• Bill Bullock

2016 Fourth Quarter

"I see no reason, despite the fact we've had two sizable bear markets in the past 15 years and a nice run from the March 2009 lows, to stay away from equities. U.S. stocks are only slightly above their longer-term average price-earnings ratio." - Jeremy Siegel, Professor of Finance at the Wharton School of the University of Pennsylvania, in a November 28th, 2016 interview.


Happy New Year! The biggest news over the past few months has undoubtedly been the election of Donald J. Trump to the presidency of the United States of America. While the market reaction on election night indicated that the Dow Jones Industrial Average was going to have a rough open the following day, the market quickly reversed itself and the fourth quarter turned out to be one of the strongest quarters of the year. The stock market certainly views the Republican control of the House of Representatives, the Senate and the presidency as corporate friendly. That said, many analysts believe any corporate tax cuts and proposed corporate deregulation are already priced into the current stock levels; thus, anything less than what was promised during the campaign may send the stock market heading south. Add to that the inherent uncertainty with any newly elected president along with the fact that we are at all-time stock market highs, 2017 could be a volatile year.


Below you will find my year-end review of our current areas of investment. Not everyone will have the funds I mention below, but most of you will.


Fixed Income: For the most part, our fixed income funds (both short and intermediate) hovered in the +2 to +3% total return range for the year. To give you some perspective, the intermediate-term Bloomberg Barclays US Aggregate Bond index was up 2.65% in 2016. I thought it was impressive to have our short-term bonds return almost as much as intermediate bond index considering there is less volatility risk involved with the short side of the yield curve. There were some intermediate bond standouts: PIMCO Income fund was up over 8% and our inflation protected bonds were up over 4%. I was pleased with the fixed income results.


Large-Cap Domestic Equities: You know, it is funny. Our worst performers in 2015 within this space were Berkshire Hathaway and Oakmark Equity & Income (OAKBX). 2016's best performers included Berkshire and the 60% equity and 40% fixed income OAKBX! This is a major reason why one cannot be too quick to sell - you have to cut these managers some slack in order for them to beat the index over the long-term. Berkshire rose as the price of oil increased throughout the year and OAKBX increased as some of their long-held value plays became attractive again. As you may or may not know, mutual fund managers have had a difficult time keeping up with the S&P 500 index over the past few years, but I am starting to see signs that the higher quality companies (i.e. companies with stronger balance sheets) that value managers crave are starting to become popular again as this long bull market continues. Investors might be thinking the higher quality companies will give them some downside protection should this market suffer a correction and are, thus, starting to add them to their portfolios. Last but not least, the S&P 500 index and total stock market funds/ETF's put up strong double digit returns in 2016.


Mid and Small-Cap Equities: Once again, a loser in 2015 was our best performing fund this past year. Royce Special Equity (RYSEX) was down more than 12% in 2015 and shot up 32.21% in 2016. This performance placed it in the top 8% of all funds within the "small value" category according to Morningstar. Small-cap was one of the best categories in 2016 as small-caps finally received their day in the sun after struggling to keep up with large-cap stocks for a number of years. Schwab U.S. Small-Cap ETF - a good representative of the small-cap market - was up 19.97% last year. Our mid-cap value fund, Vanguard Selected Value, was up 16.34%.


Foreign Equities: What started out as a promising year for First Eagle Overseas (it was up double digits for a while), ended with it up close to 6%. While that is relatively low when compared to the S&P 500, that return actually places it in the top 7% of all funds within its category in 2016. First Eagle represents at least half of our overseas allocation. The other half is equally divided between Oakmark International (OAKIX) and IVA International. OAKIX's ride was nothing short of a roller coaster. Through June 27th, 2016, this fund was down over 15%. It rallied towards the end and by 12/31, it was +7.91% - good for the top 3% within its category in 2016. IVA International is the most conservative foreign fund we own, but still manages to stay within the underlying 100% stock index performance. With 40% in cash and bonds, IVA was up 2.82%.


Near-Term Outlook: As I have written in the past, it is impossible to make any accurate predictions of what will take place in the next month or two. No one knows what will happen in the short-term. The Federal Reserve has forecasted three interest rate hikes in 2017. As rates go up, bond prices go down; thus, I like our current allocation of 50% short-term bonds (less sensitive to interest rate increases) and 50% intermediate-term bonds (slightly more sensitive to interest rate increases). I consider our current bond positioning to be the "sweet" spot of the fixed income space. On the equity side, President-Elect Trump and the Republican Congress has agreed that one of their first priorities will be to lower the corporate tax rate. Most analysts agree that lowering that tax rate should increase the earnings-per-share for corporations and, thus, could help justify the current price levels of the S&P 500. Should revising the corporate rate falter in Congress, the stock market will struggle.


Long-Term Outlook: Whether you love him or loathe him, Donald J. Trump will be our president for four years. If you are concerned about your portfolio with a President Trump, I am reminded of an article Vanguard published shortly before the election stating that from 1853 - 2015, there is "no difference in average annual stock market returns based on party control of the White House." The nominal (before inflation) year-end equity market returns average 11% for both Republican and Democrat party presidents. Over the next ten years, however, many analysts believe average annual equity returns will be closer to 5 to 8% while bond returns will average about 2 to 3%.

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