“Same old story, same old song, Goes all right till it goes all wrong…Same old story, same old song” — B.B. King
In terms of political market drivers, there is a lot that might be described as the “same old story” right now. I wrote in June here about presidential politics and their historical relationship to US stock market movements. In that post I explained that typically US stocks do very well in an election year. Optimism about the new president push sentiment in a pretty positive direction.
I think it is safe to say right now, there sentiment is on the rise post-election and that rising sentiment has been moving markets. US stocks ended 2016 in double digits with the SPY returning +11.2%, and ~2.5% of that return coming post election.
World stocks ended 2016 +5.99% as judged by the Vanguard World Stock ETF (VT).
The optimism and historical trend for election years played out in 2016. Will the dissatisfaction of inaugural years play out in 2017 for US stocks?
If 2017 sees a sentiment driven decline in US stocks it will be “the same old story, same old song” that we’ve seen before.
Coming into the week the S&P 500 was at +12.84% YTD returns, and the MSCI EAFE was at +0.50% YTD returns. It is very unlikely that there will be a change in leadership between US stocks and foreign developed stocks, meaning that for the 4th consecutive year US stocks will lead their foreign developed counterparts.
“The Market” as measured by the Vanguard Total World Stock ETF (VT) is at roughly +6.5% year-to-date.
The second estimate of US 3Q16 GDP showed an uptick in US growth with an expansion from 1.4% last quarter to 3.2% this quarter. Expansion of the US and world economy my not be racing, but it does continue a slow and steady tortoise walk.
3Q16 earnings among S&P 500 companies grew 13.8% year-over-year which was the first positive growth in six quarters. This disconnect between growth in earnings highlights a couple of factors about how markets work. Most would assume that markets would have declined over these past six quarters if earnings were declining. Markets however are a function of supply and demand, and the many variables that move supply and demand are vast.
Inflation appears to be rising, as headline CPI grew by 1.7% year-over-year and the core measure grew 2.1% year-over-year in November.
The Fed raised expectations for inflation and the number of rate hikes for next year. The FOMC expects it will raise rates three times in 2017. Of course we know that the Fed has been very off on most of their predictions and timelines over the last several years. If rates do in fact finally rise, mid and long duration treasuries should be a major underweight in fixed income portions of portfolios.
Investing in capital markets means taking your medicine. I mean that markets have an incredible consistent habit of reminding us that over short-term periods they are wildly unpredictable.
Sometimes even when you are wrong, you are right, and when you are right you are wrong. Wait is that right? Case in point the behavior of the markets post election. I like many assumed a Clinton victory. I was wrong, medicine taken there.
I, like many others thought that a surprise Trump win might lead to a drastic overreaction to the downside in markets. I thought it would be potentially excellent tactical buying opportunity. Here I was right, and I was wrong. The markets did drop, and they dropped fast, futures traded down 5% over night until trading was halted. However, this short-term downswing was much shorter than I expected (I had thought at least a week like the Brexit swing) as markets recovered the following morning. Markets have been climbing ever since. Take a little more medicine on that one.
What was great about this recent activity in the markets is that it reiterates and important investing point. You can always be wrong. You can put in the time, the research, have sound logic, be well educated, etc., but you can always be wrong when dealing in capital markets.
Knowing that we can always be wrong is why we diversify our portfolios. It is why we use a broad benchmark like the Vanguard World as a framework to build our equities portfolio.
Knowing that we can always be wrong is why as investors we scrutinize over our asset allocation, and make sure we have the right mix of stocks, bonds and cash in our portfolio in relation to our goals, time horizon, and cash flow needs.
If we were never wrong we could make wholesale shifts in our portfolios into and out of different types/categories of securities. We can’t do that, so we ask and analyze “what happens to our portfolio if we are wrong? What are the different ways we could be wrong?”
We as investors always have to be ready to take our medicine, because Mr. Market is really unpredictable over short-term periods.
