Fourth Quarter 2016 Market Review
Investors spent much of the last few years concerned that the economy might slip back into a recession given the slow growth environment we were experiencing. This perception changed abruptly during the fourth quarter as indicated by the surveys for consumer confidence, investor confidence and small business expectations which all turned strongly positive. Since better economic growth usually results in higher inflation and interest rates, financial service stocks dominated with a 21.1% gain during the fourth quarter while the energy sector (inflation beneficiaries) was the second best with a 7.28% increase. Dividend stocks, on the other hand, were held back by an increase in inflation expectations and increased only 0.49% for the quarter.
Value stocks significantly outperformed growth stocks during both the fourth quarter and for the year, while small stocks also easily beat large cap stocks during both periods. Value stocks benefit the most from better economic conditions and the new administration’s plan to lower corporate tax rates would benefit small companies more as they tend to have higher effective tax rates. The S&P 500 increased 3.82% for the quarter and 11.96% for the year. And finally, with interest rates moving higher, 5-year municipal bonds declined 2.76%, while Intermediate Gov’t/Corporate bonds dropped 2.1% for the quarter.
We believe the sudden and sharp improvement in business and investor expectations has played an important role in the stock market’s success of late. As such, it may be that prices (stocks) have advanced too far ahead of the improvements investors are looking for. Under these circumstances, stock prices typically tend to consolidate or even correct lower as investors wait for the improved expectations to become a reality. This looks to be what has been happening during the month of January thus far. From our perspective, we see economic conditions and corporate profits already improving and this higher level of growth will continue throughout the coming year. As a result, it should be a favorable environment for the stock market.