What a year 2016 turned out to be for investors! U.S. stocks ended the year better than anyone predicted, but other categories had mixed results. If you weren’t paying attention, you may be wondering what happened to your portfolio.
The U.S. stock market represented by the S&P 500 and the Dow Jones Industrial Index started 2016 by going down over 10% in the first six weeks, but both ended the year up. Thanks to the strong rally experienced during the last seven weeks of the year (post presidential election), the S&P 500 finished up almost 12% and the DOW even stronger with a yearly return over 13%. In fact, investors saw the DOW approach the 20,000 mark -- but ended the year just shy.
The sudden moves of the U.S. stock market captured all the attention in 2016. Meanwhile, it was the performance of other investment categories that may have created either disappointment or elation for investors. Here are our top three surprises for 2016:
Bonds Returns Get Cut in Half
Bonds had a nice run during the first half of 2016 with the bond index (Barclays Aggregate Bond Index) posting a return of nearly 5% by early July. From that point on, bonds started to slowly fall as investors worried about future rate increases by the Federal Reserve. The selloff in bonds intensified after the election. The index lost nearly 3% in the final three months of the year to finish up slightly more than 2.6% for the year. Literally, the July 2016 bond return by year-end was cut in half!
The unfortunate impact for many investors was seeing the negative returns in the final three months from bonds eat away at the positive returns they had gained during the same time period from the stock market. However, the opposite was true during the first six weeks of 2016. While the stocks were losing 10%, bonds had gained a positive 2%. In both instances, diversification provided some heartburn relief!
Small Cap Stocks Explode
Small cap stocks, measured by the Russell 2000 Index ended the year up over 21% beating most U.S. stock indices. Here’s the surprise: 20% of the total year’s return came between November 3rd and December 9th! If you missed those five weeks, you basically missed it all!
If you are a well diversified investor you may be lamenting over your bond returns, but ecstatic regarding your small cap stock returns. However, a little perspective always helps. Small cap stocks were one of the worst performers in 2015, returning a negative 4.3%, while bonds were slightly positive.
International Stocks Whimper Out
Pull up a one-year chart of almost any diversified international stock index and you will see what looks like a really bad EKG chart! International stocks could find no sustainable footing throughout the year.
The widely watched international stock index (MSCI ACWI – Ex U.S.) finished the year up 4.5%, but gave up 1.25% in returns in the final three months of the year. This was opposed to U.S. stocks finishing the final three months sharply positive. This represents another year of internationals underperforming U.S. stocks by a significant margin. Investors who are not already weary of international stocks are probably being pushed to the brink after 2016!
Here’s something to remember: During years in the past, international stocks have experienced a strong outperformance compared to U.S. stocks. From 2003 to 2007, the emerging international stock index (MSCI EM) returned a total of over 482%, while the non-emerging international stock index (MSCI EAFE) returned over 267%. This is in contrast to U.S. large cap stock index (S&P 500), which returned a total of 182% during this same period.
Question to ponder: Will international stocks begin to outperform U.S. stocks in the coming years? If you believe in “reversion to the mean”, international stock outperformance would be a logical assumption.
Summary
So as we look back upon 2016, we learned that investment markets can surprise us and sometimes in very short order. Investors who hold a mixture of investment strategies in their portfolio will always have some winners and some losers -- that’s the point of diversification. However, in the long run, that generally beats trying to pick which investment will outperform at any given moment.
