2017 First Quarter

Kreitler Financial:

Our views on the investing landscape.

2016 will no doubt be remembered as an eventful year.  The year started with a bear market, with the S&P bottoming in February after a -14.1% decline from summer 2015.  On June 23, UK voters chose to leave the European Union, triggering a nasty but brief selloff. US voters experienced a particularly hard fought election culminating with Donald Trump’s win.  This is not a comprehensive list.

If an investor were told at the beginning of the year some of the major events that would happen in 2016, they might very well have come to the wrong conclusions.  Not many would have forecast the US stock market to be up strongly despite Brexit and an upset win by Donald Trump.  By year end, however, the Dow was flirting with 20,000 and the S&P ended up 12.0%.  Nationally the US housing market finally recovered to its pre-crisis levels.  In the UK, the FTSE 100 large company index set an all-time high, closing out the year up 14.4% (local currency).

2016 may well serve as a reminder of humility for investors.  Attempting to predict the future can be challenging at best and downright harmful at worst.  2016 also reinforced the importance of using effective risk management to permit investors to maintain their strategies through uncertain periods.  Avoiding the market during this year could have resulted in missed opportunities.

In this newsletter, we will review the financial markets for 2016, share our thinking on global trends, and discuss positioning for the new year.

2016 Market Review

Stock markets in the US had a rocky start (S&P 500), dropping an additional 8.8% through February 11 on top of the declines in second half of 2015.  International stocks had even larger declines.  By year end, however, US stocks in particular had good performance.

There is a popular perception that stock markets made their gains after the election.  While that is partly true, it does not tell the whole story.  The year’s markets should be evaluated in three distinct periods: beginning of the year, pre-election, and post-election.

2016 Index Results
  Jan 1 - 11 Feb 11 Feb 11 - Nov 8 Nov 8 - Dec 31 2016 YE
S&P 500 -8.8%; 11.0%; 4.6% 12.0%
Russell 2000 -16% 25.3% 13.5% 21.3%
MSCI EAFE -13.0% 10.7% 2.2% 1.5%
MSCI EM 10.4% 26.9% -4.5% 11.6%
Bloomberg BarCap Agg 2.2% 2.5% -2.1%; 2.7%

" Source: S&P Dow Jones Indices, FTSE Russell, MSCI, Bloomberg

As the table above illustrates, the post-election markets were good, but not as good as the period between the February lows and the election.  Stocks did very well in this period, and generally the asset classes that fared worst in 2015 fared best, with emerging markets up +26.9% and US small companies up +25.3%.  This period was generally a very kind one to investors.

Immediately after the election, investors adjusted expectations rapidly.  While the US rally continued, emerging markets suffered declines on speculation of trade restrictions.  Bonds experienced one of their largest interest rate moves in years in the expectation that Trump’s policies could increase growth and raise inflation.  When interest rates rise, bond prices fall.  This was particularly felt in the tax-free municipal bond market, where investors also bet that individual tax rates would be cut. 

Global Events

Our Second Quarter newsletter “A Fork in the Road to Globalization” discussed the consequences of the Brexit vote.

A bigger question is whether the UK referendum is a signal of a larger change in the global economy— a potential step back from globalization, free trade, and immigration. It appears that the “Leave” voters in the UK were those most likely not to have benefited from globalization: older, less affluent, less educated, and more likely to come from rural or fading industrial centers. “Remain” voters, on the other hand, tended to be younger, more educated, live in urban centers, and be more economically mobile. This tension between the globalization ‘haves’ and ‘have nots’ has been building, perhaps accelerating ever since China joined the World Trade Organization in 2010.

Many in the press have drawn parallels between this and disaffected voters in other countries. In the United States, we have people who feel disenchanted with the status quo on both the right (the supporters of Donald Trump and the Tea Party) and the left (Bernie Sanders and the very progressive left), although they propose different ways of addressing the problems. For Europe, the UK broke a taboo as the first country to vote to leave. Germany has elections in 2017, and the rise of the Alternative for Germany right-wing populist and Eurosceptic political party could present another challenge to EU unity.

Trump’s election in November demonstrates that these trends continue for now. Next year Europe has significant elections in the Netherlands, France, and Germany.  Each of these could bring challenges to the European Union and the global status quo, as discussed later in this newsletter.

What to expect going forward?

The post-election market optimism was fueled by the possibility that one party would control the White House and both the House and Senate, thus ending gridlock and making change possible. Now, investors will begin to pay more attention to the actual implementation of specific policies than to Trump’s announcements as they adapt to the new President’s theatrical style.

How the House and Senate will work together with Trump is uncertain, but we expect a honeymoon period where a great deal gets done in the first 100 days.  The Democrats have enough leverage in the Senate to block major legislation, but they also have a number of Senators who are vulnerable in 2018 elections, perhaps creating the possibility of bipartisan compromise.

The Trump team has signaled its major priorities for 2017 to be tax reform (combined with infrastructure spending), immigration reform and border security, reforming the Affordable Care Act (Obamacare), and regulatory reform.  We also expect a political fight over a Supreme Court nomination.  Over his term, Trump will have opportunities to fill positions at many levels of the court system with appointees that favor his philosophies.  Frequently presidents get a lot done in their first days in office, but this has not been a typical election season.

What might the impacts of these events be?  First, the markets have anticipated tax and regulatory reform.  Stock markets moved up in the US and sold off in emerging markets.  Interest rates rose on the expectation that there will be both higher growth and higher inflation. Watch for the markets to pay close attention to the detail of specific policies instead of broad political promises.  While we are optimistic on the potential impacts of tax and regulatory reform particularly, the US still has major headwinds to address looking further out such as aging demographics and large structural deficits.

We tilted portfolios toward US assets to take advantage of what we perceive as potential advantages for the US markets and to hedge possible disruptions elsewhere such as a currency swings, European elections, or geopolitical events.  This may be unwound as the world settles.

Major Themes to Watch

Overall, we remain cautiously optimistic that policy changes like tax reform may spark higher US growth rates.  We will be watching closely as real policy takes form over the coming months.

Interest rates seem to be bottoming and we believe that fixed income investors need to adapt to a possible rising rate environment.  In our portfolios, we shortened duration and moved to higher yielding bonds, strategies that may benefit investors if rates continue to rise.  We have used non-traditional strategies in our portfolios for a number of years, and during the recent post-election rate jump these generally performed as we hoped.  Tax sensitive investors may have fewer options.

Another possible consequence of the zero (or negative) interest rate policy around the world is that capital may have been misallocated into bad investments.  When money is free, it can be sunk into unprofitable businesses or questionable infrastructure projects.  If rates begin to rise, it is likely some of the investments that were profitable at cheap rates may blow up under historically normal ones.  We are reminded of Warren Buffett’s quip, “Only when the tide goes out do you discover who's been swimming naked.” As rates normalize, investors should expect a few surprises along the way.

Globally the wave of populism or nationalism continues.  Britain still needs to formally trigger the exit process from the European Union.  Upcoming elections in Europe include France in April and May, the Netherlands in March, and Germany in September.  Trump’s blustery style may be misinterpreted by global powers, raising the possibility of geopolitical turmoil.  There remains a lot of uncertainty and we don’t expect markets to be smooth.  Historically, long term investors receive returns better than they could on cash by accepting these types of risks, but as always there are no guarantees.

One theme we expect to address is the likelihood of significant volatility in future tax rates.  If rates are cut today without addressing structural deficits and the looming entitlement expenses as more baby boomers retire, we think it likely we will return to higher rates in the future.  Lower rates in the near term may represent a significant planning opportunity for tax sensitive individuals and families that we intend to take advantage of. 

Happenings at Kreitler Financial

Charlie was one of only 68 advisors in the Raymond James Chairman’s Council in 2017, which recognizes the top advisors in the firm*.  Our clients benefit from the additional resources and access this affords us.

Beau Tillinghast joined Kreitler Financial in 2016 as Associate Relationship Manager.  Beau graduated from Virginia Tech with a degree in finance and a concentration in Financial Planning in May 2016.  This year he obtained his Series 7 and 66 licenses, and he is working toward completing the requirements for the CERTIFIED FINANCIAL PLANNER™ certification.  If you have not already met Beau, please take the opportunity to introduce yourself when you next visit. 

We would also like to recognize and thank Relationship Manager Kersti Melchiore, who celebrated her 15th year assisting clients at Kreitler Financial.

We are investing in improved processes and recently signed a multi-year technology deal partnering with Envestnet Tamarac for portfolio reporting and rebalancing tools.  Our existing reporting platform was the best solution at the time; this upgrade will continue our practice of using the best tools available.  Clients should look forward to more robust consolidated statements in the second half of 2017.  This will also result in an improved client reporting web experience.  Concurrently we are building significant improvements in our portfolio management process to increase efficiency and responsiveness to market conditions, while maintaining the same long-standing portfolio management principals, tax management strategies, and customization our wealth management clients already experience.  

Our team took advantage of a number of events to further build skills and expertise.

  • Bob attended the Raymond James Chairman’s Council Summit in Chicago.
  • Charlie attended the PIMCO Global Advisory Committee in New York which included Ben Bernanke, Jean-Claude Trichet, Gordon Brown, Anne-Marie Savage, and Ng Kok Song as speakers. He had the pleasure of spending time with several of them.
  • Charlie also attended the Advanced Planners Study Group with other top Raymond James advisors in Colorado and a Dimensional Fund Advisors practice management seminar in Texas.
  • Kim DiRaffaele went to the Junxure Conference in Colorado to share wealth management best practices.
  • Jake attended the Raymond James Regional Conference for Professional Development in Philadelphia.

We wish you a happy, healthy and prosperous 2017.

With warm regards,

Charles F. Kreitler, CFP®
Robert P. Kreitler, CFP®
Founding Partner

This material is being provided for information purposes only and is not a complete description, nor is it a recommendation. Any opinions are those of Charles and Robert Kreitler, CFP and not necessarily those of Raymond James. The information has been obtained from sources considered to be reliable, but Raymond James does not guarantee that the foregoing material is accurate or complete. Diversification and asset allocation do not ensure a profit or protect against a loss. Investing involves risk and investors may incur a profit or loss regardless of strategy selected. Inclusion of any index is for illustrative purposes only. Individuals cannot invest directly in any index and index performance does not include transaction costs or other fees, which will affect actual investment performance.Past performance does not guarantee future results. There is an inverse relationship between interest rate movements and bond prices. Generally, when interest rates rise, bond prices fall and when interest rates fall, bond prices generally rise. RJFS does not provide tax advice. You should discuss any tax matters with the appropriate professional. International investing involves special risks, including currency fluctuations, differing financial accounting standards, and possible political and economic volatility. Prior to making an investment decision, please consult with your financial advisor about your individual situation. Investments mentioned may not be suitable for all investors.

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