Eclectic Associates Review and Outlook Meeting
Every January, our advisors meet to review recent economic trends and investment returns. After we identify key factors, we develop our long-term investment outlook. Ultimately, we end with a vision for best positioning client portfolios weighing the tradeoff between investment risk and potential returns.

Here is a summary of the key points we covered in our recent Review and Outlook meeting.

2016-in-Review
As we wrote in our fourth quarter 2016 client letter, we were pleased overall with investment returns in 2016, especially considering that the year began with the worst 10-day start for U.S. stocks in history. By the year’s end, U.S. stocks had bounced back and balanced portfolios with a 40% stock allocation returned in the 5-6% range.

Below is an outline for some of the key numbers for the year:

U.S. Large Cap Stocks = +11.8%
U.S. Small Cap Stocks = +21.6%
International Stocks = +2.7%
Muni Bonds = +0.1%
Total Bond Market = +2.5%
U.S. Real GDP = +1.6%
U.S. Inflation = +2.1%
12/31/15 10-Year U.S. Treasury Yield = 2.3%
12/31/16 10-Year U.S. Treasury Yield = 2.4%

We saw a number of sharp reversals in market trends in 2016. Here are a few:

Oil jumped 82% from the low point in January 2016.
S. value stocks outpaced U.S. growth stocks by over 10% from February low.
After the U.S. election, interest rates increased sharply and bond prices dropped.
S. small cap stocks beat U.S. large cap stocks by 19% following the February low.

As we write this in early 2017, stocks have continued to rally and bonds have also earned positive returns.

Here are a few highlights from our review of broad market valuations:

The S&P 500 (a popular index of U.S. large cap stocks) appears modestly overvalued based on the price/earnings ratio. However, when we adjust the price/earnings ratio for low interest rates and low inflation the S&P 500 appears close to fairly valued.
Similar to U.S. large cap stocks, small and mid-sized U.S. stocks also appear slightly overvalued.
International stocks look undervalued relative to both historical averages and U.S. stocks. Further, international company earnings have lagged U.S. company earnings since the start of the current recovery in 2009.
Historically low interest rates mean future returns in bonds will be below historical average. We are mindful of the risks in the bond market (interest rate risk, credit risk). We continue to focus on stability over growth with the bond funds we recommend. We are also biased to shorter duration bonds over long duration bonds, to be conservative.
The U.S. dollar appears overvalued relative to most other currencies following years of dollar appreciation against both devel90ed and emer90ng country currencies.

A few specific areas of concern we discussed were:

S. trade protectionism, Brexit negotiations, and anti-EU sentiment in Europe could impact global trade in the short-term.
If the Federal Reserve embarks on an aggressive policy of interest rate hikes in 2017, it could hurt investment returns.
President Trump could help bring positive reforms (such as corporate tax reform) that would help the markets, but he could also say or do something that would negatively affect the markets.

What this means for you:
As we review client portfolios, we will be buying more international stocks, which have lagged U.S. stock returns recently, but also appear cheaper than U.S. stocks. We don’t plan to do this as a prediction of short-term performance. Rather, the fundamental attractiveness of international stock prices statistically makes them more likely to outperform U.S. stocks over the coming years. International investments would also stand to benefit from a reversal of the dollar strengthening trend of the past several years.

The dollar looks overvalued when compared with other developed market currencies.

Our investment strategy is to:

Invest across a mix of cash, bonds, stocks & other investments (diversification)
o Reduce exposure to any one particular asset class
Own quality investments
o Use mutual funds and ETFs with managers who have proven long-term track records
Own investments that complement each other
Consider all costs of an investment
Manage overall portfolio risk by considering each client’s tolerance for investment risk and their goals.
Review often and rebalance the portfolio as necessary

Final thoughts
As we’ve said in the past, the short-term predictions of so-called experts have often been no better than guesses. Even if one could predict the outcome of significant events, such as the U.S. election, it would still be very difficult to predict the market reaction. Who would have guessed that gold would drop and stock markets would rally following a Trump victory? There are just too many variables that influence the markets in the short-term. As Warren Buffett says, in the short-term the markets are a voting machine but in the long-term they are a weighing machine.

Our goal is to provide you with peace of mind about your money and your future. Our strategy is to focus on building investment portfolios that match your goals and combine this with sound financial planning.

As always, please contact us with any questions or concerns you may have about your personal financial plan.

Eclectic Associates 2016 Year-In-Review & 2017 Outlook