What a year! From a tumultuous start, with concerns about the health of the Chinese economy and depressed oil prices plaguing growth prospects, to the Brexit vote in the summer — and of course, our own presidential election in November — it was an eventful year in the financial markets.
It was also an exciting year for investors, one in which maintaining discipline reaped handsome returns.
The S&P 500 Index of U.S. large-company stocks gained +12.0% for 2016 (+3.8% for Q4). While U.S. large-cap stocks fared well over the course of the year, small-cap stocks, represented by the Russell 2000 Index, soared, returning an impressive +21.3% for the year (+8.8% for Q4). Value stocks outperformed growth stocks, with small-cap value stocks performing the best (the Russell 2000 Value Index was up +31.7% for 2016 and +14.1% for Q4).
Returns shown in the chart above are for the calendar year 2016.
The phenomenon of value stocks outperforming growth stocks and small-cap stocks outperforming large-cap stocks carried over to international markets as well. In international-developed markets, the MSCI EAFE Value Index returned +5.0% for the year versus the MSCI EAFE Growth Index return of -3.0%. The dollar rallied against most major currencies, particularly in the fourth quarter, which tempered returns for U.S. investors overseas. Despite currency headwinds, emerging-markets equities gained +11.6% in US$ terms for 2016. Stock markets in Brazil (+66.8%) and Russia (+55.9%) were among the top performers within emerging markets last year.
On the fixed-income side, the U.S. bond market was a tale of two halves. During the first half of the year, Treasury yields declined (and bond prices went up), reflecting risk-off sentiment; the 10-year Treasury note yield reached a low point of 1.37% in July. In the latter half of the year, following the U.S. presidential election results, the yield on the 10-year note climbed and it ended the year at 2.45%, as investors’ expectations for growth and inflation under the new president perked up. Despite declining by 3.0% in the fourth quarter, the Barclays Aggregate Index of domestic investment-grade bonds gained +2.6% for the year. Municipal bonds faced headwinds, due to rising rates and the prospect of lower taxes under the new administration. The Barclays Municipal Bond Index lost 2.6% in the fourth quarter (the index was flat at -0.1% for 2016).
High-yield bonds were a bright spot within fixed income, returning +14.8% for the full year (+1.3% in Q4). The recovery in oil prices in 2016 (U.S. crude rose 45% and ended the year at $54 per barrel) had a strong, positive effect on the high-yield segment, as a large percentage of high-yield issuers are in the energy sector. Although currency headwinds and higher interest rates in the U.S. erased some of the gains earlier in the year, emerging-market bonds also finished the year strong (JPM GBI-EM Global Diversified Index UH gained 9.9% for 2016).
This year rewarded an investment approach, such as ours, that emphasizes the small-cap and value segments of the market. Achieving these strong returns required discipline in the face of economic, political and other uncertainties, as well as the recent dominance of large cap and growth through the end of 2015. As we delight in the returns 2016 had to offer, we remain cognizant that investing is a marathon and not a sprint; even so, some years can have a disproportionate impact on the outcome of the race, and this was likely one of them.