Instead of experiencing “the calm before the storm” this year, the markets experienced “the storm before the calm.” Right out of the gate, the U.S. stock market dropped nearly 9% in the first few trading days of the year. It then continued its downward move until February 11, when it bottomed out. On this day oil prices hit $26.05 – their lowest in 13 years, junk bond yields skyrocketed as fearful investors sold their securities, and U.S. government bond yields hit 1.66% as investors piled into these “safe-haven” assets. Things then calmed down a bit until the end of June when an unexpected approval of Britain’s exit from the EU went through. Following this “Brexit” vote, U.S. government bond yields again plummeted, with the 10-year Treasury rate eventually hitting 1.36% in early July, the lowest level ever recorded. The U.S. stock market dropped significantly as well, and the British pound fell to its lowest level in decades.
Since these volatile days following “Brexit,” the “storm” seemed to be over. With Donald Trump being elected November 8th and all the optimism associated with the expectation for an expansive fiscal policy coupled with less regulation, interest rates and stock markets have increased significantly. In the end of November, OPEC (The Organization of the Petroleum Exporting Countries) made a groundbreaking agreement to cut oil production for the first time in eight years. A few days later, in early December, Russia and other large producers agreed to follow suit and cut their production as well. With these cuts oil prices rose as intended, touching prices of over $54 a barrel – more than double the prices seen in January. Following the strength in capital markets and a strong economic outlook, the Federal Reserve finally raised short-term interest rates for the first time during the year and only the second time since the recession began in 2007.
Since the election, the S&P 500 has continued to hit new highs and the Dow Jones Industrial Average has come within just a few points from hitting 20,000 points, a milestone value never reached before. At the same time interest rates have climbed considerably. The 10-year Treasury rate went from 1.85% the day before the election to a 26-month high of 2.6% in mid-December. With Trump’s plans to likely cut taxes while also building the U.S. through roads, bridges, etc., the bond market deemed it highly probable that the funding would come from increased debt issuance. This increase in money supply would likely lead to inflation, which is one of the main drivers of longer-term yields, so it is logical that both inflation expectations and the 10-year Treasury yield have increased together. Although the U.S. stock indices have increased a large amount since the election, not all stocks have risen. With interest rates improving, rate-sensitive stocks such as defensive dividend-paying stocks and REITs did not receive the same positive enthusiasm as others. Moreover, many technology stocks with global exposure did not rise as much as others either, as Trump’s trade policies seemed potentially detrimental to some of these companies. The stocks that performed the strongest were those in the Financials sector that do best when interest rates increase and those in the Industrials sector and other cyclical sectors. Industrial companies would potentially benefit as they take on new business in areas such as building bridges.
Gamble Jones Capital Management takes pride in building portfolios that align with the stated goals and objectives of each respective strategy. We utilize a fundamentally driven research process. Although some of the aforementioned sectors such as Financials and Industrials may have increased more than your holdings in the short-term, we want to remind our clients that in the long run stocks are driven by earnings. Ben Graham, one of the most famous investors of the modern era, is quoted as saying: “In the short run, the market is a voting machine but in the long run, it is a weighing machine.” Our philosophy remains the same and our focus continues to be on companies with strong economic moats that generate recurring revenues and cash flows. Ultimately, it is still unclear what exactly Trump’s plans are, when they will take effect, how exactly they will affect companies here and abroad, how they will affect other countries, and what the ripple effects may be. Rather than operating under a “herd mentality” and following others into the more volatile stocks that have been doing well as of late, we will continue to hand-pick individual companies that have a strong likelihood of staying healthy in the face of difficult times while also growing their earnings. We feel fairly optimistic about what 2017 holds for the U.S. economy but are keenly aware of the inflated valuations of the U.S. equity market. Our investment process, therefore, is especially valuable at times like these, as we can pick individual companies with attractive valuations rather than buying an entire market index that may not be trading at what we deem to be an attractive valuation. We look forward to continuing to manage your precious assets with prudence and care.
From all of us at Gamble Jones, we wish you a Happy New Year!
Gamble Jones Capital Management