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2016: Celebrations and reminders

new year

By Kyle Tetting

Despite early hiccups, 2016 gave investors much to celebrate. All three major U.S. stock indexes reached record highs in the closing weeks of the year as the U.S. economy continues its slow and steady expansion. The S&P 500 posted double-digit returns for the fourth time in five years, despite an 11% correction by mid-February.

Stocks quickly erased the worst start to a year in modern history. The sell-off, though, challenged the resolve of investors worried about weakness in China, declining oil prices and the economic impact of rising interest rates. Before many investors could open their February statements, some stability in oil prices and shifting expectations for the direction of interest rates hastened the recovery.

Britain’s vote in June to leave the European Union raised questions about the path forward for the regional alliance, but the reaction to the unanticipated outcome quickly steadied. Market declines immediately following the Brexit vote were significant, especially in foreign stocks, but investors now seem to recognize that the full impact is still to be determined.

In November, U.S. stocks rallied following the unanticipated outcome of the U.S. presidential election. Expectations for a more favorable corporate environment gave new life to a bull market that has run more than seven years – the second-longest in history. Reaching several record closes near the end of the year, it would not be fair to say that stocks are cheap. However, strong earnings forecasts and room for the economy to continue its expansion give hope for the quarters ahead.

After sitting on its hands for much of 2016, the Federal Reserve raised the overnight lending rate in December. Bonds had strong returns through the end of October then hit a post-election decline as interest rates rose, in part from expectations of higher inflation amid talk of increased federal spending on infrastructure. Despite a poor finish to the year for bonds, February’s stock market correction reminded investors why they hold such investments.

Rising interest rates lent further support to the U.S. dollar, extending the rally another year against other major currencies. A strong dollar can benefit U.S. consumers by making imported goods and services more affordable. However, it also makes competition more difficult for U.S. corporations, especially large multinationals doing business around the world. The strength of the dollar will play an important role in expectations for earnings growth in the quarters ahead.

A particular challenge in 2016 has been the weak performance of stocks outside the U.S. With the exception of emerging markets, overseas stocks largely treaded water in 2016 as fears over the breakup of the European Union and continued economic stagnation weighed in Europe and Japan. Poor performance detracted from 2016 returns abroad, but a number of exceptional companies outside the U.S. are well-positioned to capture growth throughout the world.

More than many years, 2016 reminded us of the volatility inherent in investing. Declines of 10% or more are common, but markets just as quickly can turn the corner and even surprise. So, despite some unanticipated outcomes, 2016 will go down as a solid year for investors, rewarding those who stayed the course.

Expect 2017 to include many of the same issues: Chinese growth, the price of oil, Britain’s exit from the European Union, the path of interest rates, the strength of the dollar. The new year will also include new events whose outcomes we certainly cannot anticipate. Our goal is to lean into the opportunities while insulating, as best we can, from the setbacks we can’t foresee.

Kyle Tetting is research director and an investment advisor at Landaas & Company.

(initially posted Dec. 30, 2016)

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