Each year I make a practice of reviewing The Ten Surprises of the year that has passed. Last year’s list was on its way to being one of my best and then Donald Trump won the presidential election and everything changed. Before that, oil was in a downtrend, the Standard & Poor’s 500 was heading toward its January starting point and interest rates were surprisingly low. After the election, investors decided that growth would be boosted by Trump’s plans to lower corporate and individual income taxes; deregulate energy, healthcare and financial services; and offer tax incentives for infrastructure spending. Equities rallied almost every day for two weeks and bond yields moved higher. Even the president-elect could not have expected such a favorable reaction to his victory.
The purpose of The Ten Surprises is to stretch my thinking (and hopefully yours) about what might happen in the coming year. I don’t tamp down the Surprises to get a high hit score. Every year there are a number of unexpected events that influence the financial markets and 2016 was a good example. Very few expected Trump to be elected. I certainly didn’t. I define a Surprise as an event that the average professional investor would only assign a one in three chance of taking place, but I believe is probable, meaning it has a better than 50% chance of happening during the year. Usually I get five or six of the Surprises more or less right.
My first 2016 Surprise was that Hillary Clinton would win the presidency against Ted Cruz. I knew the Republicans would pick an outsider, but I thought Donald Trump would prove too extreme and unconventional to be nominated. I underestimated Cruz’s unpopularity with the Republican establishment and Trump’s ability to connect with an electorate yearning for change. He had a clear economic message that resonated with many Americans who felt that Hillary Clinton would not improve the country’s growth. I also thought the Democrats would take the Senate, but the Republicans retained control. Other than expecting a low voter turnout, there was no part of the First Surprise that I got right.
I did not do any better on the Second Surprise. I thought earnings for U.S. companies would be disappointing because of a profit margin squeeze and the S&P 500 would end the year in negative territory. Moreover, as I expected, worries about global instability did encourage investors to maintain large cash balances and this hurt the performance of many hedge funds. Profit margins did shrink as a result of a lack of pricing power, modest revenue growth and increased wages. But overall the market shrugged off the bad news and ended the year up by 9.5% on the S&P 500 and 12% with dividends.
Finally, in the Third Surprise, I got one right. I said the Federal Reserve would only raise interest rates once during the year even though they indicated in December 2015 they might raise rates four times. My reasoning was the economy would only be growing at about a 2% pace and be too fragile to endure four rate increases. The Fed’s comments remained cautious all year.
The Fourth Surprise was really hurt by the outcome of the election. I had thought that foreign investors would reduce their holdings of U.S. assets including stocks and the dollar would weaken. While the dollar did show some signs of softness during the year, the Trump victory caused people to believe it would strengthen because of renewed growth in America. So I ended up getting this one wrong also.