The New Year usually begins with hope and enthusiasm, especially when the occupant of the presidential suite is changing. This year has a qualitatively different feeling due to extreme uncertainty in the air. The US stock market’s year-end rally was impressive and mostly unexpected. Financial companies in particular skyrocketed due to the assumption that the Trump administration will usher in a less onerous regulatory environment that will boost corporate profits and therefore deliver higher returns to shareholders. By the end of 2016, the typical large US Company in the Dow Jones industrial average was trading about 20% over its long-term historical average, but this didn’t stop the major large-cap indexes from setting new records as the year came to a close. The average stock in the broader based S&P 500 index is now about 30% more expensive than their historical level.
The 2016 US stock market’s run up was not based on profits but on low interest rates and excess liquidity extended by the Federal Reserve. We are near the end of that phase which has now lasted almost a decade. The Dow Jones Industrial Average started the year with its worst performance ever and ended on a high note, up 16.5% for the year including dividends. The S&P 500 rose 12% in 2016 as stocks shook off a recession scare, worries about a slowdown in China and the British vote to exit the EU. The NASDAQ index of US technology companies rose 7.5% in 2016 and interestingly, the worst performing industry in the US was biotechnology, declining 19.4%. Pharmaceuticals declined 11% while gold rose 8.46%. Natural gas was the top performing commodity, up 59.4%.
The London stock market roared ahead, up 14.43% for local investors as Britain’s release from EU constraints kindled optimism among global investors. Italy’s market was down 10.2% as their banking system’s problems came to a head in December as Banca Monte Dei Paschi Siena, the oldest bank in the world, had to be taken over by the Italian government, contrary to European commission rules.
European large-company stocks lost 2.2% in US dollars during the year. The Japanese stock market ended the year flat but their economy did gain some bare minimum of traction as inflation stabilized in the 1% level which was highly disappointing, given the highly proactive Abe government program of extreme monetary and fiscal expansion. The central bank in Japan has been buying domestic stocks and putting them under their mattress in order to prop up the Japanese market.
Stocks in Europe are trading considerably cheaper, almost 40% less, than their US counterparts. Anxiety about the stability of the euro zone and anemic EU growth, along with high anxiety about immigration issues all weigh heavily on European markets. The US dollar has gone up by more than one third against other currencies since 2011 and is likely to go higher if the Federal Reserve carries through on its promise of multiple interest rate increases in 2017. A stronger US dollar should help European companies export to the US as their prices go down when the US dollar rises.
Unfortunately for China, a rising dollar only makes the problem of capital outflows by Chinese investors and companies worse for the Chinese government. Chinese bond and currency markets have been in a panic as the Federal Reserve lifts interest rates in the US, causing the Chinese to drain $300 billion out of their cash reserves as 2016 came to an expensive close.
Oil posted its biggest annual gain since 2007 but it remains to be seen whether the recent OPEC agreement to cut production will hold as very few have in history. Oil prices were up 45% in 2016 and so energy was the best performing sector in the entire stock market.
The bond market for US Treasury bonds, considered the safest in the world, lost money in 2016 with a return of -0.02%. Corporate bonds, issued by private companies and with higher risk, gained 5.85% while the lowest quality corporate bonds gained even more, up 13.03%. Municipal or tax-free bonds declined even more than Treasuries, down 0.15%.
Brazil was the best performing emerging market stock market, up 38.9%, a result of the crackdown on corruption in that country. A long succession of leaders has now been booted out by the populist assembly in Brazil. Canada’s resource rich companies gained 17.5% on average as oil and gas led the way. China’s stock market continued to lose money, down 12.3% while India’s stock market gained 1.9%.
The market is now assuming that all the best things will happen when Trump takes office and is not focused on the likely problems that he will have when he starts to deal with Congress. Many promised policy changes could fall short of the market’s expectations which would take some wind out of the sails of rising stock prices. While the incoming administration may talk a good game of imposing higher tariffs to fend off foreign competition and lower corporate taxes to ostensibly create more jobs for Americans, the likelihood of a broad stimulus plan, financed by increasing the US government’s deficits, is extremely low due to splintering within the Republican Party.
US economic growth measured 3.5%, a marked improvement over the last two years. Reported unemployment rates are below historical averages but these numbers are suspect as many people are no longer looking for work and so are not counted as officially unemployed. Go figure.
As 2017 unfolds, we will see if the new president’s plan to reduce corporate taxes to 20% from 35%, which would raise US corporate earnings per share about 18%, becomes reality. Trump’s promise to roll back the Dodd – Frank Act may, in fact, not take place. Banks have already increased the amount and quality of their capital and liquidity as well as reduced the risk of their proprietary trading operations.
These improvements are unlikely to be swept aside easily.
If Trump is successful in leading the passage of a fiscal stimulus program, spending big dollars on the “crumbling” infrastructure and retooling of America, this will lead to higher wage inflation and start a cycle of rising interest rates which will likely challenge current stock market levels. For the last 35 years, we have had falling inflation and interest rates and if the next four years are different, we will likely see nearly all asset classes experience relatively slow price growth. Our prognosis is that most of Trump’s initiatives will face severe challenges from the Republican Congress. Immigration is a good example as several Republican senators are already working with Democrats to shield three quarters of 1 million of undocumented immigrants from deportation. The concept of a border wall is highly implausible and because increased fencing, more border patrol agents, and increased use of drones and other high-tech resources to curb illegal entry are steps that can be taken quickly and with less cost.
With Trump’s enthusiastic can-do spirit and apparent connection with America’s middle and lower classes, getting down to business with Congress will be particularly important. As the President, he is only a link in the chain of people who will not easily be able to control the issues that come to his attention. Most presidents realize quickly that they end up alone in making important, life and death decisions and that there are many factors other than economics and money that come into play. Trump has no experience in this realm, nor do most of us, and even with whatever group of advisers he gathers around him, most of the important decisions will be made by him alone. This is the big unknown we all are wondering about as 2017 comes in like the tide.
Unfortunately, the stock market has overestimated Trump’s ability to repeat the Reagan era accomplishments. Interests rates were very high when Reagan took office, as was inflation and the US deficit was about 1/20th its current size. Reagan was able to convince Congress to go along with his spending plans but this Congress has vowed not to increase the national debt. This makes it exceedingly unlikely that the new president will be able to fulfill his pledge to cut taxes as well as bring on an economic stimulus program that costs real money.
Europe’s markets also reacted strongly to the Trump victory even though they continue to have a very fragile economic recovery. It is likely that populist politics, as occurred in Britain’s vote to exit the EU and the US electoral College’s landslide victory of surprise candidate “the Donald”, will play a central role during 2017. While the US central bank expects to raise interest rates in 2017, the European central bank is keeping interest rates low by buying assets when it can find them but their flawed quantitative easing strategy continues to fail to gain traction in the real economy. There are concerns that there are not enough stock and/or bonds for the European central bank to buy in the open market to keep prices up and therefore the EU authorities may have no choice but to come to an end of their current program of monetary stimulus. Their next logical step would be to pass some kind of fiscal easing or spending program for public projects but EC rules do not offer much scope for change. As a result of this, the US dollar has soared to new heights against the European currency.
One reason the European Union is in danger of coming apart is due to the influence of Russian Pres. Vladimir Putin. Putin has proven himself to be a master at exploiting the media in order to spread misinformation to generate public disdain for their local politicians which furthers his agenda. The upcoming electoral season in France, the Netherlands, and Germany are critical to Putin’s efforts to destabilize the European Union. The Italian referendum at the beginning of December showed that political pressures for fundamental changes to loosen the ties that bind the EU countries together are gaining ground. The continued fallout from the Brexit vote indicates Britain’s economic growth is slowing while inflation from its weak currency is rising. The status of London as the financial capital of the world is now at risk to being usurped by New York. Russia’s involvement in Syria has been a major factor causing waves of immigrants to descend into central and northern Europe which has already destabilized many of these societies. If any of the nationalistic, pro-Russian leaders in France, Germany or the Netherlands take office, Putin may succeed in his effort to destabilize his long-term adversaries.
Cash and Real Estate
India experienced some traumatic events late in 2016 as the central government implemented reforms that removed much of the cash currency from circulation in that fast growing country. This was done ostensibly to cut down on black markets, tax evasion, and drug activity, but it looks more like a thinly veiled way for the government to exert more control over their citizen’s financial affairs. When Prime
Minister Modi outlawed the use of the two largest denomination bills, he effectively wiped out the financial means of a wide swath of India’s population, bringing the economy to a screeching halt. These moves on the part of the government of India are in keeping with those of EU bureaucrats in Brussels who are trying to expand the monitoring of its citizens’ transactions by forcing them to take place on line. The stated reason for outlawing paper currency is to enhance the government’s taxing authority, thereby increasing revenue that would support social programs. What do you think is the truth here?
Cash is under attack in other places around the world. Larry Summers, an influential US economist at Harvard, who would have played a large role in a Hillary Clinton administration, put forth a proposal last year to remove the $100 bill from circulation in the US. The European Union has removed the €500 note from its markets. Interestingly, the Swiss, who love their freedom as well as their cash, are well known to prefer using paper bills for much of their commerce. I think the reason the Swiss like to pay with cash, even for large ticket items like automobiles, is that they don’t want anyone intruding on their private, personal affairs.
In the real estate world, hedge funds and private equity companies helped the US single-family housing market recover after the crash in 2008 by going whole hog into the rental business. They are now America’s biggest landlords and are 70% more likely to file eviction notices on a much shorter time frame then individual landlords. Approximately 25% of rental properties in the US that are under the ownership of these large institutional funds have tenants who are delinquent and in some phase of the eviction process. President-elect Donald Trump’s inauguration committee chairperson is the largest shareholder of one of these heavy-handed firms. Hedge funds are extremely slow to make necessary repairs and quick to evict tenants who withhold rent because of complaints. Institutional investors want nonpaying tenants out of the homes quickly and have highly sophisticated legal processes for mass- producing eviction notices and displacing nonperforming tenants. Many of these homes are in hard-hit markets that are characterized as poor and mainly populated by minorities.
On the other end of the spectrum, luxury apartments around the US are finally seeing a decline in market pricing due to overbuilding. Rent concessions of up to six months are now being offered to prospective renters in New York City. Almost all urban rental markets are experiencing overcapacity and competitive price cutting. Development in and around commercial hubs like Atlanta, Denver, and Oakland continues at a brisk pace due to the widespread need for work force housing in desirable urban areas. With rising interest rates, it is likely that all real estate prices will head south unless there is a new influx of foreign capital, job growth, or due to special cultural/recreational amenities becoming popular with rising millennials or retiring baby boomers.
Rob: After traveling throughout the Western USA during much of the fall, I was happy to stay close to home for the holidays. We had a lovely open house –birthday party here at the office. Out in the studio, a new diptych is taking form: a combination series of egg tempera and oil, representational and abstract – all with a bowling alley theme! We are pleased to welcome a new member and great addition to the Rikoon team, Patrick, whose bio is included below.
Patrick Gendron has a Bachelor of Arts in Communication from the University of New Mexico and has been in the financial services industry since 2008. Originally from the Mimbres Valley in southern New Mexico, Patrick has a deep love for the environment and practicing lifestyles that are in harmony with the land. At the University of New Mexico, Patrick was the Campus Director of the New Mexico Public Interest Research Group and organized students to get involved with environmental and consumer rights issues. Upon graduation, Patrick moved to Berkeley, California where he worked for one of the country’s largest banks. After five years in the Bay Area, he had a longing to return to the Land of Enchantment and so he moved to Santa Fe, where he worked for a well-respected mutual fund management company. Patrick enjoys most outdoor activities including snowboarding, hiking, mountain biking and rock climbing. He participates in the vibrant art culture in Santa Fe and is familiar with many of the restaurants that the town has to offer. Patrick believes in giving back to the community and volunteers with a few local non-profits. At the Rikoon Group, he focuses on tailoring portfolios to client’s specific needs and specializes in providing options for Environmental and Socially Responsible Investing.
Dana: This fall, I devoted myself to rediscovering New Mexico, mostly within a 100 mile radius of Santa Fe. I drove up to Mora and picked raspberries at Salman Ranch; climbed Hermit’s Peak; studied the original kiva frescoes at the Coronado Monument and went twice to visit the amazing Tinker Town Museum on the road to Sandia Crest. The Christmas highlight was a morning dance to drumbeats at Tesuque Pueblo with 68 dancers in a row framed by the earthen plaza; its backdrop the adobe church adorned with evergreen wreaths set against a blue sky and snowcapped mountains. I’m grateful for this fresh outlook on my high desert home, the spirit of which keeps me warm through the winter.
Robyn: Happy New Year Everyone!! After returning from a 2,651-mile-long road trip, I am so happy to be home! We have begun rehearsal for Almost Maine, a sweet and magical play consisting of 9 vignettes portraying different couples at different stages in relationship (of which I will play five, gulp). The show will open February 10th and run through the 26th at El Museo Cultural with a special Valentine’s Day Performance. When that finishes up, the Santa Fe Playhouse has asked me to direct the 1963 adaptation of George Orwell’s masterpiece work, “1984”. The opening performance will be March 30th and I am extremely excited to direct this full length play which takes place in a “dystopian future”. Beya, the puppy continues to grow and Rob and I continue to cultivate vegetables in the geodesic greenhouse dome behind the office.
Anthony: The cold winter season is upon us and the Holidays have now come and gone, for which my Family was extra special. Our daughter, Amaya, experienced this as the first year she could open gifts on her own. Seeing the joy and excitement in her eyes Christmas morning was the best feeling for my wife and me. We finally finished construction on our first home and closed escrow at the end of the year.
Now comes the joys of moving: out with the old, and in with the new. Happy 2017!!
Jeff: We spend a week in Phoenix at Thanksgiving time. My wife routinely goes to Phoenix to check on her elderly mother but this time, I went with her. We used to live in Phoenix and so, in addition to seeing her mother, we had the opportunity to visit with lots of friends and family. I got to see and sit in with several of my musician friends that I used to play with when we lived there which was a lot of fun for me.
Kyle: Life really slows down during the school year and for that I am grateful. James and Johnnie have been enjoying the first grade and I get to spend a lot of time quizzing them for their weekly spelling tests. My wife and I recently took a vacation to Boston. It was great trip and one of only a few trips we have taken without our boys in tow. We had a chance to visit many of Boston’s historical sites and museums and also enjoyed some excellent meals. The holidays were a whirlwind with lots of friends and family in town. I enjoy having everyone in town but am always glad to have school start up again so everyone can get back into a routine.
Please join us for our quarterly gathering to discuss economic and market related events at 2218 Old Arroyo Chamiso in Santa Fe on Tuesday, March 7 at 3:30 PM. We generally go until 5:00 PM. The conference call, open to all out-of-town clients and friends, will occur the next day, Wednesday, March 8 from 3:30 to 4:30 PM. The call-in number is: 719.234.7872, after which you will be prompted to enter the code: 470070#.
This commentary represents the opinions of The Rikoon Group which are subject to change from time to time which do not constitute a recommendation to purchase and sale or any security nor engage in any particular investment strategy. The information contained herein has been obtained from sources believed to be reliable but cannot be guaranteed for accuracy.