Thu | Oct 19, 2017

US stocks headed for big gains in 2016 despite early stumble

Published:Friday | December 30, 2016 | 12:00 AM
In this Tuesday, October 25, photo, a pedestrian walks past the New York Stock Exchange in lower Manhattan.

In a year with no shortage of surprises and stomach-churning turns in the market, stock investors can feel pretty good about 2016.

Wall Street repeatedly bounced back from steep slumps, including the worst start to any year for stocks, the second correction for the market in five months and investor fears of a global slowdown. It also weathered plummeting oil prices and the surprising outcomes of Britain's vote to leave the European Union and Donald Trump's US presidential election win.

A turnaround in company earnings growth, more stable oil prices, a steadily improving US economy and job market all helped keep the market on an upward trajectory. More recently, investor optimism that the Republican election sweep will usher in a bevy of business-friendly policies spurred the market to new heights.

"It's been the year of the unlikely happening, but the crazy thing about the unlikely happening is you would expect that to lead to big sell-offs, and we experienced the exact opposite," said J.J. Kinahan, TD Ameritrade's chief strategist. "The more things happened that were unlikely, the more we seemed to rally."

Solid gains

As of Tuesday's close, the Standard & Poor's 500 index, the broadest measure of the stock market, was on track to end the year with a gain of 11 per cent after an essentially flat finish in 2015. Including dividends, the total return was 13.4 per cent. That means if you invested $1,000 in an S&P 500 index fund at the beginning of the year you'd wind up with $1,134 at the end of the year.

Other major market indices were also on course to post solid gains. The Dow Jones Industrial Average was headed for a gain of 14.5 per cent, a surge that had the 30-company average flirting with crossing the 20,000 mark. The Nasdaq composite was on track for a 9.6 per cent gain.

Small-company stocks trounced the rest of the market, however, especially since the election. The Russell 2000 index soared more than 21 per cent in 2016.

Investors anticipate that smaller companies will benefit more from an improving US economy than their larger rivals because they tend to do far more of their business domestically. They also have fewer ways to dodge taxes through overseas subsidiaries, so they'll have more to gain if corporate taxes go down, and they'll also have less to lose if trade frictions flare up.

For the most part, markets overseas also fared better than in 2015.

In Europe, Britain's market was headed for a 13.2 per cent gain, despite jitters that rocked the market following the summer's 'Brexit' vote to leave the European Union. Indices in Germany and France were on their way to gains of 6.8 per cent and 4.6 per cent, respectively. Japan's Nikkei was on track to eke out a gain of 1.8 per cent, and Hong Kong's benchmark index was down 1.5 per cent.

Few anticipated the kinds of gains for US stocks this year in January, when the market kicked of the year in a deep slump that knocked the Dow, Nasdaq and S&P 500 into a correction, or a drop of 10 per cent or more from their recent peaks. For the S&P 500, it was the second correction in five months.

Fear that an economic slump in China could spark a global economic slowdown, and alarm as the price of crude oil fell below $30 a barrel to its lowest level in 12 years, triggered the market slide. Weak US economic data didn't help.

Surprise to investors

The downturn was a surprise to many investors. Few expected another market correction so soon, and the Federal Reserve's move in December 2015 to raise interest rates for the first time in nearly 10 years signalled to many that the US economy was healthy.

By the end of March, the market had started to regain its footing. By April, it recouped its losses and continued to mostly head higher. Then, towards the end of June, investors got blindsided by the Brexit vote. That dragged the market sharply lower and sent investors piling into US bonds.

The slide lasted only a couple of days, and once again the market headed mostly higher.

Throughout the summer and into early fall, stocks rode an encouraging wave of developments: The US job market continued to post strong monthly gains. Consumer confidence strengthened. More companies began to report better earnings and revenue for the third quarter, snapping a losing streak of five quarters for S&P 500 companies, according to S&P Global.

And crude oil prices stabilised, holding above $50. An agreement by OPEC and other major oil-producing nations to cut production next year, in an effort to mitigate a glut in global supplies, helped support energy prices. US benchmark crude remains far lower than it was in mid-2014, when it topped $100 a barrel.

The market jitters returned as the race between Trump and Hillary Clinton began to tighten, leading to a nine-day slump for stocks ahead of election day.

Wall Street had largely seen Clinton as more likely to maintain the status quo, while viewing Trump's policies as less clear. The billionaire's surprise win initially set off a sharp sell-off in Asian markets, signalling more pain for US investors. But the opposite happened.

Global financial markets soon steadied and US stocks kicked off a rally that extended well into December, driving the major US stock indices to record highs.

Priorities change

Investors are now betting that Trump and a Republican-controlled Congress will have a clear pathway to boost infrastructure spending, cut taxes and relax regulations that affect energy, finance and other businesses.

That agenda has flipped investors' priorities since the election away from defensive assets like bonds, utilities and phone companies, which traders had favoured for much of this year, to financial, industrial and small-cap stocks.

It's also increased expectations of higher inflation and interest rates next year, which could make some fixed-income investments like bonds less attractive.

The anticipation of higher interest rates led to a sell-off in bonds, since the election, that sent bond prices lower and drove up the yield on the 10-year Treasury note to the highest level in more than two years. The yield, which is used to set interest rates on many kinds of loans, including mortgages, bottomed out at 1.36 per cent in July and went as high as 2.60 per cent in mid-December.

The move away from bonds, utilities and other safe-play assets is likely to continue as long as investors believe that Trump's economic policies will lead to economic growth and usher in higher interest rates.

December also saw the Federal Reserve boost its interest rate by a quarter-point. The central bank also signalled that it could begin to gradually raise interest rates as employment and inflation increase.

Even with the gains this year, market strategists say the current bull market, now in its seventh year, should continue, as long as company earnings continue to improve.

- AP