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2017 Q1 Economic Update from Transition Financial Advisors, Inc.

The U.S. equity market reached new highs in 2016 and stocks in most developed and emerging market countries delivered positive returns as well. The year began with anxiety over China’s uncertain economy, falling oil prices, a potential U.S. recession, and negative interest rates in Japan. Global stock markets went into a steep decline and had the worst start of any year on record. Markets began improving in mid-February until investors faced uncertainty from the Brexit vote in June and the U.S. election in November.

But the markets finished 2016 quite strong. The MSCI All Country World Index (ACWI), the most widely followed benchmark for the global equity market, returned 8.42% for the year. U.S. stocks outperformed international once again, although returns at the country level were widely dispersed. For example, returns ranged from -24.87% in Israel to +66.24 in Brazil, when calculated in US Dollars (USD).  The Canadian stock market had a very nice year where gains reached almost 25% in USD.

Many investors did not expect stocks to deliver healthy returns in such a tumultuous year. 2016 highlights the importance of sticking to one’s investment strategy despite the uncertainty and fear generated in the media.  Almost all asset classes ended the year with positive performance and if you had panicked anytime along the way, you would have missed out on pretty good returns.

Most U.S. and non-U.S. fixed income markets also posted positive returns in 2016, albeit much lower than the returns generated by the stock market. The total U.S. Bond Market, as measured by the Bloomberg Barclay’s U.S. Aggregate Bond Index, returned 2.5% for the year. Corporate bonds were the best performing sector in fixed income, with lower quality corporates leading the way with double digit returns. Floating rate loans, a sizable position in most of our client portfolios, also achieved returns at or near double digits. The yield on the 10-year Treasury note hit a record low of 1.37% in July yet ended the year higher than it began at 2.45%. This is a very large swing for a low volatility asset class like Treasuries. The yield on the 30-year Treasury bond increased .05% to end the year at 3.06%, still a historically low level.

Midstream energy stocks and MLPs (Master Limited Partnerships) finished 2016 with strong gains, although the year was characterized by exceptionally high volatility. The Alerian MLP Index returned over 18% for the year as we began to recoup some of the losses from the two prior years. Conditions were difficult as the period began, with oil prices continuing their prolonged decline, reaching 13-year lows in February. However, by the end of 2016’s first quarter, dramatic reductions in global exploration & production along with strengthening global oil demand helped to firm oil markets and drove a crude price rally of over 70% through the end of May.

We continue to believe that midstream energy companies and MLPs represent an attractive investment opportunity. While the distribution-cut cycle appears to be nearing an end, we may see a few more reductions in the coming months. We then expect companies to reaccelerate distribution growth as the fundamental cycle improves and profitability increases.

We see a buying opportunity shaping up in U.S. REIT’s as valuations have improved as prices have fallen over the last several months. The big stories are 81 months of job growth, a 9-year low in unemployment, and a potential jolt to economic growth from planned tax cuts and infrastructure spending proposed by the current administration. All these factors lead us to believe we are in an environment where commercial landlords will continue to be able to raise rents. And when rental income is rising, history shows that REITs deliver very strong returns, even when interest rates are heading north.

We are entering 2017 facing a world in transition. The result of the U.S. presidential election and the earlier Brexit vote in the United Kingdom, in our view, reflect a populist sentiment that appears to be challenging the decades-long march towards globalization. The uncertainty brought on by this political shift, paired with sluggish economic growth across much of the world, could leave many economies vulnerable to economic shock. That said, the global economy continues to move forward, and there are a number of bright spots. In the U.S., despite the political uncertainty, a strengthening consumer is driving stronger growth. A large fiscal stimulus under the new administration could well provide another boost to the U.S. economy. Valuations in many parts of the U.S. stock market appear stretched, but with a pick-up in corporate earnings, the market may not remain expensive.

Europe remains challenged, with uncertainty about the future of the European Union, an anemic economy, and high unemployment. Yet many companies are rising above regional problems. The currency depreciation brought about by U.K.’s Brexit vote has been a tailwind for exporters, including some select luxury retailers. For example, a devalued pound is making Burberry coats and scarves less expensive to overseas buyers. Health care companies with innovative therapies have also fared well. Swiss-based Novartis, for example, has seen increasing sales of its heart drug Entresto.

Emerging markets are bouncing back after a very tough stretch these past few years. Currencies have strengthened, commodity prices have stabilized, and global interest rates remain low. Emerging market valuations look attractive and aggregate earnings are forecasted to grow. Times have changed for developing economies in that materials and energy companies used to be the key drivers of growth. But today, the focus has shifted to technology and consumer companies that benefit from the rising wealth and purchasing power of the new “emerging” consumer.

All in all, the global economy appears to be picking up a bit after an extended period of below-trend growth. The current administration has pledged to slash taxes and boost infrastructure spending, both positives for economic growth. We recognize the risk of temporary pullbacks, especially with an unpredictable administration, but all in all, we expect 2017 to be another positive year for stocks.

Sincerely,

Transition Financial Advisors Group, Inc.

Mitch Marenus, Chief Investment Officer
MBA, CFP® (US), CFA®

Brian Wruk, President
MBA, CFP® (US), CFP® (Canada), CIM, TEP

Lucas Wennersten, Financial Advisor
CFP® (US)