BIONDO Perspectives

February 6th, 2017

A Challenging 2016 Closes with Focus on New Political Leadership and the Federal Reserve

By Joseph P. Biondo

Happy New Year!  We hope that you had a happy and healthy holiday season and wish you all the best for 2017.

2016 was a challenging year for many investors.  As the year began, markets were in the midst of a correction that deepened quickly in the first few weeks.  We had many concerns coming in to 2016, as we wrote about in prior newsletters.  The three big concerns were the Federal Reserve, the economy and the election.  In December of 2015, the Fed raised interest rates for the first time since the great recession and was signaling more hikes in 2016 (but did not until December 2016).  The economy was sputtering along with meager growth in GDP for Q4 2015 and Q1 2016 (although managed to avoid recession).  S&P 500 earnings growth in 2016 was projecting a forecasted decline of nearly 2%.  Finally, we were in the midst of a contentious election primary which was bound to lead to the most divisive Presidential election in modern history (the outcome of which surprised most prognosticators).

While in the moment of the above occurrences our inclination was to invest cautiously, which we did for the majority of 2016.  This meant fairly strict adherence to our sell discipline and caused us to trim or eliminate positions that were acting poorly and had the ability to cause longer-term damage to portfolios.  It also meant carrying elevated levels of cash in portfolios throughout the year, which is not typical for us as investors.  Our overriding sense throughout the year was that 2016 had the potential to be one of those big down years and we invested in a manner that sought to limit the potential downside.  The risk we took with this approach was that equity markets would be up and we might not capture all of the upside (which turned out to be the case for most of our portfolios).

In retrospect, all of our hand-wringing throughout the year turned out to be unfounded.  US equity markets turned in a positive year, with the S&P 500 Index up 11.96%, the Nasdaq Composite up 8.87% and the Dow Jones Industrial Average up 16.50% and hovering near 20,000 by year-end.  While unaudited as of this writing, our three flagship strategies 2016 were as follows:  Biondo Growth Strategy 0.20%, Biondo Focus Strategy up 1.06% and Biondo Dividend Strategy up 7.96%.  Exposure to healthcare was the biggest drag on Growth and Focus returns, as they represent a healthy allocation in these portfolios and were the worst performing sector in 2016.  Allocations to International, Fixed-Income and Alternatives were generally slight drags on overall returns in 2016.  As always, we encourage you to schedule a review of your personal performance with us so we can adjust allocations as necessary for 2017 and beyond.

While healthy to review the lessons of the past and to learn from them, we do begin a new year and must have our eyes forward on the future. As we begin 2017, the same three topics are top of mind as we implement our investment process:  the implications of new political leadership, the Fed and the economy.  While many have tired of politics from the exhausting events of 2016, we must spend some time discussing what the potential economic implications are of a Trump Administration, as the impact could be substantial in terms of investment outlook.  The Federal Reserve’s interest rate policy will certainly play a major role and as always, the economic backdrop in which our companies operate in must always be considered.  To some degree all three are intertwined, but we will try to address each separately.

While healthy to review the lessons of the past and to learn from them, we do begin a new year and must have our eyes forward on the future.

The election of Donald Trump as President of the United States came as quite a surprise to many in 2016.  From our perspective, it appeared for much of the year that markets were anticipating a Clinton victory.  As such, it was our expectation that a surprise (from a market view) Trump win would lead to a Brexit-like downside move that would be sharp and short and likely an opportunity to invest in high quality companies at cheaper prices than prior to the election.  Like many, we were completely wrong – US equity markets opened mildly lower the day after the election, closed that day higher and have yet to look back.  From Election Day through year end, the S&P 500 advanced 4.98%, the Dow Jones Industrials gained 8.21% while the Nasdaq Composite was up 3.85% – meaning nearly half of the year’s gains came in the final 6-7 weeks.

The “Trump Trade”, as it has been termed, centers on the emerging premise of broadening economic growth and higher inflation.  This is to be fueled by large deficit spending on infrastructure, a program aimed at the repatriation of foreign profits, an era of deregulation and “big-league” tax cuts for both individuals and corporations.  In addition, the immediate focus appears to be the “Repeal and Replace” of Obamacare.  While prior policies led to nearly a decade of secular stagnation, any hope of revitalization in economic output and corporate earnings should not be ignored.  While we have our doubts about the success in getting some of this agenda through, any of it will likely bode well for US equities in the future.

As this unfolds, it will be important to keep a watch on the Federal Reserve, whose decisions are primarily keyed off of inflation and employment figures.  Should some of the above-mentioned policies take hold, our expectation would be for higher inflation and job growth – both of which will dictate the Fed raising interest rates.  Longer-term, this may become a roadblock for equity markets as lower-risk investments become much more attractive.  However, it appears to us that we have a long road to travel before this becomes detrimental, particularly if the Fed is raising rates for the right reasons.  Our expectation is for two or three rate hikes in 2017 which should bode very well for the financial sector.

If some or all of the above-mentioned policies are implemented, the likely outcome would be positive for the economy.  More importantly, economic acceleration will lead to higher corporate earning – which we have long believed to be the primary driver of equity markets over the long haul.  As it stands now, expectations for S&P 500 profits in 2017 are for an increase north of 20% after essentially no growth over the past two years.  This profit acceleration is likely to aid stock market returns in 2017 and in our view, provides the most impactful driver as we build portfolios.

While there are certainly reasons for optimism (market perspective), much work remains ahead and time will tell how this all plays out.  In the meantime, we will remain focused on the individual investments that we make in each of our strategies.  We are as confident in our ability to identify excellent investment opportunities and look forward to implementing this on your behalf.  As always, our team stands ready to address all aspects of your financial lives and we appreciate the trust and confidence you have placed in us.  Again, best wishes for a happy and healthy (and prosperous) 2017.

Sources:  Index Performance-Bloomberg; Strategy Performance & Sectors-IAS, Dorsey, Wright & Associates; Trading-Biondo Investment Advisers LLC; Rates, GDP & Election- CNN Money, WSJ, bea.gov

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