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Despite Brexit concerns, the probability of rising rates, and uncertain political outcomes, the S&P 500 climbed 2016’s wall of worry and posted a +11.96% total return.  More economically sensitive, the DOW Index did even better moving up +16.5% and came within a hair’s breadth of breaching 20,000.  Following the election, the markets made the determination that the projected economic benefits of constraining Obamacare, reducing taxes, and cutting red tape would outweigh the possible downside of any Trump initiated trade war.

The roundtrip that interest rates made during 2016 begs for commentary.  While we started the year with a 10 Year Treasury yield of 2.27% and ended at 2.45%, we dipped as low as 1.37% (July 5) immediately following Brexit.  So, interest rate sensitive securities such as bonds, preferred stocks, electric utilities, etc. had a fantastic rally and posted impressive paper gains for the first six months of the year.  However, rising from 1.37% up to 2.45% reversed some of those earlier gains.  The fact that December’s rate hike was only the second rate hike in ten years serves to remind investors that many income portfolios, including ours, have been built at lower tide, i.e., a decade of lower rates.  Foreseeing this, we have constructed the portfolios with shorter maturities which will better withstand a series of rate hikes.

The energy sector had been steadily moving up all year long on rumors of an OPEC negotiated production cut; the sector finished the year up +23.7%.  The real shocker was the financial sector’s return, which, up until late in the year, had actually been negative.  The hope for less bank regulation combined with December’s rate increase propelled the financials to a +20.5% gain in the fourth quarter alone.

In the 4Q, drug companies seemed to take some solace from Trump’s election.  Momenta Pharmaceuticals, a biotech focused on biosimilars, and BioSpecifics, a biotech focused on the collagen market, both posted returns north of +20%.  Seadrill, weathering the energy storm, gained +44%, albeit from a very low base.  Stratasys was down -31% as the market reassessed the long term growth outlook for plastic 3D printing which we conclude is still favorable, e.g., artificial joints.

We sold General Cable in the 4Q based upon full valuation.  We purchased no equities because we did not identify any individual securities we judged attractive within a margin of safety.  If anything, the market’s PE has only become more expensive.  Current Goldman Sachs research concludes that “across an average of seven valuation metrics, the S&P 500 is in the 90th percentile when it comes to valuation versus historical data.”  Following Trump’s election, we sense ‘animal spirits’ are overwhelming fundamentals and, rather than rely on hope, we insist on actual earnings.

Gold Leaf is an independent Registered Investment Advisor that buys stocks/bonds in cash positive companies with sustainable competitive advantages.  As an independent firm, Gold Leaf provides objective investment management.  Our goal is to protect client assets on the downside while participating in most of the market’s upside.

January 1, 2017                                                                            Paul F. Rodgers, CFA

Gold Leaf does not provide legal, accounting, or tax advice.  Please consult your personal                                                         lawyer or accountant.