Eclectic Associates Q4 Client Letter

Overall, we’re pleased with investment returns in 2016, especially considering that the year began with the worst 10-day start for U.S. stocks in history. By the year’s end, U.S. stocks had bounced back and balanced portfolios with a 40% stock allocation returned in the 5-6% range.

Large-cap stocks gained 11.8% during 2016, marking the eighth consecutive year that the S&P 500 Index had a positive return. While streaks of this length have occurred twice before, the market has never had a nine-year winning streak. A combination of rising oil prices and the U.S. election helped financial stocks and energy stocks perform very well in the 4th quarter. Value oriented managers did particularly well because of an overweight to these sectors.

Looking overseas, emerging-market stocks performed well but developed international stocks were laggards. European stocks did poorly, falling 0.4% in U.S. dollar terms, although they gained 7.2% in local-currency terms. For the third straight year, U.S. dollar appreciation was a drag on European stock returns. The major currency decliner was the British pound, triggered by June’s Brexit vote. Overall, the U.S. dollar index rose around 4% against a basket of developed-market currencies.

For the year, bonds produced gains in the low single digits. Investment-grade municipal bond returns, however, were slightly negative on the year. Though core bond prices got off to a strong start with the 10-year Treasury yield dropping to an all-time low of 1.37% in early July, yields then reversed course, rising to 2.5% by year-end. In the fourth quarter, the core bond index fell 3.2% due to rising interest rates, reflecting its worst quarterly performance in 35 years.

Some have asked why we continue to recommend owning foreign stocks following a long period of underperformance relative to U.S. stocks. Though there are risks in foreign stocks, their low prices suggest that the market is adequately reflecting these risks. There’s a lot of negativity being reported regarding China’s debt and rising nationalism in Europe. But the news must only be “less bad” for sentiment and stock prices to improve.

History has shown how U.S. and foreign stocks go through relative performance cycles which can be long-lasting. We think it is prudent to allocate to foreign stocks, particularly after this prolonged period of underperformance and while U.S. stock valuations look a little rich. A reversal of the trend of U.S. dollar strengthening would also help foreign stock returns.

Looking ahead to 2017, we don’t want to make a prediction of what financial markets will do. Even if one could know in advance the outcome of many of the important individual variables (such as election results, central bank policy decisions, and currency movements), one would still be likely to make many inaccurate market forecasts. For example, how many experts would have predicted gold would drop and stock markets would rally in the days and weeks after an unexpected Donald Trump election victory?

We continue to expect the unexpected but our focus is on sound investment strategy. We’ll continue to weigh the risks and potential rewards for investments in our clients’ portfolios and recommend changes as necessary this year

On a personal note, James Moore and his wife, Tiffany, welcomed their first child, Desiree Loring, on New Year’s Day. Mother and daughter are healthy and happy. Please say congratulations to James next time you speak with him.

Thank you for entrusting us with your financial lives. We take this responsibility very seriously and we consider it a privilege to serve you. If you have any questions, please feel free to give us a call.