It is exciting to write this letter as the Dow Jones Industrial Average has exceeded the 20,000 level for the first time ever. Since the inception of South Texas Money Management, we have remained steadfast in our conviction that publically traded common stocks are a competitive asset class long-term and appropriate for the vast majority of investors for some portion of their portfolios.
While we could have chased high yields, hedge funds and other esoteric investments, we remained bullish on common stocks. We have also worked hard to determine the appropriate asset allocation for our clients, given their risk tolerance. We have also elected to invest in high quality bonds in order to help hedge the stock volatility, if appropriate.
Stocks are volatile. That rule will likely never change. And 2016 was certainly a volatile year for global stock markets.
Total stock returns for the full year were very good, but they were uneven. In fact, the first several weeks of 2016 were a very rocky start with weak global economic numbers and a cyclical low in oil prices. The S&P 500, for example, was down approximately nine percent before a market upturn, which continued until the surprising Brexit vote outcome on June 24. That was a very negative surprise for the financial markets. Again a recovery followed, then a flat line and pull back with a very strong finish to the year after the presidential election. Such volatile years are a reminder not to try to time the stock market. That is generally not a successful strategy.
And these knee jerk reactions are the main reason that stocks are so volatile. Highly liquid (fortunately) stock prices and even bond prices are very efficient and discount information quickly. I think it is quite rational that stocks reacted so positively to information about the new administration’s confirmation of a likely reduction in corporate income tax rates and reduced regulation.
Early in the election, The Tax Foundation, a non-partisan group, analyzed the stated tax proposals for each presidential candidate, as well as each candidate’s fiscal spending plans. The Tax Foundation’s proprietary models then projected GDP (or economic growth) and resulting deficits. There were meaningful differences in their work between the candidates.
Corporate tax reform seems to be the low hanging fruit in our view. Discussed earlier in the Obama Administration, and now even likelier it seems with Republican control of the House, reduced taxes for corporations could increase corporate earnings and even imply more US corporate cash coming back to the US. Stock prices reflected this quickly. I believe that, in the long run, stock markets only care about corporate earnings.
The Federal Reserve’s policy stance on interest rates has now shifted with a 25 basis point increase in the Fed Funds Rate in December of last year. This is the first tightening in a year and only the second in a decade and many strategists believe there could be more to come. We feel that this was widely anticipated and done for the right reasons: continued economic expansion and low unemployment rates.
We have continued our commitment to investing in non-US stocks for diversification despite our anticipation that the US dollar would remain strong to other currencies that may be particularly volatile after the Brexit vote. There are many great non-US companies that trade on US exchanges via ADRs and file earnings reports and disclosures to the SEC. The currency exchange was a headwind last year in our portfolios (click here to view chart). This has indeed been a long, historical period where US stocks have outperformed non-US stocks, but we think that could, once again, change.
We also continue to balance our stock portfolio between growth and value stocks, as 2016 was a prime example of how cyclical each style (value and growth) is and how countercyclical they are to one another. A good hedge. Separately, sector rotation was fast and furious last year. We control our sector risk by owning all sectors and limiting their maximum exposure. Our goal is to participate in market upswings, but to protect, to the extent possible, downside volatility. For this reason, we will stay disciplined in our diversification roles of owning both value and growth stocks, all sectors and US and non-US companies.
Our Fixed Income Team had some recent changes due to Hutch Bryan’s resignation for other pursuits. Dr. Jim Kee and I will continue to lead that team and Joe Van Meter, our fixed income external consultant whom I have worked with for over 28 years, has become involved on a daily basis in the interim. Joe has been working with STMM for 8 years in a consultant capacity and has extensive experience with bonds, serving as Frost Bank’s Head of Fixed Income for 15 years.
Your year-end book is now complete and will be arriving under separate cover or emailed to you if you made that election. We hope that you will continue to watch our quarterly webcasts, which are, in my view, our most comprehensive updates from our Investment Team. I am certain it will be an interesting year.
Please click here to view our quarterly non-profit spotlight. We are pleased to be highlighting the Seedling Foundation based in Austin, Texas. Please let us know if you would like a copy of our updated ADV part 2B.
Thank you for being our client.
Jeanie Wyatt, CFA®
Chief Executive Officer & Chief Investment Officer
This letter is not intended to constitute investment advice. Market and economic views are subject to change without notice and may be untimely when presented here. You are advised not to infer or assume that any securities, sectors, or markets described in this letter were or will be profitable. Securities identified in this letter do not represent all of the securities purchased, sold, or recommended for advisory clients, and you should not assume that the recommendations made in the future will be profitable or will equal the performance of the securities identified above. A complete list of all equity recommendations made by STMM during the past year is available upon request. Past performance is not indicative of future results. There is a risk of loss.
CFA® and Chartered Financial Analyst® are registered trademarks owned by CFA Institute. ©2017 South Texas Money Management, Ltd. All rights reserved.