unknown seemed to be the prevailing sentiment. But when the dust settled and US markets opened on Wednesday November 9th, a rally began that has driven many market indices to new highs.

Investor behavior can be hard to figure. 2016 finds us in the 8th year of a bull market expansion in the S&P 500. While there have been some dips along the way, this bull market is the 2nd longest in duration and 3rd in terms of price change (over 200%) in history1. With S&P company earnings only recently turning positive quarter over quarter (i.e., Q3 2016 vs. Q3 2015)2; valuations have become a bit stretched.