A common question was raised at our client events throughout 2016: “What changes are you making in client portfolios to prepare for the Presidential Election?” Based on our many years of experience, including numerous elections, we believe such events drive short-term volatility but this does not deter us from remaining focused on fundamentals as we make decisions for the long-term. In essence, we will not attempt to “outsmart” the market. The 4th quarter is a perfect example of why remaining disciplined is our preferred approach. At the tail end of reporting election results, we experienced an extreme drop in the futures market overnight where Dow futures were trading down 800 points and gold spiked considerably. But when the markets opened in the U.S., these extremes quickly reversed direction and U.S. equity markets have continued to hit new highs since then.
Due to the recent run-up, we believe overbought conditions currently exist across U.S. equity markets. For 2017, our fundamental support level of 17,550 on the DJIA remains unchanged. Similar to how markets tested our support level of 16,000 in the first quarter of last year, should markets test the 17,550 support level, we believe that it would represent a healthy trading pattern and not be cause for alarm due to steady macroeconomic factors.
Even at lofty levels, we maintain a positive long-term outlook anticipating pullbacks driven by the rebalancing of fluctuating gaps between fundamentals and expectations. Seeking reasonable valuations may be a challenge, but we believe opportunities still exist in various sectors such as financials and consumer staples. The outlook for the financial industry appears to be favorable due to higher interest rates and proposed deregulation, while consumer staples look attractive due to reasonable valuations and economic growth expectations.
Domestic small & mid cap companies had a great year in 2016. We are maintaining our allocation to these positions moving forward based on two reasons: strong fundamentals as measured by sales and earnings growth as well as a lower exposure to a stronger U.S. dollar which has a negative impact on trade and earnings. We must note that based on current economic projections, we expect lower overall equity returns this year as compared to 2016.
Interest rate sensitive investments have recovered off recent lows after being under pressure for most of the 4th quarter. Following the December rate increase, we saw prices rebound in the utility sector and REIT’s despite the yield on the 10 year note remaining at recent highs. Even bonds showed positive signs of life during the month of December. Entering the last quarter of the year, the interest rate path was reflective of future rate increases based on existing economic conditions. Now the post-election path reflects relatively higher rates due to new concerns about the incoming administration’s proposed fiscal spending. Historically, election promises often diverge from reality and we’ll continue to monitor the political landscape to see how it will impact economic factors in the future.
We would like to wish everyone a Happy New Year and hope to see you at one of our client events in 2017.