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Fourth Quarter 2016 - Pinnacle Investment Management, Inc.

Fourth Quarter 2016

January 5, 2017 / Quarterly Newsletters

In the hours immediately following the US Presidential election, global equity markets declined briefly before advancing strongly in November and early December. Although the advances plateaued after the Federal Reserve raised interest rates in December, US equity markets posted strong returns for the fourth quarter, capping a respectable year. Most US stock market indexes posted double digit returns for 2016, the best year since 2013.  The Dow Jones Industrial Average has more than tripled since March 9, 2009, at the depths of the financial crisis and the S&P 500 has gained even more.  Small company US stocks lead the way in 2016 while most major foreign markets lagged significantly.

Financial markets withstood a myriad of concerns in 2016, including declining oil prices, a slowing Chinese economy, the possibility of rising interest rates, the British vote to exit the Eurozone, the resignation of the Italian Prime Minister Matteo Renzi, and the unexpected election of Donald Trump.   It is generally considered a bullish sign when markets advance in the face of what many investors consider bad news.

The Federal Reserve raised short term interest rates by 0.25% in December. This was the first increase since December 2015, and an indication that the Fed believes the US economy is making progress toward its objectives of full employment and price stability.  Short term rates are still very low by historic standards and the Fed appears ready to raise rates two or three times in 2017.

The interest rate on ten-year US Treasury bonds declined from 2.27% at the beginning of the year to 1.49% in June and has since the election has risen abruptly to 2.45%. Rising interest rates provided a head-wind for bond returns and the US Aggregate Bond Index lost 3.1% for the quarter but closed up 2.4% for the year.

The prospect of stimulative spending by the Trump administration and interest rate increases by the Fed made the US dollar more attractive vs. foreign currencies. The US dollar has risen 5% on a trade-weighted basis since the election and is now up 4% for the year.  The strong US dollar resulted in lower dollar returns on overseas investments.

Returns for key indexes were:

1st Nine




4th Qtr



Full Year


Dow Jones Industrials index 7.2% 8.7% 16.5%
S&P 500 index 7.8% 3.8% 11.9%
NASDAQ 6.1% 1.3%  7.5%
S&P 400 mid-cap index 11.0% 7.0% 18.7%
Russell 2000 small-cap index 10.2% 8.4% 19.5%
Total International, excluding US 6.9% 2.0%   4.8%
Dow Jones Global Stock index 5.1% 0.8%      5.9%
Barclays US Aggregate Bond index 5.7% 3.1%    2.4%


Economic and Market Outlook The US economy is healthy and resilient as we enter 2017.  Although economic growth is sluggish, unemployment has declined to 4.6%, and interest rates remain low by historic standards. The Trump presidential administration will likely initiate corporate tax reform and streamline burdensome regulations both of which should prove beneficial to corporate earnings and are the likely reasons that US equity markets have rallied since the election.

There are several methods of measuring whether the stock market is over or under-valued and at this juncture there is no consensus. Some methodologies suggest that the US market is overvalued while others suggest it is undervalued.

Financial markets will face new and unknown policies in a Trump administration. Some policies, such as tax and regulatory reform, should prove positive for the markets, while others, such as tariffs or trade barriers, could undermine the earnings of US and foreign corporations and be a negative for businesses, the economy and markets.   An additional uncertainty is that the Federal Reserve is expected to increase interest rates three times in the coming year.  Small and infrequent rate increases would likely have minimal impact on the financial markets however large and more frequent rate hikes would create a serious obstacle to both the stock and bond markets.

Although both developed and emerging overseas markets are undervalued, foreign markets face challenges in the upcoming year. The European Union is contending with the aftermath of Britain’s vote to exit the European Union and additional potential challenges lie ahead.  If there were any lesson to be learned from 2016 it was that voters around the globe are dissatisfied with their current elected representatives and sometimes elections produce unexpected results.  With that backdrop, it is with some trepidation that Germany, France and Italy, the three largest economies in the Euro Union and which have zone adopted the Euro as their currency, face elections in 2017.  Some geopolitical analysts believe that the European Union is in a slow process of unravelling. If election results in any of the three countries indicate the slightest hint that any of the winning candidates even question whether they should continue their membership in the EU, it could conceivably generate significant market volatility.

Emerging markets are also undervalued by historic measurements. Because much of the corporate debt in emerging markets is denominated in dollars (rather than local currency), rising interest rates combined with a strong dollar make it more expensive for companies in emerging markets to pay interest on their loans, creating an obstacle to earnings growth.

Rising interest rates also present a challenge to fixed income investors since they diminish the value of existing bonds. Shorter term bonds will not be subject to as much interest rate risk as longer term bonds.  If interest rates rise slowly, most bonds and bond funds should continue to produce positive returns, although they will be fighting a headwind

While there are many reasons to be optimistic as we enter the New Year, the many political uncertainties here and abroad, suggest it would be prudent to invest cautiously both in the US and overseas.

The impact of rising government debt when interest rates are also rising.   It is no secret that the US faces serious long term fiscal challenges.  The US national debt held by the public is currently about 77% of GDP, the highest ratio since 1950, during the Korean War and in the aftermath of World War II.  During fiscal year 2016, the budget deficit was nearly $600 billion, which means about $1.6 billion per day was added to our national debt.  According to the non-partisan Congressional Budget Office (CBO) the debt will exceed $1.2 trillion in ten years unless spending is reduced and/ or taxes increased.  The growth in the deficit is due to the significant increase in spending on retirement and healthcare (as a result of aging baby boomers) along with the growing interest payments on the debt.  If tax and / or spending policies are not changed, within eleven years interest costs are expected to be the third largest category in the federal budget, just behind Social Security and Medicare. In slightly more than thirty years, interest payments will be the largest category of government spending, and more than double what the government spends on R&D, infrastructure and education combined and will crowd out spending on social programs, education and defense.  The current situation is the result of the spending policies of both political parties, both houses of Congress and spans multiple Presidential administrations. Doing nothing is not a viable option if we believe that we have a responsibility to future generations and the future of the country

About the author

John Eckel: CFP®, CFA is President of Pinnacle Investment Management Inc. of Simsbury. He has been included in BusinessWeek.com’s list of the Most Experienced Independent Financial Advisors, has been named four times to Worth Magazine’s list of Top Financial Advisors, included twice in Medical Economics list of Top Financial Advisors for Doctors and named twice in JK Lasers list of Top Professional Advisors for Baby Boomers.

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