Equity Overview – Year in Review and A Look Forward

Although equity markets started 2016 in the red, they rebounded to post solid gains.  For the year, the S&P 500 increased 9.54%, the Nasdaq Composite gained 7.5%, and the Dow Jones Industrial Average rose 13.42%.

The dynamics of sector rotation hit the equity markets in the final two months of trading in 2016.  Healthcare, utilities and consumer sectors saw an exodus as financials, energy, and industrials saw an inflow.

Substantial fiscal and regulatory changes are expected in 2017.  Prominent among these are personal and corporate tax cuts, increased government spending, and less regulation.  The expectation is that these changes will boost economic growth and should also boost earnings for stocks.  But as with any change, the benefits are likely to be distributed unevenly among companies, which is the classic setting for a stock pickers market.  The challenge will be to identify the winners and losers.

With U.S. companies having reduced expenses and minimized debt exposure over the past few years, any increase in margins has become difficult.  Thus the key to increased earnings in 2017, and an accompanying increase in stock prices, will be revenue growth generated by increased economic activity.

Macro Overview – Year in Review

Uncertainty ruled in 2016, highlighted by concerns over interest rates, economic growth, oil prices, the presidential election, and Brexit.  But initial reactions to a variety of surprising developments proved temporary.  Thus, the 10-Year Treasury Bond yield drop to 1.36% in July, after Brexit, was followed by a rise to almost 2.5% by year end.  Oil also made a powerful comeback in 2016, rising from $26 a barrel in February to $53 a barrel at year-end, propelled in part by OPEC production cuts.  And the immediate precipitous decline in the futures markets on the night of the presidential election, in the wake of Trump’s victory, was followed by a dramatic recovery the next day and significant gains in equities in the last two months of the year.

The rally stalled toward the end of December, as doubts surfaced regarding Trump’s success in garnering support for his proposals from both Republicans and Democrats in the House and Senate.  The pause was reinforced by a gradual shift from equities to bonds, encouraged by the increase in bond yields which makes fixed income investments more attractive. This rebalancing often occurs at year end, as multi-billion dollar pension funds reallocate asset classes as expectations adjust.

A number of banking and financial industry regulations are in question as Trump is expected to repeal various rules and provisions that many believe have hindered lending and consumer credit expansion. Trump will have the ability to repeal numerous rules and regulations almost immediately under the Congressional Review Act (CRA). The possibility of political hurdles and non-approvals for some of Trump’s appointments may cause uncertainty leading to volatility in the markets.

Two well regarded barometers of consumer confidence rose in December to higher levels. The University of Michigan’s preliminary consumer confidence index rose to 98 and the Conference Board’s Consumer Confidence Index rose to 113.7. Sentiment among U.S. consumers will be critical to the health of economic growth, as greater spending evolves from growing confidence.