I believe it is safe to say that the last quarter of 2016 was quite interesting – not only was there the US election in November, but the Fed raised rates for the first time in 2016 and there was an 8 week Trump rally in the markets following the election.
The rally actually started the day before the election with the S&P 500 closing up 2.2% on November 7th, up 0.4% on Election Day and then up another 1.1% the day after; as-of December 30th, the S&P 500 managed a 7.4% gain in just 8 weeks. Maybe part of the reason for the rally was relief that the campaign was finally over, but there has been a significant amount of positive sentiment regarding the outlook for the Trump Presidency. Such enthusiasm is probably too hasty given that Trump has no political experience. We believe the market has, for some reason, put on a pair of rose coloured glasses and has forgotten that it hates uncertainty.
Even before Trump’s inauguration on Friday, the amount of uncertainty (and controversy) surrounding him seemed to grow by the day: he drew the ire of China over comments regarding Taiwan; he called NATO obsolete; rumors and questions about connections with Russia and Vladimir Putin increased and he was singling out specific companies regarding off-shore jobs. It is possible he could end up being a very good President, however, as it stands today, we believe that a wait-and-see approach is more prudent.
We began to reduce risk in portfolios last September by selling all medium and long-term bonds, which have since fallen after the Fed rate hike. While we have deployed the majority of the proceeds from the sale of the bonds, there remains a portion to invest, which we are cautiously waiting for the right opportunity. We have also invested in another asset class: gold bullion. In light of the potential for long term political and economic risks we believe that gold bullion will act as a hedge to these various risks.
Canada – The Canadian equity market was the star performer of 2016, up 21.1% for the year; small caps were up 38.5% and value was up 25.6%. Will this trend continue into 2017? Part of the answer will depend on the price of oil as well as Trump. Trudeau has taken the preemptive steps to work with Trump and remain off his radar, which is likely a prudent move.
United States – The rally in Q4 helped to propel the US market to an 8.8% gain, with small caps up 14.2% and value up 14.3%. The big question now is to what extent are US equities fully or overvalued. As noted above, the new Trump administration is the real wildcard in 2017 and we will be watching events closely.
International & Emerging Markets – The Q4 equity markets rally had only minimal yet positive effects on international equities; even though they finished the year down -2.0%, they were up 1.4% in Q4. Small caps were down 1.0% for the year while value was up 2.0%. Emerging markets fared much better, up 7.7% but were held back with Q4 down -2.1%.
Fixed Income – Up until the end of Q3, fixed income was having a good year: Canadian bonds were up 5.3%, US bonds up 1.0% and international up an impressive 7.0%; however, what a difference three months make. Canadian bonds finished the year up only 1.7%, US bonds were down -0.5% and international fell -2.0%. Our significant move to reduce bond holdings in favour of fixed income alternatives such as mortgages, private debt, receivables discounting and life settlements, has been a prescient move. We believe the Fed will raise rates again in 2017 and we continue to look for safe fixed income opportunities that we feel will have limited impact by rising rates.
Economic News – The US Fed raised rates 25 basis points on December 14, which was widely predicted by almost every financial analyst. Going into 2017, many analysts expect two rate increases with additional increases over the next several years. According to Bloomberg, some economists believe Trump’s 3-4% growth target will spur inflation in the US thereby prompting the Fed to raise rates to keep it within their 2% target; this will likely put Fed and Trump policies at odds.
On December 7th, the Bank of Canada elected to keep rates stable and the general expectations are for rates to remain stable in 2017; however, Stephen Poloz has not ruled out a rate cut depending on how potential US protectionist policies unfold and affect the Canadian economy. While growth was slow in the first half of the year, it picked up in Q3 and is expected to have moderated in the last quarter. Even though inflation has increased in 2016, core inflation remains close to 2%.