Quarterly Commentary – December 2016

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After mostly going sideways since July, U.S. Equity markets picked up the pace nicely in November after the election helping propel valuations to a higher level. The following are performance numbers from various popular indexes for the quarter. Index numbers are not individually comparable to a properly diversified portfolio. Each portfolio may include an allocation to securities similar to these indexes in varying amounts based on your personal risk tolerance and should only be compared in that context. The S&P 500 was up 11.96% for 2016. The Dow Jones Industrial Average was up 16.50%.The Nasdaq Composite Index was up 7.50%. International equities as represented by the MSCI World Ex U.S. Index were up 2.75%. Fixed Income as represented by the Barclays Aggregate Bond Index ended up 2.65% for the year.

This certainly has been an interesting year on many fronts. It is important to understand the internals of the market at the asset class level to make sense of what happened. For example, the Dow Jones Industrial Average certainly had its day in the sun this past quarter as it approaches the magical 20,000. The index was up strongly during the quarter, however beneath the surface, one company, Goldman Sachs, contributed to a third of the move. Reaching 20,000 is mostly symbolic and from a historical perspective, it is a testament to U.S. Equities as a long-term investment vehicle. However, it is important to realize that the index represents a very narrow view, basically a hand few stocks and is a poorly constructed index. It is however one of the longest running U.S. Equity index using only 30 stocks which are simplistically price weighted. Price-weighting is old-school and anachronistic. It means that each stock influences the index in proportion to its price per share, so that a stock trading for $100 per share has 10 times the pull of a stock trading at $10 per share. All this to say that despite the attention the media gives it, one should not pay attention to it for comparative purposes. We created an analysis about the make-up of the Dow which can be found by pointing your browser to: ifrahfinancial.com/about-the-dow/

It is also important to note that although U.S. Equities this past quarter had a nice run, this coincided with a significant drop in the fixed income component of a diversified portfolio, thereby muting the overall gains. International equities overall, also a necessary component of a diversified portfolio underperformed relative to the U.S. The post-election outlook switched almost overnight which triggered a swift increase in interest rates before the recent move by the Fed and caused fixed income to adjust downward abruptly this past quarter. Equities delivered a strong performance in 2016 as investors bid up valuations in anticipation of improved earnings growth in 2017, partly due to expected tax reform, reduced regulations, and further economic expansion. This is likely to continue, however it could be offset by the impact of the stronger U.S. dollar which can hurt trade and U.S. company earnings doing business overseas.

The financial markets shook off several shocks in 2016: Fear of a Chinese hard landing in the first quarter, the surprise vote for Brexit in late June, and Donald Trump’s unexpected victory in the U.S. election in November. At the very least, some of the uncertainties that held things back this year are no longer present. Central bankers from developed countries were facing reduced monetary accommodation as the marginal benefits of such policies were starting to fade and were looking toward politicians to provide the necessary fiscal and structural changes to promote growth. Investors believe that this shift toward more accommodative fiscal policies is on its way here in the U.S. With the expectation of increases in GDP, one cannot overlook the possibility of inflation accelerating and the Fed having to increase the pace of interest rate tightening which could in itself put the brakes on growth. Although risk taking is back on for now, some could argue that things could be getting ahead of themselves. The markets are anticipatory in nature and obviously are thereby subject to constant unpredictable adjustments in the short to intermediate term.

Overall, it seems that the glass has suddenly become half full and worry has turned into hope. Hope can be a powerful thing as we’ve seen this past quarter. Thank you for the opportunity to serve you.