Market & Economic Update
As expected, the Federal Reserve voted unanimously last week to raise their benchmark rate by one-quarter point, as the committee believes that the economy is strong enough to withstand tighter monetary policy. This was the first rate increase in 12 months, and only the second rate increase since 2006. There were no major surprises in their release, and the committee expects to raise rates gradually as we head into 2017. The fact that there were no major surprises with their report resulted in continued appreciation in U.S. equities and continued strengthening in the U.S dollar relative to major currencies due higher rates. In fact, the S&P 500, Dow and Nasdaq are up between 3-5% since the jobs report on December 2nd while rising interest rates negatively impacted bonds and international equities due to a stronger U.S. dollar. With the third and final release of Q3 GDP coming in better than expected, continued strength in the labor market and an uptick in inflation, our expectation is for interest rates to rise as we head into 2017. Still, we expect the Fed will gradually raise rates, although any increase in the speed or magnitude of rate hikes has the potential to shock the market if not communicated properly.
The populist movement that resulted in the Brexit vote over the summer and Trump victory here in the U.S. has continued abroad, as Italian citizens voted no on constitutional reforms which resulted in their Prime Minister resigning from office. This raises the possibility that the country may vote to leave the European Union at some point over the next year once the new government takes power. However, this vote had little to no impact on equity markets as the Dow climbed towards a historic level of 20,000. It remains to be seen how any of this will play out with regards to market performance and prospects for economic growth. Here in the U.S., we are just starting to get an idea of Mr. Trump’s economic policies and the market is trading on the expectation of an increase in fiscal spending, tax cuts and de-regulation. We feel a sense of “irrational exuberance” to borrow an old Alan Greenspan phrase, given the strength of this post-election rally and the uncertainty as to whether his policies will come to fruition.
Therefore, we continue to maintain our cash levels that were raised over the last three to four months. We positioned our portfolios for higher interest rates earlier in the quarter through an overweight to financials and lower duration (less interest rate sensitive) fixed income, and we plan on maintaining these exposures as we head into the new year. We will continue to monitor the current environment and deploy cash as we see opportunities to invest.