2016 YDFS Investment Review

So President-elect Trump didn’t crash the market; the world didn’t fall apart after the Brexit vote; and the worst start to the year in history didn’t derail what ended up being a pretty good year in the stock markets. “Who da thunk it?”

You know you’re deep into a longstanding bull market when you see things like average pedestrians keeping one eye on the market tickers outside of brokerage houses to see when the Dow Jones Industrial Average has finally breached the 20,000 mark.  Who would have imagined record market highs at this point last year, when the indices ended the year in slightly negative territory?  Or when the new year 2016 got off to such a rocky start, tumbling 10% in the first two weeks—the worst start to a year since 1930?

The markets eventually bottomed in mid-February and began a long, slow recovery, turning positive by the end of March, suffering a setback when the U.K. decided to leave the Eurozone, and endured another hard bump right after the elections.  In the end, we were disappointed; the Dow finished at 19,762.60 for the year—but the bull market has continued for another year.

This was the second year in a row that the final quarter provided investors with solid gains. The Wilshire 5000–the broadest measure of U.S. stocks—was up 4.54% in the fourth quarter of 2016, ending the year up 13.37%.  The comparable Russell 3000 index gained 4.21% in the final quarter, to finish up 12.74% for the year.

Large cap stocks were up as well.  The Wilshire U.S. Large Cap index gained 4.14% in the fourth quarter, and finished the year up 12.49%.  The Russell 1000 large-cap index closed with a 3.83% fourth quarter performance, and finished the year up 12.05%, while the widely-quoted S&P 500 index of large company stocks was up 3.25% in the fourth quarter, finishing up 9.54% for calendar 2016.

The Wilshire U.S. Mid-Cap index gained 5.31% in the final quarter, finishing the year with a gain of 17.22%.  The Russell Midcap Index gained 3.21% in the fourth quarter, and was up 13.80% in calendar 2016.

This was a year to remember for investors in small company stocks.  As measured by the Wilshire U.S. Small-Cap index, investors posted an 8.30% gain over the last three months of the year, for a total return of 22.41% over the entire 12 months.  The comparable Russell 2000 Small-Cap Index finished the year up 21.31%, while the technology-heavy Nasdaq Composite Index rose 1.34% in the fourth quarter, to finish the year up 7.50%.

International investments contributed a slight decline to overall portfolio returns.   The broad-based EAFE index of companies in developed foreign economies lost 1.04% in the fourth quarter of the year, finishing the year down 1.88% in dollar terms (I expect these stocks to carry the winning torch any day now).  In aggregate, European stocks lost 3.39% for the year, while EAFE’s Far East Index gained just 0.14%.  Emerging markets stocks of less developed countries, as represented by the EAFE EM index, gained 8.58% for the year.

Looking over the other investment categories, real estate investments, as measured by the Wilshire U.S. REIT index, lost 2.28% during the year’s final quarter, but managed to finish up 7.24% for calendar 2016.

Last year, investors were wondering why they owned commodities in their portfolios, when their statements showed that the index delivered a whopping 32.86% loss.  This year, they may be wondering why they weren’t more committed to the asset class, as the S&P GSCI index gained 27.77%, fueled in part by a 45.03% rise in the S&P crude oil index.  Gold prices shot up 8.63% for the year and silver gained 15.84%.

In the bond markets, it’s possible that the decades-long bull market—which basically means declining interest rates—has ended, and the fixed-income world is experiencing rate rises.  But despite the nudge by the Federal Reserve Board, the moves have not exactly been dramatic.  Over the past year, rates on 10-year Treasury bonds have risen from 2.25% to 2.44%, while 30-year government bond yields have risen from 3.00% to 3.07%.  According to Barclay’s Bank indices, U.S. liquid corporate bonds with a 1-5 year maturity have seen yields rise incrementally from 2.4% to 2.8% on average. Despite the many cries and declarations that the 30 year bull market in bonds is over, rest assured that bonds won’t go down without a fight (winning streaks that last so long never die that quickly).

As always, there were many unpredictable anomalies in the investment world.  In the international markets, anyone lucky enough to have speculated on the Brazilian Bovespa index—comparable to the U.S. S&P 500—would have reaped a gain of 68.9% this year, despite all the headline drama around the Zika virus and political uncertainties that were reported on during the Olympic games.  Russian stocks were up 51% for the year, despite the recent sanctions from the U.S. government and the lingering international sanctions related to the invasion of the Crimean peninsula.

As is my obligation as a financial planner, I have to point out that while you may not have realized anywhere near the kinds of returns outlined above for the year, having a diversified and perhaps hedged portfolio means that you never have enough of the stuff that went up and too much of the stuff that came down or underperformed. Risk management of any kind during this bull market (read: diversification) tends to blunt returns during the good times, but is a welcome friend when the markets turn against us. Since no one knows when this is, you have to stick to your investment approach through thick and thin (you do have an investment approach, don’t you? We’re available to help you craft an investment approach if you need us).

What’s going to happen in 2017?  Short-term market traders seem to be expecting a robust economic stimulus combined with lower taxes and deregulatory policies that would boost the short-term profits of American corporations.  But it is helpful to remember that we are entering the ninth year of economic expansion, making this the fourth longest since 1900.  In addition, growth has not exactly been robust; the U.S. GDP has averaged just 2.1% yearly increases since the Great Recession, making this the most sluggish of all post-World War II expansions.

Slow but steady has not been a terrible formula for workers or stock investors.  The unemployment rate has slowly ticked down from a post-recession peak of 10% to less than 5% currently.  U.S. stock indices are posting record highs with double-digit gains, and that Dow 20,000 level, while essentially meaningless, is still catching a lot of attention.

It’s clear that the new President-elect wants to accelerate America’s economic growth, but the policy prescription has not always been clear.  Will we rip up longstanding trade agreements, cut back on immigration quotas and deport millions of workers who crossed the border without a visa?  Will there be a wall built between the U.S. and Mexico?  Will the government pay for huge infrastructure projects, at the same time reducing taxes and thus raising the national debt?  Will Congress raise the debt ceiling without protest if that happens?  Will the Fed raise rates more aggressively in the coming year, or cooperate with the President-elect in his efforts to drive the economy into a faster lane?

At the same time, there are many unknowns around the globe.  China’s economic growth has stalled for the second consecutive year, and you will soon be reading about a banking crisis in Italy that could force the country to leave the Eurozone—potentially a much bigger blow to European economic unity than Brexit or a still-possible Greek exit.  Russian hackers may have ushered in an era of unfettered global intrusions into our Internet infrastructure, and there will surely be a continuation of ISIS-sponsored terrorism in Europe and elsewhere.

Every year of this longstanding bull market, we have to look over our shoulders and wonder when and how it will end.  With the January downturn and so much uncertainty at this time last year, nobody could have predicted double-digit returns on U.S. stocks at year-end.  This year could bring more of the same, or it could fulfill the dire predictions many have made during the election cycle, including both Democrats and Republicans who believe the country is in worse shape than the numbers would indicate. Just remember that bull markets rarely die of old age; instead, they die from excessive enthusiasm and ebullience. This bull market is anything but ebullient.

What we have learned over the past few years is that the markets have a way of surprising us, and that trying to time the market, and get out in anticipation of a downturn, is a loser’s game.  At the county fair or amusement park, when we get on the roller coaster, we don’t bail out and jump over the side at some scary point on the track; we hang on for the remainder of the ride.  The history of the markets has been a general upward trend that benefits long-term investors, and looking out over the long-term, that—and a few hard bumps along the way–is probably the best outcome to expect.

This is not to say that you should commit 100% of your capital to the market or stay all in at all times. It never hurts to take a few chips off the table when things are going well so that you have some dry powder to deploy when those hard bumps come along. Rebalancing into underperforming investment classes at least once or twice a year is always a good idea as well.

If you would like to review your current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

You can interact with Sam TheMoneyGeek and read his latest musings on Twitter at http://twitter.com/themoneygeek

Sources:

Wilshire index data: http://www.wilshire.com/Indexes/calculator/

Russell index data: http://www.russell.com/indexes/data/daily_total_returns_us.asp

S&P index data: http://www.standardandpoors.com/indices/sp-500/en/us/?indexId=spusa-500-usduf–p-us-l–

Nasdaq index data: http://quotes.morningstar.com/indexquote/quote.html?t=COMP

http://www.nasdaq.com/markets/indices/nasdaq-total-returns.aspx

International indices: https://www.msci.com/end-of-day-data-search

Commodities index data: http://us.spindices.com/index-family/commodities/sp-gsci

Treasury market rates: http://www.bloomberg.com/markets/rates-bonds/government-bonds/us/

Aggregate corporate bond rates: https://index.barcap.com/Benchmark_Indices/Aggregate/Bond_Indices

Aggregate corporate bond rates: http://www.bloomberg.com/markets/rates-bonds/corporate-bonds/

 Muni rates:  https://indices.barcap.com/show?url=Benchmark_Indices/Aggregate/Bond_Indices

http://www.wsj.com/articles/chinas-stock-market-still-a-draw-after-tumultuous-year-1451303164

http://www.marketwatch.com/story/these-are-the-bestand-worstperforming-assets-of-2016-2016-12-30?link=sfmw_tw

http://www.theworldin.com/article/10632/unsettling-year-markets

http://www.forbes.com/sites/maggiemcgrath/2016/12/30/markets-end-last-trading-day-of-2016-in-red-but-post-gains-for-the-year/#7db846fd7c07

The MoneyGeek thanks guest writer Bob Veres for his contribution to this post

 

Third Quarter 2016 YDFS Market Review

Over seven years into this bull market and the fears of a market swoon or bear market have not materialized. In fact, 100 days after the Brexit scare, nine months after the most recent Fed rate hike, the markets once again confounded the instincts of nervous investors and went up instead of down.  Last week, Fed Chairperson Janet Yellen told the world that the U.S. economy is healthy enough to weather a rise in interest rates, but the Fed governors met in September and declined to serve up the first rate hike since last December 15.  That was reassuring news to the Wall Street traders, and investors generally, helping to provide yet another quarter of positive gains in U.S. stocks.

The Wilshire 5000 Total Market Index–the broadest measure of U.S. equities—gained 4.53% for the third quarter, and is now up 8.39% for the first three quarters of the year.  The comparable Russell 3000 index was up 4.40% for the quarter and is sitting on 8.18% gains so far this year.

Larger companies posted the lowest gains.  The Wilshire U.S. Large Cap index was up 3.92% in the third quarter of 2016, putting it at a positive 8.01% since the beginning of January.  The Russell 1000 large-cap index provided a 4.03% return over the past quarter, with a gain of 7.92% so far this year, while the widely-quoted S&P 500 index of large company stocks posted a gain of 3.31% in the third quarter, and is up 6.08% for the year so far.

Meanwhile, the Wilshire U.S. Mid-Cap index was up 4.35% for the quarter, and is sitting on a positive gain of 11.31% for the year.  The comparable Russell Midcap Index gained 4.52% for the quarter, and is up 10.26% for the year.

Small company stocks, as measured by the Wilshire U.S. Small-Cap index, gave investors a 7.67% return during the third quarter, up 13.03% so far this year.  The comparable Russell 2000 Small-Cap Index gained 9.05%, posting an 11.46% gain so far this year, while the technology-heavy Nasdaq Composite Index gained 9.67% for the quarter and is up 6.06% heading into the final quarter of 2016.

Looking abroad, the U.S. remains a haven of stability in a very messy global investment scene.  The broad-based EAFE index of companies in developed foreign economies gained 5.80% in dollar terms in the third quarter of the year, but is still down 0.85% for the first three-quarters of the year.  In aggregate, European stocks have lost 2.67% so far in 2016.  Far Eastern stocks are up just 1.73% for the year.  In contrast, a basket of emerging markets stocks domiciled less developed countries, as represented by the EAFE EM index, gained 8.32% for the quarter, and are sitting on gains of 13.77% for the year so far.

Looking over the other investment categories, real estate investments, as measured by the Wilshire U.S. REIT index, were down 1.21% for the third quarter, but still enjoy a gain of 9.75% for the year.  Commodities, as measured by the S&P GSCI index, lost 4.15% of their value in the third quarter, but are sitting on gains of 5.30% for the year so far.

On the bond side, the interest rate story is essentially unchanged: rates are still low, once again confounding all the experts who have been expecting significant rate rises for more than half a decade now.  10-year U.S. government bonds are currently yielding 1.59%.  Three-month notes were yielding 0.27% at the end of the quarter, while 12-month bonds were paying just 0.58%.  Go out to 30 years, and you can get a 2.32% annual coupon yield. Looking ahead to December, the experts might be proven right as the markets currently give nearly a 2 in 3 chance that the Federal Reserve will raise short-term interest rates by 0.25%.

While it’s interesting to compare your quarterly rates of return with the above indexes, you should expect that your returns will not match them. If you have a diversified or hedged portfolio of domestic stocks, foreign stocks, bonds, real estate, commodities, etc., your blended rate of return will likely be something less than any one of the above indexes. Diversification tends to blunt overall returns, but it’s the only way to weather the ups and downs of the market over the long term.  No one should be fully (100%) invested in risky assets.

What’s keeping stock prices high while sentiment appears to be—let’s call it “restrained?”  Nobody knows the answer, but a deeper look at the U.S. economy suggests that the economic picture isn’t nearly as gloomy as it is sometimes reported in the press.  Economic growth for the second quarter has been revised upwards from 1.1% to 1.4%, due to higher corporate spending in general and especially as a result of increasing corporate investments in research and development.  America’s trade deficit shrank in August.  Consumer spending—which makes up more than two-thirds of U.S. economic activity-, rose a robust 4.3% for the quarter, perhaps partly due to higher take-home wages this year.

Meanwhile, if someone had told you five years ago that today’s unemployment rate would be 4.9%, you would have thought they were highly optimistic.  But after the economy gained 151,000 more jobs in August, unemployment remained below 5% for the third consecutive month, and the trend is downward.  At the same time, average hourly earnings for American workers have risen 2.4% so far this year.

Based on their reading of the Treasury yield curve (the rates of interest paid plotted over short, medium and long term periods), economists at the Federal Reserve Bank of Cleveland have pegged the chances of a recession this time next year at a low 11.25%.  They predict GDP growth of 1.5% for this election year—which, while below targets, is comfortably ahead of the negative numbers that would signal an economic downturn.  (In general, a steep yield curve has been a predictor of strong economic growth, while an inverted one, where short-term rates are higher than longer-term yields, are associated with a looming recession.) Other indicators that we follow give a less than 10% chance of recession over the next year.

On top of everything else, as you can see from the accompanying chart, corporate profits have been on a long-term upswing, even if the rise has been choppy since 2008.  Will this long-term trend continue?  Who knows?

ca-2016-10-1-quarter-end-report

The U.S. returns have been so good for so long that many investors are wondering: why are we bothering with foreign stocks?  A recent Forbes column suggested the answer: historically, since 1970, foreign stocks have outperformed domestic stocks almost exactly 50% of the time, meaning the long trend we’ve become accustomed to could reverse itself at any time.

Nobody would dispute that the economic statistics are weak tea leaves for trying to predict the market’s next move, and it is certainly possible that the U.S. and global economy are weaker than they appear.  But the slow, steady growth we’ve experienced since 2008 is showing no visible signs of ending, and it’s hard to find the usual euphoria and reckless investing that normally accompanies a market top and subsequent collapse of share prices.  At the current pace, we might look back on 2016 as another pretty good year to be invested, which is really all we ask for.

If you would like to review your current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

Sources:

Wilshire index data.  http://www.wilshire.com/Indexes/calculator/

Russell index data: http://indexcalculator.russell.com/

S&P index data: http://www.standardandpoors.com/indices/sp-500/en/us/?indexId=spusa-500-usduf–p-us-l–

Nasdaq index data: http://quicktake.morningstar.com/Index/IndexCharts.aspx?Symbol=COMP

International indices: http://www.mscibarra.com/products/indices/international_equity_indices/performance.html

Commodities index data: http://us.spindices.com/index-family/commodities/sp-gsci

Treasury market rates: http://www.bloomberg.com/markets/rates-bonds/government-bonds/us/

Aggregate corporate bond rates: https://indices.barcap.com/show?url=Benchmark_Indices/Aggregate/Bond_Indices

Aggregate corporate bond rates: http://www.bloomberg.com/markets/rates-bonds/corporate-bonds/

https://www.yahoo.com/news/yellen-defends-tougher-banking-regulations-141913276.html

http://www.bls.gov/news.release/pdf/empsit.pdf

https://www.yahoo.com/news/u-economy-less-sluggish-2nd-165152063.html

http://www.tradingeconomics.com/united-states/corporate-profits

https://www.clevelandfed.org/our-research/indicators-and-data/yield-curve-and-gdp-growth.aspx

http://www.forbes.com/sites/wadepfau/2016/09/29/us-markets-are-outperforming-global-markets-what-should-you-do/?utm_content=38955693&utm_medium=social&utm_source=twitter#476c0e8f3308

The MoneyGeek thanks guest writer Bob Veres for his contribution to this post