January 06, 2017
The “Trump Rally” put a crescendo on what had already been a respectable 2016 heading into the 4th Quarter. The S&P 500 TR was up 3.83% during the final three months, and 11.93% for the year. Remarkably, 2016 began with the worst start in stock market history, as investors dealt with a number of economic risks. Looking back to January of last year: The Federal Reserve had just raised rates for the first time since June 2006, an end to eight years of ZIRP (zero interest rate policy). China’s economic risks seemed to be escalating and their stock market was tanking. Domestic earnings growth continued to be unremarkable, with the energy sector suffering from an historic drop in oil prices. Much of the world’s interest rates were “under water.” Inflation was nowhere to be found. As summer began, investors were surprised with a vote for Britain to exit the European Union. As summer ended, most investors were caught off guard by the market reaction of the unexpected election of Mr. Trump.
As we begin 2017, what has changed?
Markets are clearly forecasting an end to the economic malaise that has plagued the global economy. This is particularly true for domestic stocks. After all, markets only care about future growth and the major indexes have recently achieved all-time highs. The Dow Jones Industrial Average sits today at about 20,000 (10,000 was first achieved in 1999). Investors are saying that the new political regime will unleash the animal spirits of capitalism, unshackling entrepreneurs and businesses to increase innovation and productivity. This may be the case. However, it is an ambitious goal.
The risks of 2016 have not completely abated. Mild inflation has sprung up, led by a recovery of gas prices, with the most recent Consumer Price Index figures at 1.7%. Core CPI (inflation ex- food and energy) has stayed over 2% which, coupled with low unemployment figures (staying below 5%), has provided an excuse for the Federal Reserve to creep rates higher. Higher rates have not had a noticeable negative impact thus far on economic growth (Q3 GDP jumped up to 3.5% from 1.4% in Q2).
Today’s primary market risk, in our view, is that S&P 500 earnings have not kept pace with the rally. The forward price to earnings ratio 18.92x at year end is elevated above historical averages, and the dividend yield for the index is an unremarkable 2.07%. Keep in mind, however, that last year the forward price to earnings ratio stood at 22.74x. The possibility of sustaining the rally exists, but the future gains are predicated on high political expectations and earnings growth will have to materialize. Cutler views the current valuations with some skepticism, but also some optimism that opportunities can be found in today’s stock market. Participate, but participate cautiously. As the cartoon above suggests, get in the boat, but don’t forget to wear your lifejacket!
Equity Income Commentary
Cutler’s Equity Income strategy had a very nice year, with composite performance up 15.40% (net) versus the S&P 500 TR of 11.93%. For the quarter, the composite performance was 5.63% (net) versus 3.82% for the S&P 500. What were the main drivers of this outperformance? Some industrials stocks had “eye popping” performance for the year, as Caterpillar (+42%) and Deere (+38%) recovered from a period of weak earnings growth. Energy recovered from the bear market of 2015, and Chevron had a 2016 performance of +36%. Despite the weakness in bonds heading into year end, interest rate sensitive sectors such as Telecommunications finished the year up +23%. Bristol-Myers Squibb was the worst performing position for the year, down -13% on the heels of a failed trial for their flagship Optivo drug.
Financials, which typically benefit from a steepening yield curve, were the biggest beneficiaries of the change in the interest rate dynamic in 2016. This sector rallied an impressive +27% for the year, and +21% in the 4th Quarter alone! Cutler’s strategy maintains an underweight in Financials, as many banks cut their dividend in the financial crisis and do not meet our dividend history criteria. However, we added Northern Trust (NTRS) in May, selling Monsanto on the heels of a buyout offer from Bayer. NTRS reduced our underweight in the Financials sector.
We made one position change in the 4th Quarter, selling Sysco and buying Kroger. Sysco had been a beneficiary of the current pricing environment, while the opposite is true for Kroger which has struggled with food price deflation. We felt this was an opportunity to “sell high, and buy low”, which is clearly an objective of any investment strategy. Given our market commentary above, we like the defensive attributes of Kroger (groceries are fairly immune to economic conditions). However, we believe the valuation at purchase justifies participation in the market rally should stocks continue heading higher.
|Top 5 And Bottom 5 Holdings By Performance- As of 12/31/2016|
|Best Performing Securities||Average Weight (%)||Security Contribution to Portfolio Return (%)|
|M&T Bank Corp.||2.71||0.91|
|Northern Trust Corp.||2.17||0.66|
|Deere & Co.||3.15||0.66|
|American Express Co.||2.43||0.39|
|Worst Performing Securities||Average Weight (%)||Security Contribution to Portfolio Return (%)|
|Becton, Dickinson, & Co.||3.57||-0.29|
|Proctor & Gamble Co.||2.88||-0.17|
|Merck & Co.||2.89||-0.15|
|Wal-Mart Stores Inc.||2.89||-0.11|
These blogs are provided for informational purposes only and represent Cutler Investment Group’s (“Cutler”) views as of the date of posting. Such views are subject to change at any point without notice. The information in the blogs should not be considered investment advice or a recommendation to buy or sell any types of securities. Some of the information provided has been obtained from third party sources believed to be reliable but such information is not guaranteed. Cutler has not taken into account the investment objectives, financial situation or particular needs of any individual investor. There is a risk of loss from an investment in securities, including the risk of loss of principal. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will be profitable or suitable for a particular investor's financial situation or risk tolerance. Any forward looking statements or forecasts are based on assumptions and actual results are expected to vary. No reliance should be placed on, and no guarantee should be assumed from, any such statements or forecasts when making any investment decision.