What We Can Learn from 2016 Using a Momentum Lens

Nasdaq Dorsey Wright & Associates Point & Figure Chart

The stock market had a solid end to the year and finished up the year strong. U.S. equities, as represented by the S&P 500 Total Return, were up 3.8% for the quarter and 12.0% for the year. Many people had predicted a poor year for U.S. equities so these strong returns caught a lot of investors off guard. The returns for other asset classes were mixed during the fourth quarter, but on a year-to-date basis most of the broad asset class benchmarks finished in positive territory. One standout was small cap U.S. equities. The Russell 2000 Total Return Index was up 8.8% in the last three months of the year and 21.3% for the year. Bonds lagged equities, but did end the year with positive returns. Another big story was commodities, which had seen dreadful returns for the past couple of years. The rally in energy propelled the S&P GSCI Commodity Index to a gain of 11.4% in 2016.

The biggest story during the fourth quarter had to be Trump winning the election. Very few people predicted that outcome, and even fewer predicted what the market’s reaction would be with a Trump victory! Once again, we learned how difficult it is to mix politics with investing. We have always focused on price and left things like political forecasting to the people that need material for their television appearance. Initially, the market had a huge selloff when it became clear Trump was going to win. But before the dust even settled the market turned right around and shot higher as confused investors looked on. A Trump presidency will no doubt be filled with a lot of uncertainty. However, there are a few themes that have emerged since the election that have affected our portfolios. Financials (specifically Banks) have rallied on the hopes of looser government regulation. Whether or not that is good for Americans as a whole is not really for us to decide, but it should make it easier and cheaper for banks to do business going forward and the market recognized that very quickly. We saw our exposure to Financials increase after the election as a result of the sector’s relative strength. Trump’s plans for improving infrastructure also helped Industrials rally in to the end of the year. Again, we have seen that strength flow through to our Dorsey Wright momentum models, and we have large allocations to that sector in most of our strategies.

Lost in the shuffle of the fourth quarter was the Federal Reserve raising rates for the first time in a year. The move was largely expected, but that didn’t prevent bonds from having a rough quarter. The positive return from bonds for 2016 was largely earned in the first part of the year. The Barclays US Aggregate Index was down –3.0% for the quarter so the fear of rising rates among investors is real. Our Tactical Fixed Income strategy navigated the choppy waters very nicely in 2016. We were able to post nice gains at the beginning of the year by being in long maturity bonds as well as areas that do well in a strong bond market (High Yield, Emerging Markets, Corporates). As the probability of a rate hike grew and bonds began to falter we were able to switch the portfolio out of the “risk-on” bonds and into short term U.S. Treasuries to preserve those gains.

The two major events discussed above caused quite a bit of change in our models. That was really the theme all year. While the market posted impressive gains as a whole, there were a lot of crosscurrents under the surface. All year long, old trends died, and new ones emerged. At the beginning of the year, investors were favoring Low Volatility stocks and equities with high dividend yields. As the year wore on that leadership began to fall apart and investors began favoring more “risk on” investments like small caps that are more volatile and don’t provide as much current income. Gold was also a theme that came and went during the year. There were many themes like that over the course of 2016 and that led to us making a lot of changes in the portfolios throughout the year. Trading activity was much higher than normal as our models continued to adapt to emerging themes and get rid of old ones. It was definitely a transition year, but it looks like we are well positioned heading in to the New Year. The crosscurrents under the surface will eventually subside. When they do, we should be well positioned to capture the trends in the new leadership.

Nothing contained herein should be construed as an offer to sell or the solicitation of an offer to buy any security. Dorsey Wright (inclusive of its affiliates) is not soliciting any action based on this document. This document does not constitute a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual clients. Before acting on any analysis, advice, or recommendation in this document, clients should consider whether the security or strategy in question is suitable for their particular circumstances and, if necessary, seek professional advice. This information is from sources believed to be reliable, but no guarantee is made to its accuracy. Unless otherwise stated, performance numbers are not inclusive of dividends or fees. Investors cannot invest directly in an Index. Past performance is not indicative of future results. Potential for profits is accompanied by possibility of loss. The relative strength strategy is not a guarantee. There may be times where all investments and strategies are unfavorable and depreciate in value. Relative strength is a measure of price momentum based on historical price activity. Relative strength is not predictive and there is no assurance that forecasts based on relative strength can be relied upon. ADVICE FROM A SECURITIES PROFESSIONAL IS STRONGLY ADVISED.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.