December 06, 2016
Monthly Market Summary – November 2016
The results of the U.S. presidential election surprised market participants and led to a sharp drop in global financial markets during the night of the election. S&P 500 futures dropped 5% overnight. However, the negative reaction was short lived in the U.S. equity market with the major equity indices closing higher the day after the election and continuing to rally throughout the month hitting multiple new record highs. The tone of the global financial markets has also changed since Trump won the election. Sentiment has shifted as market participants have increasingly focused on the potential for stronger economic growth and higher inflation in the U.S. bolstered by the increased fiscal spending, lower taxes, and less regulation favored by President-elect Trump. The U.S. dollar reached a 13-year high on post-election expectations for stronger economic growth and inflation, but also on expectations that the Federal Reserve (Fed) will tighten monetary policy beginning with a rate hike in December. The implications of Trump favored policies are not positive for all asset types however. The prospect of tighter foreign trade policies has pressured equity markets and currency values of many U.S. trade partners since the election, especially in Latin America. The prospect of higher government spending pushed bond yields higher and prices lower. Higher bond yields hurt interest sensitive stocks, such as real estate related stocks.
Market Indices – November 2016
Much of the economic news reported during November showed improving conditions and added to market participant’s expectations for stronger economic growth, higher inflation, and higher interest rates. For example, the third quarter U.S. gross domestic product (GDP) growth estimate was revised up to 3.2% from the initial estimate of 2.9%. Both the Markit manufacturing and services purchasing managers’ indices (PMI) were higher than in the previous month. Retail sales were up a better than expected 0.8% and durable goods orders also topped expectations with a 4.8% increase. Other economies continue to see improvements also. European Central Bank President Draghi commented that “the economy is now recovering at a moderate, but steady pace”. Data such as the euro area composite PMI rising to a better than expected 54.1 give support to his comments. China’s manufacturing PMI also rose reaching 51.2 in the latest report. Japan’s third quarter GDP growth was 2.2%, which was well above the 0.8% average of analysts’ forecasts.
The Dow Jones Industrial Average (DJIA), NASDAQ, S&P 500, and Russell 2000 equity indices each reached new all-time highs in November. The DJIA surpassed 19,000 for the first time and the S&P 500 surpassed 2,200. Small-capitalization (cap) stocks outperformed large and mid-cap stocks by a significant margin. The Russell 2000® index had a return of 11.1% compared to returns of 3.7% for the S&P 500 and 5.4% for the Russell MidCap® index. Small-cap stocks in general were seen as benefiting the most from Trump administration policies because they tend to have more domestically focused businesses. But not all stock prices went up in November. Stocks expected to benefit from Trump policies rose while those more likely to benefit from Clinton policies declined even within the same industry sector. For example, within the healthcare sector, biotechnology stocks rose on expectations for less regulation while managed care and hospital stocks prices fell on expectations for major revisions to or repeal of the Affordable Care Act (Obamacare). Within the energy sector, coal and oil company stocks rose while alternative energy stocks fell. Bank stocks rallied on expectations for higher interest rates due to forecasts for stronger economic activity and a strengthening dollar. Those same interest rate expectations hurt interest sensitive stocks, such as home builder and real estate stocks on concerns about higher funding costs. Even with the various cross-currents, at the end of the month 7 of the 11 sectors in the S&P 500 index had a positive return. The financials sector was by far the best performing sector with a return of almost 14%. The industrials sector was another top performer on expectations for higher domestic spending. In the Russell MidCap® and Russell 2000® indices, energy was the top performing sector by a wide margin followed by materials. Energy stocks gained in reaction to the production cuts agreed to by the Organization of Petroleum Exporting Countries (OPEC). Materials stocks rose in expectation of higher demand from increased spending on infrastructure projects. Information technology and utilities stocks were among the weakest sectors across the market capitalization (cap) spectrum as investors moved out of previous performance leaders into stocks expected to benefit more from Trump policies. On a style basis, value outperformed growth in the equity indices because materials, energy, industrials, and financials had the best returns and information technology and consumer related stocks had lower returns.
International equity market results were negative in November. The MSCI EAFE index of developed international market equities had a return of -2.0% and the MSCI Emerging Markets (EM) index had a return of -4.6% on a U.S. dollar basis. Currency moves had a negative impact for U.S. investors as the dollar strengthened. On a local currency basis the EAFE and EM indices had returns of 1.2% and -2.2% respectively. The U.S. election results had a negative impact for many regions. Concerns about tighter trade policies, a strengthening dollar, and higher U.S. interest rates under a Trump administration resulted in significant capital outflows pressuring prices for many developed and emerging economy equities. Latin America was the most negatively impacted. The Latin American index declined over 10% for the month. However, stocks in commodity heavy economies were higher on expectations for increased infrastructure spending and generally higher economic activity.
For the fourth consecutive month, the Bloomberg Barclays U.S. Aggregate Bond index had a negative return. The index return was -2.4%. The prospects of higher government spending due to Trump polices creating inflation coupled with expectations that the Fed will raise its Fed funds rate in December pushed bond yields to 18-month highs. Bond prices decline as yield rise. The 10-year Treasury bond yield rose to 2.39% at month-end which is up from 1.83% at the end of October and 2.27% at year-end 2015. Yields on corporate, mortgage-backed, and municipal bonds also rose as prices declined. Bonds with a longer time to maturity had larger price declines than shorter maturity bonds. For example, the Bloomberg Barclays index of U.S. Treasury bonds with 20 or more years to maturity had a return of -7.7% for November whereas the index of U.S. Treasury bonds with 1-3 years to maturity had a return of -0.4%.
The Bloomberg Commodity index had a return for November of 1.3%. The industrial metals sub-index posted a gain of over 10% for the month. Expectations for increasing demand for commodities from higher infrastructure spending in the U.S. drove industrial metals prices higher. The energy sub-index was also a top performer for the quarter with a gain of over 4%. After falling much of the month, the price of crude oil surged over 9% on the last day of the month after OPEC reached an agreement on cutting production by 1.2 million barrels a day. Natural gas also rose sharply during the month. The precious metals sub-index was the weakest sector of the commodity index. Gold was down 8% for the month and silver declined 6% as the U.S. dollar strengthened.
Vogel Consulting, LLC (Vogel) Tactical Recommendations
No changes were made to our tactical asset allocation recommendations during November. While there was a shift in sentiment to a more optimistic outlook on expectations that tax cuts and infrastructure spending proposed during the presidential campaign will lead to higher economic growth in the U.S., the details and timing of any policy changes are not known. Due to that uncertainty, it is likely financial markets will experience bouts of volatility as more details emerge about any fiscal or monetary policy changes. Therefore, we are maintaining our neutral position in U.S. equities. In addition, we continue to underweight developed international stocks because uncertainty remains high in Europe due to several upcoming elections, referendums, and decisions from central banks about monetary policy. We continue to expect interest rates to move gradually higher and therefore continue to underweight fixed income.
Our tactical asset class recommendations include an equal weight position in U.S. large-cap, mid-cap, and small-cap stocks as well as emerging market equities with an underweight to developed international equities. We continue to recommend an equal weight to hedge fund strategies and an underweight to fixed income. We favor hedge fund strategies over fixed income for the lower expected volatility portion of portfolios since bond yields are near historically low levels and are likely to rise and bond prices fall as central bank polices are adjusted. Within fixed income we continue to recommend a focus on short to intermediate term bonds. We also continue to favor non-Treasury bonds for the yield advantage they provide compared to Treasury bonds. Since our expectation is for a moderate rate of inflation to continue, we recommend an equal weight to real assets. Finally, we expect that financial markets will experience periods of wide swings up and down as more details become known about any actual or expected changes to government policy and regulations as the Trump administration begins work as well as to changes in expectations about Federal Reserve interest rate policy, oil prices, economic data reports, and political news particularly in Europe. Therefore, we continue to recommend using periods of market strength to raise any cash needed to support spending needs over the coming 12-24 months.
The statistical information contained in this commentary has been compiled from publicly available sources and is presented to you for your review and for discussion purposes only. The information contained in this commentary represents the opinion of the author(s) as of its date and is subject to change at any time due to market or economic conditions. These comments do not constitute a recommendation to purchase, sell or hold any security, and should not be construed as investment advice or to predict future performance. Past performance does not guarantee future results.
The statistical information contained in this commentary was derived from sources that Vogel Consulting, LLC believes are reliable, and such information has not been independently verified by Vogel. Russell Investment Group is the source and owner of the trademarks, service marks and copyrights related to the Russell Indexes. Russell® is a trademark of the Russell Investment Group. An index is not managed and is unavailable for direct investment.