January 2017

In January, we maintained our twelve-month forward outlook to reflect the inflationary environment that is expected to result from the new regime in the U.S. while the rest of the world continues to struggle with stagnation. While the International Monetary Fund projects that global GDP in 2017 will improve to 3.4% from 3.1%, there is currently a wide dispersion of projections given the uncertainty surrounding the policy stance of the incoming U.S. administration and its global ramifications. With price pressures building in the U.S., but not elsewhere, monetary policy divergence leading to upward pressure on the dollar will create some headwinds. The Federal Reserve is targeting three interest rate hikes next year while other global central banks remain accommodative. Powerful structural forces including an ongoing overhang of debt, adverse demographics in most major economies, ineffective monetary policy, and low financial asset returns will challenge all global economies including the United States.

U.S. fiscal stimulus will be implemented at a time when the economy is already close to full employment. At 4.7% in December, the unemployment rate is now below Fed officials’ median estimate of its natural level. The impact that technology has had in creating uneven incomes and a decline in employment opportunities will continue to be a challenge. America’s current job creation recognizes that there has been technological displacement in select industries that previously had not benefited from technological innovation. The Great Recession revealed the weakening of the link between value creation and job creation. Please see our 2016 Fourth Quarter Summary Outlook to see our additional thoughts on the impact that this global phenomenon has and will continue to have on the ability of all economies to grow.

The anticipated tightening in U.S. monetary policy commenced as December saw the Fed announce an increase in its key interest rate for just the second time in the last seven years. The S&P 500 Total Return Index surged to the finish in 2016, up 12% for the year, as investors indicated optimism with Trump’s pro-growth policies. It is notable that only about 50% of the index outperformed, with gains led by cyclical areas such as Financials, Energy, Industrials, and Materials, as these areas are expected to be direct beneficiaries of the new regime. Gains in smaller-cap equities were even stronger, as the S&P Mid-Cap 400 Total Return Index and the S&P Small-Cap 600 Total Return Index were up 20.7% and 26.6%, respectively, for the year. Global equity markets generally ended the year positively, while underperforming the U.S, in part due to the currency headwinds caused by the rising dollar. An exception was Canadian equities, with the S&P/TSX Composite Total Return Index up 21.1% for the year. The MSCI Emerging Markets Net Total Return Index ended the year up 11.2%, although the MSCI China Net Return USD Index posted a more modest 2016 return of only 0.9%. The European Central Bank continued with quantitative easing policy throughout the year and yields declined.

Following major asset allocation shifts in December, we maintained these allocations in all models in January. The models continue to reflect exposure to asset classes that provide superior expected returns in this new environment, while attempting to avoid the asset classes expected to detract from positive returns. This continues to include a high exposure to U.S. mid- and small-cap equities, and smaller exposures to Australia and Canada. Fixed Income exposure is short duration across all models.

We continue to believe reflation in the U.S. will be the key investment theme in 2017, a significant departure from the post-2008 period when dovish monetary policy kept interest rates on a downward spiral. We do not expect the new regime to carry out all the extreme protectionist threats that were at the center of the election campaign. In addition, with commodity prices likely to recover, aggregate growth in emerging economies will continue to accelerate, although China’s economy will likely continue to slow.

We will continue to monitor the data for growth signals from employment, consumer spending, business sentiment, Fed policy, the yield curve, inflation, and global economics. Our focus is on protecting portfolios from downside risk, and we believe that our investment process is working to achieve that goal.

 

Deborah Frame, President and CIO
Data Source: Bloomberg