A Tale of Two Halves
2016 can be described as a Tale of Two Halves. Many investors took a “risk-off” approach to the markets in the first half of the year due to a decline in oil prices and slow growth in both China and the US. The second half of the year saw a “risk-on” sentiment as many of the first half factors stabilized or improved in the second half. US Small Cap equities outperformed all other asset classes, up nearly 22%, while US Large Cap Equities were up almost 12%. Core Fixed Income, REITs, and other interest rate sensitive sectors were negatively impacted by the second half rising of interest rates and increased expected inflation and economic growth.
Looking to 2017, many economists expect global growth and inflation to improve. Concurrently, corporate earnings growth are expected to improve their levels in the upcoming year while interest rate sensitive assets may still face headwinds from three signaled interest rate increase from the Federal Reserve Bank.
US Economic News
The US Economy continues to show resilience seven years into a recovery. Employment, with an average of 176,000 jobs added each month, has been steadily improving. The housing market remains strong, consumer confidence hovers at high levels, and energy prices show signs of advancement. Third quarter GDP is estimated to be +3.5%, higher than the prior +3.2% previous estimate and +1.4% reading of the second quarter.
Dispersion in returns for equities has been increasing through 2016 as the ten primary economic sectors generated a wide variance in performance. Within Large Cap styles, Value significantly outperformed Growth stocks where traditional Value sectors such as financials, energy and industrials led the index. International stocks generated worse performance than US equities overall as the surprise results of the US presidential election has raised concerns about protectionist US trade policies.
Anticipation of a hike in the fed funds rate, an improving economic outlook, and record equity prices were a few of the key drivers of fixed income performance in 2016. These factors were strong enough to allow the FOMC to follow through on their desire to normalize interest rates, and much of the fixed income yield curve continued to accelerate its rise after the election results were realized. A difference realized in the fourth quarter was the steepening of the yield curve as longer term interest rates rose. By the end of 2016, the 10-year US Treasury note rose to a yield of 2.45% from 1.60% on September 30th.