Fourth Quarter Market Review
What a difference an election can make. Following an especially contentious election cycle, US equity markets rose on the promise of pro-business rhetoric relating to the three “R’s”: repatriate (of corporate cash held overseas), reform (tax reform in specific), and repeal (Obamacare). The best performers this quarter were the firms set to benefit from these promises—US small and large capitalization companies—up 8.8% and 3.8%, respectively. In fact, post election, the Russell 2000 (small cap index), doubled its YTD return of 6.3% in just the last eight weeks of the year, returning over 21% for the full year. For its part, the S&P 500 gained almost 5% post-election, and global energy prices continued to strengthen with the news of an OPEC reduction in drilling activity and inventory drawdown. Conversely, emerging markets and global REITs were penalized on fears of rising US interest rates, trade protectionism, and relatively elevated real estate prices.
Although global equity returns were positive, the realization of escalating US interest rates due to Federal Reserve monetary tightening put pressure on global fixed income returns. The lone bright spot in the fixed income markets was high yield bonds (debt rated less than investment grade, also known as junk bonds), which are highly correlated to equities. The same catalysts pushing equities higher caused high yield spreads to tighten and high yield indices to gain 1.8% for the quarter and 17% for the year. On the other hand, corporate bonds, treasuries, and municipal issues struggled due to the longer dated nature of their maturities.
The Fed’s telegraphed December rate hike is an indication the US economy is growing without Fed intervention while inflation is getting closer to the Fed’s stated targets. We are encouraged by a range of positive economic data (small business surveys, consumer confidence readings, and rising real employee wages to name a few). If Congress passes promised fiscal policy reforms, we can envision continued strength in the US equity markets. Should these initiatives fail to come to pass, globally diversified portfolios should help absorb some of the disappointment.