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From The No-Load Fund Investor, 1/17...
New Year’s Tweaks
The market ended 2016 in a festive mood. While the S&P 500 gained 1.8% in December, even the much maligned MSCI EAFE Index of foreign developed-country stocks thrived, with a gain of 3.3%. For the year, the S&P 500 was up 9.5% pre-dividends and almost 12.0% with dividends, while the small-cap Russell 2000 Index performed especially strongly, with a gain of about 20.0%.
The year’s losers resided mainly overseas, as the MSCI EAFE lost 1.9% pre-dividends. However, even in the U.S., the healthcare sector lost money, pulled down by the biotechnology industry. Among funds, the best diversified performers tended toward those of the small- and mid-cap value style, while the worst were the so-called blue-chip growth funds.
Though indexes of higher-quality bonds were up for the entire year, they struggled in the last half. Case in point: the Barclays Treasury Bond Index plummeted 12.0% from July through December. Lower-quality bonds performed better, however, as several high-yield corporate bond funds in our database notched total returns in 2016 of more than 10%.
Best Buys Commentary. Our Best Buys models had a decent year, with gains in the mid-4% range for our most conservative models up to 10.8% for ETF Pre-Retirement. Our best performers invest mainly in small-cap and mid-cap value stocks. On the other hand, our weakest diversified equity performers included funds that invest almost exclusively in large-cap growth stocks.
For details on year-end performance and fund winners and losers, see our January issue.
Forecast for 2017
In our stock market forecast for 2016, we were wrong on a few things but right on the big picture. This likely resulted in a pretty good year for most of the subscribers who followed our advice.
We were wrong to rely to some extent on so-called PEG ratios (price/earnings ratio [P/E] compared with earnings growth), which led us to incorrect calls on size/style combinations in the marketplace. For example, our then-favorite sector, large-cap growth, ended up the laggard for the year, despite offering above-average earnings growth compared to its P/E, while mid-cap value was among the best, despite scoring poorly by this measure.
However, we correctly forecast an advantage for U.S. equities in 2016 compared with foreign equities, especially developed markets, and a decent return for equities overall. We predicted correctly that the Federal Reserve Board would remain friendly to the markets while corporate earnings eventually improved. And, most important, we were right to reconfirm our basic belief in diversification across equity styles, sizes and regions, regardless of our particular forecasts for each.
Looking Forward. Before stating our expectations for the 2017 equity markets, let’s first go over several factors that tend to influence them, including Federal Reserve policy, valuations, corporate earnings, and market sentiment.
A less-friendly Fed. Generally speaking, a change in the trend of Federal Reserve policy rates from looser to tighter is negative for equity markets. However, in the early stages of a tightening cycle, especially if the starting point is low, stocks can still do well. In fact, it can take years for the equity market to break down during a tightening cycle beginning from very low rates.
Case in point: in June 2004, the Federal funds rate was at a very low level of 1%, about where it had been for a year. This represented the lowest point of a multiyear trend of lower rates that followed the burst of the Internet bubble. After two-plus years of tightening by the end of 2006, the rate stood at 5.25%, yet the equity market performed fairly well during this period, with an annualized gain a little higher than the long-term average. In fact, in 2005, the first full year of the tightening cycle—and thus equivalent to current expectations for 2017—the S&P 500 produced a total return of 15.6%.
You can read our full 2017 forecast for investment markets and asset classes, including likely catalysts, in the January issue of The No-Load Fund Investor
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