Investment Review

Winter 2017

After a rocky start, the U.S. stock market had a strong year. The S&P 500 Index logged a 12% total return and small cap stocks, as measured by the Russell 2000 Index, returned 21%. Overall, performance among non-U.S. markets was also positive: Developed foreign markets logged a 3% return and emerging markets returned 12%. In 2016, the small cap and value premiums were positive across U.S., developed international, and emerging markets.

Many investors may not have expected global stocks and bonds to deliver positive returns in such a tumultuous year. This turnaround story highlights the importance of diversifying across asset groups and regional markets, as well as staying disciplined despite uncertainty. Although not all asset classes had positive returns, a globally diversified, market cap-weighted portfolio logged attractive returns in 2016.

Investment grade bonds experienced negative returns in the fourth quarter of 2016, but they were in positive territory for the year. Muni bonds had a surprisingly bad fourth quarter and were down for the year. We took advantage of this by harvesting losses in the final days of December.

 
Selected Headlines from the Past 12 Months Graphed with the World Stock Market Performance (MSCI All Country World Index)

 
We are not offering these headlines to explain market returns. But they do serve as a reminder that investors should view daily events from a long-term perspective and avoid making financial decisions based solely on the news.

 
Investment Review

Benchmark Funds	Q4 2016	12 Months Ending 12/31/2016
U.S. Large Cap Vanguard 500 Index Fund	+3.8%	+11.8%
U.S. Large Cap Value iShares Russell 1000 Value Index	+6.8%	+17.3%
U.S. Small Cap iShares Russell 2000 Index	+9.0%	+21.6%
U.S. Small Cap Value iShares Russell 2000 Value Index	+14.2%	+32.0%
International Vanguard Total International Stock Index Fund	-1.9%	+4.7%
Emerging Markets Vanguard FTSE Emerging Markets ETF	-4.5%	+12.2%
U.S. REITs Vanguard REIT ETF	-2.9%	+8.6%
Investment-Grade Bonds iShares Core Total U.S. Bond Market ETF	-3.1%	+2.4%

 
Individual Asset Classes

World Asset Classes

Looking at broad market indices, the U.S. outperformed both non-U.S. developed and emerging markets during the quarter. U.S. and non-U.S. real estate investment trusts (REITs) recorded negative returns and lagged the U.S. and non-U.S. equity markets.

The value effect was positive in the U.S., non-U.S., and emerging markets. Small caps outperformed large caps in the U.S. and developed markets outside the U.S. but underperformed in emerging markets.

U.S. Stocks

The broad U.S. equity market recorded positive performance for the quarter. Value indices significantly outperformed growth indices in the U.S. across all size ranges. Small caps in the U.S. outperformed large caps.

International Developed Market Stocks

In U.S. dollar terms, non-U.S. developed markets lagged the U.S. equity market but outperformed emerging markets indices during the quarter. Small caps outperformed large caps. Looking at broad market indices, the value effect was positive across all size ranges.

Emerging Markets Stocks

In U.S. dollar terms, emerging markets indices underperformed both the U.S. and developed markets outside the U.S. Looking at broad market indices, the value effect was positive across all size ranges. Small caps underperformed large caps.

Real Estate Investment Trusts

U.S. and non-U.S. REITs had negative performance for the quarter, lagging the broad equity market in both regions.

Fixed Income

Interest rates increased in the fourth quarter. The yield on the 5-year Treasury note rose 79 basis points (bps), ending at 1.93%. The 10-year T-note yield climbed 85 bps to 2.45%. The 30-year Treasury bond yield added 74 bps to close at 3.06%.

In 2016, the short end of the yield curve saw the greatest rate increases. The 1-year T-bill gained 20 bps to 0.85%, while the 2-year T-note finished at 1.20% after an increase of 14 bps for the year.

In terms of total returns, short-term corporate bonds declined 0.18% during the quarter but gained 2.36% for the year. Intermediate corporates fell 1.84% during the quarter but rose 4.04% in 2016. Short-term municipal bonds declined 1.07% for the quarter but increased 0.07% for the year. Intermediate-term municipal bonds fell 3.74% for the quarter and 0.45% for the year. Revenue bonds outperformed general obligation bonds for the year.

In Conclusion

We firmly believe that it is a fool’s game to try to beat the market. Financial markets are made up of millions of participants, and these participants voluntarily agree to buy and sell securities all over the world based upon their own needs and desires. Each day, millions of trades take place, and the vast collective knowledge of all of these participants is pooled together to set security prices. Any individual trying to outguess the market is competing against the extraordinary collective wisdom of all of these buyers and sellers.

Trying to outguess the market is incredibly difficult and expensive, and over the long run, the result will almost assuredly be inferior when compared to a market-based approach. Professor Kenneth French has been quoted as saying, “The market is smarter than we are and no matter how smart we get, the market will always be smarter than we are.”