In like a lion, out like a (different) lion. That pretty much sums up 2016. Opening with an alarming 10% drop from Day 1 through mid-February, followed by an 11% bounce back to break-even by mid-March, the S&P 500 looks to close the year with a 9% surge since early November. In between these book-ends, almost no change: The index rose 2% in the interim seven months. As we write this, the S&P 500 has generated a 12.5% total return year-to-date.
Small-cap stocks have done even better. As measured by the Russell 2000 Index, these stocks produced a 21.6% return in 2016. Value-style stocks overwhelmed their growth stock counterparts - by over 10 percentage points in the large-cap Russell 1000 Index and by a truly remarkable 20 percentage points in the Russell 2000.
Returns in the U.S. markets led all other major regions around the globe. The MSCI Europe index fell 4.8%, reflecting ongoing economic struggles and other issues there, whereas the MSCI Pacific index gained 1.6%. Emerging markets rebounded from their woeful 2015 performance with a decent 7.2% return as measured by the MSCI EM index.
High quality fixed income investments produced only modest gains, as interest rates moved higher. The Barclays Aggregate Index return was just over 2% YTD. However, the more equity-like BofA/Merrill Lynch High-Yield bond index generated a 17% return. Like equities, the high-yield sector was boosted by the rebound in oil and gas prices.
So what do we think 2017 holds? The market's previous assumptions about the U.S. economy - sluggish growth, rising government regulation, near-zero interest rates - seem to have reversed overnight with the election of Donald Trump. We think the changes run deeper. Households and companies are starting to move past the financial crisis, which peaked eight years ago. Demand is picking up. With it, there is a good chance that the deflationary environment is shifting back toward inflation. Trump's election could further boost growth through more government spending and fewer regulations.
Risks to the markets may increase in 2017. Every new president faces challenges, and Trump's unconventional approach may create even higher uncertainty than previous administrations. Rising interest rates are likely to create volatility. International issues, particularly relating to Russia, China and terrorist organizations, and perhaps including unexpected political events in Europe, could generate sharp market swings. Investors prepared for volatility can better hold firm when it arrives.
Delving into various investment classes, we remain unenthusiastic about bonds generally because we expect interest rates to rise further. High yield and distressed bonds, however, remain attractive. We remain moderately bullish about stocks, once again tilting toward value stocks over growth stocks, and similarly tilting a bit toward small cap over large cap. That said, we are very bullish about the prospects for profiting from individual security selection. Change creates opportunities, and we see a lot of changes ahead in 2017. More details on our market recap/forecast and best stocks for 2017 are included in the most recent issue of our turnaround investing newsletter.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.