2016 was a year when we saw plenty of action in the financial markets, be it stocks, bonds, currencies, you name it. But above all, 2016 will be remembered for the US presidential election and Brexit.
On June 24th 2016, the British people woke up to find out that 52% of them wanted out of the European Union. Markets around the world were shaken and the Pound collapsed. It started recovering shortly after. As of January 2017, the British Pound is down 18% against the US dollar, from June 2016, but the stock market has gone up 18%, basically a non-event for now. It is difficult to anticipate what will come next when the formal negotiations to exit begin. However, it does show one thing about the European Union: it is a flawed structure with more unhappy countries expected to consider exiting also…
The US election
While every poll in the world was unanimous about Clinton winning the presidential election, there was a near universal belief that a Trump victory – as unlikely as it was at the time – would spell disaster for the markets.
So what happened? Firstly Clinton did not win and secondly, the market had its best week since 2014 and continued its climb through December 2016. Go figure. As you can see, markets don’t always follow conventional logic, especially when it is one obtained by consensus.
We know that it is hard to be politically neutral when discussing Donald Trump and we have strong opinions about the coming administration. However, we will spare you those thoughts and focus on what we see as implications for investors.
The stock market has rallied sharply in anticipation of policy change promises made by the President-elect: a pro-business agenda with a combination of lower personal and corporate taxes, relaxation of business and environmental regulations, and an increase in infrastructure spending. We all know that political promises are made to be broken and some of these will not come to fruition. But some will, and these will have a positive impact on businesses.
Although many Canadians have reservations about Trump for any number of reasons, as long as he does not go crazy regarding trade, the Republican economic agenda will likely be a lot more capital-friendly than the Democratic one over the last eight years.
We believe that business in general will improve and corporate profits will increase thanks to Trump’s pro-business policies. However, while a firm’s earnings power may rise in the long run, stock prices are nevertheless subject to interest rate fluctuations. As the bond market bears witness, long term interest rates seem to have bottomed in 2016. We are not predicting any dramatic rise in interest rates in the short run but a rather more gradual rise back to “normal” levels would be a more likely scenario. Historically, the upward movement of interest rates eventually reaches levels that slows down economic activity and creates a headwind for the stock market. However, the timing is extremely difficult to get right, especially when rates have been so abnormally low for so long that it makes redefining “normal” levels a big challenge.
Markets in perspective
As investment advisors, our job is to provide you with perspectives that help you stay the course in periods of high volatility (which are practically a given at some point in the future) so you will not be pushed into a panic selling mode as often is the case when investors read newspapers, watch TV or follow social media.
Every major sell-off in history has been preceded by a period of wild euphoric speculation, followed by a mix of uncertain economic news, policy shifts, geopolitical tensions and/or some other source of consternation. Each time is different but structurally, they carry the same message: prices no longer reflect the underlying fundamentals of the businesses they represent.
Amid all this, one pattern has stood the test of time: stocks do go down a lot, followed by a period when they go up a lot more. Otherwise, there would never be new highs set in the indices that every investor follows. The explanation behind this phenomenon is quite simple: most people want a better future and when combined with human ingenuity, new technologies and processes are invented and developed to make goods and services better, cheaper and more accessible. Standards of living go up, companies make more profits and stock prices go up.
Let us quote Warren Buffett who wrote in the darkest hour of the 2008-09 financial crises: “in the 20th century, the United States endured two world wars and other traumatic and expensive military conflicts; the Depression; a dozen or so recessions and financial panics; oil shocks; a flu epidemic; and the resignation of a disgraced president. Yet the Dow rose from 66 to 11497…”
We need to update the last sentence to: “yet the Dow rose from 66 to 19950 as of January 2017…” The bottom line is: yes, there will be volatility and yes, markets can be scary. However, if we stay disciplined and patient in our approach, time is indeed on our side when investing is concerned. Ultimately, it can be very lucrative and a whole lot of fun.
Happy and prosperous New Year to all.
The Claret Team
Just a couple of reminders:
- Allowable TFSA contribution for 2017 is $5,500.
- The maximum RRSP contribution for 2016 was $25,370 and the last day to contribute is March 1, 2017.
- The maximum RRSP contribution for 2017 is $26,010.