Overall our model portfolio ended 2016 up 8.10%. The year started off in difficult market conditions, with the portfolio suffering and registering a low of -5.3% by late January, before turning around in February.
Both the equity and bond markets turned positive and eventually the portfolio reached a peak performance of 11.03% in early September. The year ended with every single asset class in positive territory, led by US and emerging market equities (+13%) while US bonds ultimately lagged (+2%).
Up and down
The first half of 2016 was marked by higher volatility, a drop in global equity markets and a rise in government bonds (record low yields). Meanwhile, the second half of the year (following Brexit) was highlighted with lower volatility (record low volatility), an increase in equity markets and a spike in government bond yields.
Overall, the model portfolio did what it should have done – to diversify risk and even our returns over the year.
For me, two fundamental factors drove the markets in 2016 – and they weren’t Brexit or the US election. The year started with a run of poor corporate earnings, but the outlook and actual results started to turn around in the third quarter, which gave the equity markets a positive boost. Clearly the equity markets took a turn for the better and the potential for additional stimulus from a Trump election win pushed that positive momentum further, and on into 2017.
The second factor related to yields and inflation expectations. The first half of the year saw record-low government bond yields and then, as expectations for US interest rate hikes from the US Federal Reserve and higher inflation expectations came to the forefront, yields went back up, particularly following Trump’s US presidential win; this not only signalled possible economic stimulus but also potentially higher inflation.
The 10-year US Treasury started 2016 at 2.24% before falling to 1.37% in July, ending the year up at 2.45%.
What the dichotomy of events in 2016 showed us, is that it is hard to predict the outcome of events and their effects on markets. Ultimately, it is difficult to time the market.
The best strategy was a less-active one focused on managing risk over events, rather than betting on the outcome of events.
A simple diversified portfolio, managed at a low cost (0.18% per annum) is an easy and efficient way to manage a portfolio.
So what is the outlook for 2017? First, we don’t look at it from a micro level; is it really worth looking at specific stocks, sectors or even countries which may or may not outperform over the next 12 months? Probably not. Too much is said and written, and all that noise can lead most investors down an incorrect and volatile path.
As it stands, corporate earnings are continuing to improve, while economic data, at least in the US, are solid and should continue well into 2017. Globally speaking, there are a few political ‘events’ occurring in 2017 but nothing to be concerned about in the near term.
So equity markets are expected to continue to perform modestly. I say ‘expected’ because for anyone to predict or expect anything else is really taking a bet against the markets, and speculation is an investor’s worst enemy.
As for interest rates and inflation, there should be a few more rate hikes in 2017, but it is expected, and any increase should only be marginal. Inflation expectations may continue to increase but with 10-year US Treasuries at 2.5%, it does seem to be fairly priced in, based on recent historical prices. But things may change once US president-elect Trump takes office.
Given this, it would be prudent to invest in some inflation protection, moving some of the allocations out of bonds into US Treasury inflation protected securities (TIPS), iShares TIPS bond ETF (TIP). This small change is not to provide outperformance but more of a risk control measure to lessen any effects of additional inflation expectations.
Saying all that, we will need to follow what and how Trump implements his policies; it could be a catalyst for more difficult market conditions in the latter half of 2017 and beyond. But time will tell.
While a passive strategy is hard to follow and sell, it has proven to be the best policy for most investors and at the very least should be used to evaluate a more expensive and more active portfolio management approach.
Contact Todd: email@example.com