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Market Insights - January 2017

“Hope
Smiles from the threshold of the year to come,
Whispering 'it will be happier'...”
― Alfred Lord Tennyson

 

As we write this, in the final days of 2016, investors are asking themselves how a year that started so grimly ended up…well, not all that badly. 2016 began with the worst ten trading days ever to start a year. Even after a month-end rally, the Dow lost 5.5% in January, driven by fears of a slowdown in China and plunging oil prices.  The NASDAQ fell nearly 8%. Then in June, the experts got the Brexit vote wrong, and markets once again reacted violently; US stocks fell more than 3% the following day, with the Dow losing 610 points, its eight largest point loss ever, erasing the year-to-date gains in an instant! Finally, on election evening stock market futures crashed more than 750 points, before recovering and beginning a powerful “Trump rally” in November and December.

Bonds and Interest Rates

There were two stories in the bond market in 2016. The first was the rally in bond prices driven by concerns over energy prices and the Chinese economy, which drove 10 year Treasury yields down to 1.4% mid-year. The second included the Fed hike in December, the Trump administration’s plans to accelerate economic growth, inflation concerns, and a stronger dollar; yields spiked to over 2.5%. Long terms government bonds fell 12%, the aggregate U.S. bond index lost 3%, while high yield bonds gained nearly 13%, reflecting a greater appetite for yield risk.

Stocks

The S&P 500 added 9.5% in 2016, trailing the Dow (which gained over 13%, fueled by its heavy weighting in banks and financials.) Smaller company stocks dominated; the S&P Small Cap 600 added 24.7%, while the S&P Mid Cap index rose over 18%. Stock market returns in developed countries suffered from the headwind of a strong dollar; the MSCI EAFE Index added a mere 1.3% in U.S. dollars; emerging markets, though, gained nearly 11%. Investment real estate, measured by the Cohen & Steers Realty Fund, added 5.6%.

Looking at 2017…

For balanced global investors, we anticipate moderate overall gains for 2017, somewhat in line with 2016. We believe U.S. stocks will deliver strong returns over the next 12-18 months, and will continue to be the primary driver of total return, as long as corporate earnings meet expectations. Valuations in the

market are quite high, and while this in and of itself doesn’t suggest diminishing returns, it does put a great deal of pressure on earnings and economic growth. Those expectations, today, are at a fairly high level.  Observers of the most recent Fed meeting anticipate three, possible four more small increases in the Fed funds rate in 2017; however, a too rapid surge in the inflation rate, or a sizeable unfunded stimulus, could affect the plans of a data-driven Fed.

Our analysis, that interest rates would continue at historically low levels, which has driven our fixed income strategy over the last five years has now shifted to reflect the steady trend of GDP growth, and particularly job creation, on credit markets. We plan to increase the use of laddered bond portfolios and inflation-protected bonds, shorter durations and reinvestment as rates rise, to assure that this important part of our clients’ portfolios provide both the income and stability we have come to expect. 

2016- Volatility and Diverging Returns
Us stocks (DJII) Global stocks (EFA), Emerging Markets(EEM), US 7-10 year bonds (IEF)

Changes in the Tax Code Will Impact Investments

Although the overhaul of the tax code is a work in progress and details are still unclear, proposals from President-elect Trump and the House Republicans share several features. The current seven tax brackets would collapse to three, 12%, 25% and 33%, and the standard deduction would be increased from $6,300 to $15,000 for single tax filers, and from $12,600 to $30,000 for married couples filing jointly. Itemized deductions will be now capped at $100,000 for single filers and $200 ,000 for married couples filing jointly.  Alternative Minimum Tax will likely be repealed, and estate taxes are on the chopping block as well.

Steven Weber
The Bedminster Group

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