Despite a tumultuous political environment, patient investors were rewarded in 2016 with healthy stock market gains in numerous asset classes. The S&P 500 Index of large U.S. stocks turned in a 12.0% return for the year, its eighth consecutive year of positive returns. Small U.S. stocks climbed even higher, with the Russell 2000 index up 8.8% for the quarter and 21.3% for the year. Other areas of the global stock market – foreign stocks and real estate securities in particular – booked more modest gains. For the fourth year in a row, U.S. stocks outperformed those of developed foreign markets. Bonds lost ground in the fourth quarter as interest rates surged, but still eked out a 2.1% gain for the year.
Asset class returns for the quarter and the full year were as follows:
|Barclays U.S. Government/Credit Bond Index Intermediate||Fixed Income|| |
|S&P 500||Large U.S. Stock|| |
|Russell 2000||Small U.S. Stock|| |
|MSCI ACWI ex-USA||Foreign Stock|| |
|S&P Global REIT||Real Estate Securities|| |
Dominating the headlines in the fourth quarter were the widely-followed presidential campaigns of Hillary Clinton and Donald Trump and their clash of ideas and policy proposals. After many months of debates and controversy, we will have a new president in the White House on January 20, 2017. Many media pundits were quick to warn of a negative stock market reaction to an upset victory. Leading up to the election, the S&P 500 index fell for nine consecutive days – the longest consecutive losing streak in over 35 years. On the night of the election, as the winner was announced, futures contracts on the Dow Jones Industrial Average implied a drop of about 800 points. However, when the U.S. stock market opened the next day, the stock market was flat, and went on to notch a 1.1% gain for the day. Interestingly, this marked the first time in decades that the stock market closed higher the day after a new president was elected, and the U.S. market continued to climb for about a month after the election.
|Election Winner||Election Day||Change in the S&P 500 the Day After the Election|
|Barack Obama (D)||11/4/2008|| |
|Harry S. Truman (D)||11/2/1948|| |
|Franklin D. Roosevelt (D)||11/8/1932|| |
|Franklin D. Roosevelt (D)||11/5/1940|| |
|Barack Obama (D)||11/6/2012|| |
|George W. Bush (R)||11/7/2000|| |
|Jimmy Carter (D)||11/2/1976|| |
|Dwight D. Eisenhower (R)||11/6/1956|| |
|Ronald Reagan (R)||11/6/1984|| |
|William Clinton (D)||11/3/1992|| |
|Donald Trump (R)||11/8/2016|| |
Source: Dow Jones/Yahoo! Finance
The media pundits were proven wrong in the aftermath of the election, as the predicted market decline did not materialize. The stock market’s positive reaction to the election is not out of the ordinary and is not necessarily surprising in light of efficient market theory. The Efficient Market Hypothesis (EMH), first proposed by Nobel Prize winner Eugene Fama, states that stock and bond prices reflect all available information at any point in time – and new information (e.g., the outcome of a presidential election) is very rapidly incorporated into market prices. New information about the outcome of the election was quickly priced into aggregate market prices by the buying and selling of stocks, consistent with efficient market theory.
Specifically, U.S. stocks were “re-priced” by market participants who foresaw a new political and economic environment characterized by lower corporate and individual tax rates and less regulation. Those who attempted to “time the market” by selling portions of their stock portfolio prior to the election were likely left on the sidelines as the market moved upward post-election. Of course, we do not know what the future will hold, and we do not claim to know where the market or economy will go from here. But, this election season provided a valuable lesson in the potential pitfalls of trying to outguess the stock market.
With Republicans primed to control the White House as well as both houses of Congress, momentum is certainly building for tax reform in 2017. Dowling & Yahnke has reviewed the current President-elect/House GOP proposals and will take this opportunity to highlight some of the potential changes and their ramifications. Please bear in mind that these are still proposals, and there remains a fair amount of dissent, even within the Republican Party, as to the specific priorities of a tax reform package.
Minimizing income taxes for our clients is an important part of our investment strategy, and proactive tax planning can have a dramatic effect on long-term returns. Dowling & Yahnke will monitor pending tax reform proposals and inform our clients of any potential ramifications from future tax legislation. Even though Republicans have majority control of Congress and the White House, tax reform is a drawn-out process and the current proposals will undoubtedly be altered before they are put into effect.
We thank our clients for their continued trust and support. We hope the year is off to a great start and invite you to contact us with any questions or concerns regarding your finances.