The market continues to assess the potential impact of President Donald Trump’s policy initiatives. A few key trends from late 2016 reversed during January, broadly impacting the capital markets. After rising post-election, the U.S. dollar (USD) fell relative to many foreign currencies, providing a tailwind for U.S. investors’ allocations abroad. U.S. Treasury yields stabilized as well, with the 10-year yield relatively flat on the month after rising more than 60 bps after the November election through year-end 2016. January was a positive month for most risk assets, with the exception of natural resource stocks and commodities. However, there was differentiation within marketable real assets, as metals and mining equities continued to rally on higher metal prices—fueled in part by strong Chinese demand, contained supply, a weaker USD, and optimism around the Trump administration’s growth policies/infrastructure goals. Within commodities, precious and industrial metals posted strong gains, offsetting declines in the energy sub-sector. Several domestic equity indices, including the S&P 500, Russell 3000, and the Dow, achieved all-time highs for the month. We assess the Dow’s move above 20,000 at the end of this review.
After rallying during the period between the election and year-end, the USD weakened against a majority of developed market and emerging markets (EM) currencies in January. The Dollar Spot Index fell 2.6% for the month—its worst January since 1987—resulting in a flat return for the trailing year. Goldman Sachs recently opined that President Trump highlighting that the U.S. dollar is too strong was a reason the currency was under pressure. While most currencies rallied against the USD during the month, Turkey (−6.8%), Egypt (−4.3%), and Venezuela (−2.3%) all faced select country-specific issues. The Mexican peso also fell 0.8% as tensions between Mexico and the U.S. continued to rise. In contrast, a number of developed market currencies rallied against the dollar, including the Australian dollar (+4.8%), Norwegian krone (+4.6%), Japanese yen (+3.6%), euro (+2.5%), and British pound (+1.8%). Similarly, several EM currencies appreciated, including the Polish zloty (+4.3%), Chilean peso (+3.7%), South Korean won (+3.9%), and Brazilian real (+3.5%). Similar to the group of currencies that depreciated, some currencies strengthened for country-specific reasons. For example, the British pound benefited from several factors that increase the chances of the country negotiating a “soft Brexit” from the European Union. However, overall, the pound has declined by more than 7% versus the USD since the Brexit vote, with the currency hitting a post-election low on January 11th before rallying later in the month.
In general terms, the USD may have also weakened as a result of tempering optimism following Trump’s election and his promise of tax cuts and fiscal stimulus. A number of actions taken thus far by the President—through both executive order and Congress via the budget reconciliation process—point to an active government, enacting measures promised to voters. However, these actions have yet to address fiscal stimulus through tax cuts and higher spending. As a result, the potential growth impact of these programs remains uncertain, which may cause the Federal Reserve to be more dovish on monetary policy. In its December Summary of Economic Projections, the Federal Open Market Committee prepared markets for the possibility of three rate hikes in 2017. However, markets believe the Fed may be too optimistic, as fed funds futures and overnight indexed swap rates are currently pricing in only two rate hikes this year. Also, the futures market indicates a more than 50% probability that the Fed hikes policy rates again at its June 2017 meeting.
In aggregate, currency served as a tailwind for non-U.S. investments. While the MSCI EAFE Index (+0.1%) was flat for the month in local terms, it gained 2.9% in USD terms on the back of the falling dollar. Non-U.S. developed equities outpaced U.S. equities, as the S&P 500 rose 1.9% on the month. U.S. equity volatility, as measured by the VIX, continued to trend down and finished January well below its historical average. Despite low volatility, there was wide dispersion among industries, with energy down 3.6% and materials up 4.6%. Coming off of strong 2016 outperformance for domestic value stocks, growth rebounded to start the year with the Russell 3000 Growth Index gaining 3.2% versus a 0.6% return for the Russell 3000 Value Index. Though growth trailed value by nearly 1,100 bps during calendar year 2016, they are closely aligned over the three- and five-year periods ended January 31, 2017.
Within the broader global equity market, EM equites posted strong returns as they appeared to regain the initial momentum that was impeded following Trump’s victory in November. While the “Trump trade” has lost steam in the new year, the MSCI EM Index gained 5.5%—the largest monthly gain for the benchmark since March 2016. Nearly all emerging countries posted gains for the month in USD terms. The most notable exception was Greece (−7.9%), as the country has yet to obtain billions in fresh bailout loans ahead of the looming election season in Europe. The rally in Brazil (+10.7%) continued into 2017 with the support of a recovery in the real and a surprise policy rate cut of 75 bps. South Korea (+7.7%) has also remained resilient despite ongoing political and social unrest, reaching an 18-month high in January as investors responded favorably to strong export data. After a sharp decline following the U.S. election, even Mexico (+2.2%) experienced relief in January, with gains concentrated within industrials and materials names. Amidst the recent macroeconomic volatility, frontier markets have enjoyed a period of strong performance, helped by their domestic drivers of growth and typically low correlation to global markets. Frontier market equities gained 6.7% in January and have outpaced their emerging counterparts since the U.S. election (+4.0% vs. +1.2%).
Dow Jones 20,000 Retrospective
The Dow Jones Industrial Average, while not as reflective of broad market performance as other widely followed benchmarks, remains a bellwether to many investors. Dating back to 1896, the Dow is a price-weighted index that currently tracks the performance of 30 blue chip stocks, covering all industries except transportation and utilities. In the wake of strong equity market performance post-election, both the S&P 500 and Russell 3000 achieved all-time highs in January. Similarly, the Dow achieved its latest milestone on January 25th, when it rose above 20,000 for the first time.
Dating back to November 1972, when the Dow first closed above 1,000, the benchmark has appreciated by 1,900% cumulatively on a price basis over the past 44 years—the equivalent of 7% on an annualized basis. The road from 1,000 to 20,000 has come with numerous ups and downs, and periods of sharp market volatility. Due to two bear markets, it took more than 14 years to get from 1,000 to 2,000 in early 1987. The Dow lost over 45% during the 1973–‘74 stock market crash as “Nifty 50” stocks plummeted, while the 1980–‘82 bear market was fueled by stagflation as interest rates approached 20%. In many ways, the rise from 1,000 to 2,000 was similar to the nearly 17 years it took to appreciate from 10,000 to 20,000. The Dow first achieved 10,000 in 1999, near the peak of the tech bubble. It fared much better than other more growth-oriented, technology-focused benchmarks, but still lost nearly one-third of its value peak-to-trough during the 2000–‘02 market downturn. More noteworthy was the bellwether benchmark’s decline of over 50% during the financial crisis, which caused the Dow to fall below 7,000 in early March 2009. Due to the current bull market, which is approaching its eight-year anniversary, the Index nearly tripled in value, to 20,000. By comparison, the Dow’s rise from 5,000 to 10,000 was more of a straight upward trajectory, achieved in just over 40 months between November 1995 and March 1999.
History suggests that market performance can be unpredictable after a benchmark milestone is achieved. As shown in the table below, the Dow more than doubled in the five years subsequent to reaching its 5,000 milestone, but did not materially appreciate in the five years after reaching 10,000. Conversely, the benchmark was down sharply five years after surpassing 1,000 for the first time. The market as it relates to trailing price/equity ratio is above its longer-term average, but remains below levels of early 1999. In comparing interest rate environments, despite the Fed’s recent decision to raise interest rates for just the second time in a decade, the current 10-year Treasury yield is well below levels that occurred in earlier Dow milestones—save 2013, when the 15,000 milestone was reached.