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Fourth Quarter 2016 Client Newsletter

Before getting too far into the new year we would like to provide our clients and friends with a brief review of the market moving events of 2016.  We would also like to share our baseline expectations for the coming shifts in the political environment and market fundamentals in 2017.

Looking back on 2016 we are reminded of the scattered minefield of both transitory and transformational market‐moving events and themes.  In order to organize these occurrences for presentation, we have embedded an exhibit below depicting the S&P 500 for the Calendar Year 2016 period with call‐outs for each major market pivot.  

The crash in the Chinese markets and the crash in the price of oil were the proximate causes of the worst start to any year in market history; yet they will likely be remembered as transitory incidents.  The same judgment will also likely be made about the 2 day, 5.7% decline that surrounded the surprise UK decision to exit the European Union.  Political policy, shifting global monetary policy, and geopolitical risks were all front and center throughout 2016, and they will likely continue to play a key role in market psychology in the months and years to come.

The market action of 2017 will likely be dictated, for better or worse, by a few of these major transformational motifs.  The first, and most obvious of which is the new administration and congressional shift in focus towards: deregulation, tax reform, infrastructure spending, and repatriation of corporate cash held abroad.  Please note, this discussion is not designed to judge the merits of these policy prescriptions.  For this analysis, we are purely interested in the acceptance/rejection of these policy proposals by the markets.  The promise of these initiatives has been positively received by the market thus far.

This positive response can be best illuminated by the upward revisions to the 2018 S&P 500 consensus earnings estimate.  Before the election, we were optimistic that the S&P could earn roughly $133 in 2018, which would represent a roughly 11% expansion over the next two years.  Now, given the potential for deregulation and expansionary fiscal policy, consensus estimates for 2018 earnings are $148/share, or roughly 24% growth.  These are undoubtedly aggressively optimistic estimates, so we must emphasize that they are only estimates.  

These policy shifts will begin to take form in an environment that has largely been dominated by global central banks and their accommodative monetary policies.  This transition away from monetary policy and towards fiscal policy is not without risk.  Just as with shifts of strategy at major corporations, this major shift in focus by our policy makers will be subject to execution and messaging risks.  These potential ‘bumps’ along the road of implementation will likely cause 2017 to be a volatile year.

In summary, we are very optimistic that the positive tailwinds of accelerating S&P earnings and subdued interest rates could provide a supportive backdrop that propels the market to a strong 2017.  That being said, we will remain focused on providing excellent downside protection in what promises to be a year like no other.

We welcome the opportunity to provide additional details on any of the topics discussed in this newsletter and look forward to serving you in the year to come.  Please do not hesitate to reach out with any questions you may have.