The Cornerstone Investment Commentary: End of Year 2016
Happy New Year … And what a past one we just experienced! Given the gains since the financial crisis bottomed out in Spring 2009, what’s most surprising likely isn’t that markets began 2016 with over a 10% drop by mid-February. Rather, it’s that they rebounded to a new high in early June, another high just after Labor Day and reached record territory again on November 15th. All in all, a volatile but profitable 2016.
The fourth quarter mirrored the year. By November’s first weekend, global stocks had dropped 4% since September, got back to even by mid-November and finished with modest gains. But the real action was in bond markets and interest-rate sensitive stocks as intermediate-term bonds and real estate both fell 3+%. Our October moves to reduce these areas in favor of assets classes faring better definitely helped results.
For the year, your portfolio’s equities (stocks) gained nearly 11%; its bonds rose 2%. Our active managers did well against benchmarks, and operating expenses fell to about 0.30%. As always, not every holding performed equally well. This is the curse-of-diversification. If only we had that crystal ball to know each year’s winners in advance, we could avoid anything else! Of course, we can’t. It’s why the Market Timing Hall of Fame remains empty to this day, and why we have no intention of trying to be its first inductee.
Currently, the equity portion of your portfolio holds nearly $35 of U.S. stocks for each $10 in foreign stocks; that’s over 75%. We think this is appropriate since, adjusted for profitability, U.S. stocks are 25% more expensive than those of developed countries and 40% more so than those of emerging markets. Given the rising path of interest rates begun by the Federal Reserve in December, maintaining 80% of your bond position in short-term holdings (1-2 years until maturity) also seems prudent.
Of course, the question-of-the day remains what impact the incoming Trump administration will have on all this. Though we’re not smart (or foolish) enough to make predictions and bet on them, we do believe:
- There will definitely be winners and losers from forthcoming changes in both policies and laws.
- Any stimulus via increased infrastructure spending or tax cuts will further create jobs and boost corporate profits, which – by itself – should be positive for stock prices and investment returns.
- It should also cause interest rates to rise more quickly and accelerate wage inflation once the recent rises in labor force participation level off, as well as strengthen the dollar; these hurt U.S. exports.
- The biggest wild cards, of course, are in trade policy and corporate tax reform. Changes seem likely which have not been undertaken in many years: they may be brilliant, or not. Nearly certain is that there will be unintended consequences and not all of them positive.
As events unfold, we will certainly act accordingly and be in touch. We both welcome and look forward to any questions you may have. All of us at Cornerstone wish you a year of health, happiness and meaning. As always, we thank you for the continuing opportunity to work together.