Happy New Year!
While 2016 is gone, it will surely not be forgotten. When I look back on 2016 and reflect on key events that influenced the markets, I’m struck by how many defining moments there were. 2016 started with a high degree of volatility that came on rather unexpectedly. Equity and commodity markets fell while bonds soared for the first month and a half. The S&P 500 Index experienced its second correction in six months while oil prices reached a low not seen since 2002. As we moved through the middle of the year, Brexit became the focus and the British populace shocked the world with their desire to leave the European Union. The value of global bonds, priced with a negative yield, reached nearly US$12 trillion in October. But perhaps the single most defining moment of 2016 came on Nov. 8 as Americans voted Donald Trump as the 45th President of the United States of America.
The Canadian equity market finished the year as the best-performing developed market with a return of 21.1 per cent, including dividends, as measured by the S&P/TSX Composite Index. The index now sits less than three per cent away from a record reached in September 2014. Oil prices were among the main drivers of strong calendar-year returns. Prices as measured by West Texas Intermediate (WTI) gained 45 per cent in 2016 closing at US$53.72 and up 105 per cent from its low of US$26.21, set on February 11. Oil prices had plunged nearly 62 per cent during the prior two years. As a result, energy shares in the S&P/TSX were the second-best performers in the group, up 31 per cent. On Nov. 30, the Organization of the Petroleum Exporting Countries (OPEC) announced an unexpected agreement to curb production levels, creating a surge in prices.
The United States
In the United States, the S&P 500, Dow Jones, and NASDAQ ended the year up 11.9 per cent, 16.5 per cent and 9.0 per cent, including dividends, respectively. Adjusting for the Canadian dollar, the three indices returned 8.9 per cent, 13.3 per cent and 6 per cent, respectively. After the Federal Reserve raised rates in December 2015 for the first time since 2006, U.S. stocks opened 2016 with the worst two-week performance to start a year in recorded history. After 10 trading sessions, the S&P 500 Index, Dow Jones Industrial Average, and NASDAQ were down 8.0 per cent, 8.3 per cent and 10.4 per cent, respectively. Despite the horrendous start to the year, these losses were short lived. The markets bottomed on Feb. 11 and by the end of the first quarter, both the Dow Jones and S&P 500 were back in the black.
Many were surprised when Donald Trump beat Hillary Clinton to become the 45th president of the United States. In addition to that, the Republican Party won majorities in both the Senate and House of Representatives. On enthusiasm toward the Republican Party’s reflationary policies—a mere 12 days after Trump’s victory—the S&P 500, Dow Jones, Russell 2000 ( U.S. Small Cap Index) and NASDAQ each closed at an all-time high, making it the first time since Dec. 31, 1999 that all four major U.S. indices hit new all-time highs on the same day.
Perhaps the biggest surprise emanated in Europe, where much of the focus was on British voters who surprised pollsters by voting to leave the European Union. Europe and the rest of the world now await the outcome of Brexit; a process that will likely take years to fully realize. There’s much debate on what a Brexit actually means in terms of the British economy, the European Union and potential fallout for the rest of the world.
The MSCI Europe Index gained a modest 3.1 per cent in local currency terms, including dividends, for the year (-2.6 per cent in Canadian dollar terms). In Asia, the MSCI Asia ex-Japan Index returned 5.4 per cent in U.S. dollars including dividends (2.5 per cent in Canadian dollar terms). The Nikkei 225 Index (Japan) was up 2.4 per cent in Japanese Yen terms, including dividends (2.5 per cent in Canadian dollar terms).
The U.S. Federal Reserve remained hesitant to raise interest rates throughout the year before deciding to raise rates a quarter point in December. The single rate hike in 2016 was in stark contrast to the expectations set of four rate increases at the end of 2015. Lack of global economic growth and easier monetary policies from major central banks worked against domestic trends of higher inflation and improving unemployment rates. The dot charts that map the Federal Reserve board members’ federal funds rate expectations now suggest a median expectation of three increases for 2017. The change in expectations along with the Republican Party’s reflationary policies drove Treasury bond yields sharply higher in the final two months of the year.
The U.S. 10-year Treasury yield fell from 2.27 per cent at the beginning of the year to a low of 1.36 per cent on July 8. Much of the decrease was due to investment opportunity for fixed income around the world. On a relative basis, U.S. Treasuries were a better alternative to other developed-market government bonds, which offered much lower yields. Leading into and following the U.S. election however, bond yields moved higher with the U.S. 10-year Treasury yield closing out the year at 2.45 per cent.
Canadian yields followed a similar path with the Canadian 10-year government bond yield bottoming at 0.95 per cent on Sept. 29 before gaining 77 basis points by year end to yield 1.72 per cent. The Bank of Canada held its key overnight rate firm at 0.50 per cent through the year. The benchmark index for Canadian bonds, the FTSE/TMX Universe Bond Index ended the year with a gain of 1.6 per cent, after falling -3.4 per cent and -2.3 per cent over the last three and six months of the year, respectively.
As we look ahead to 2017, the Canadian, U.S. and international economic environment appears to be much improved from a year ago. However, it would be too easy to say that with stronger economic fundamentals, markets will outperform. Market volatility is likely to remain through much of 2017, driven mostly by headline news. Yet, despite the uncertainty, the investment environment is solid if unspectacular. Misplaced fears of an imminent global recession brought on by the Brexit vote have subsided and U.S. business is improving. Oil, alongside the S&P/TSX, likely bottomed in February and is showing signs of improvement.
As with many things in life, the key to investing is balance. Extremes are easy. Balance is difficult to achieve but delivers a better and more satisfying outcome. Your balance will differ from that of other investors depending on risk tolerance, time horizon and financial goals, yet the balance we strike between asset classes may lower volatility and provide a narrower range of returns over time. Being positioned with a balance of equities and fixed income can mitigate the bumps and enable us to take advantage of any downside volatility that may emerge.
As always, if you have any questions about the markets or your investments, I'm here to talk.