U.S. stocks rose in the fourth quarter of 2016, with major indexes repeatedly reaching record highs in the final weeks of the year. Shares traded off early in the quarter in the runup to the November 8 U.S. presidential election. Uncertainty around outcomes and also a stronger possibility of an interest rate increase held equities back through October and leading up to the election. However, an unexpected presidential election victory by Donald Trump sparked a feverish stock market rally in anticipation of a friendlier regulatory environment and stimulative fiscal policies, including tax cuts and increased infrastructure spending. Small-cap stocks substantially outperformed large-caps, with the Russell 2000 Index more than doubling the large-cap S&P 500 Index (for the second quarter in a row). Value stocks significantly outperformed growth stocks across all market capitalizations but especially among small-caps. Many segments perceived to be beneficiaries of the new policy regime, most notably financials, turned in very strong performance to close out the year. Other segments viewed to be more negatively or less beneficially impacted, most notably health care and tech, turned in more subdued returns during the quarter.

As evidenced by the strong equity markets, investors have factored in significant upside to the prospects for corporate earnings moving forward in light of the election outcomes. While we are sanguine about the opportunities that implementation of a pro-growth agenda can have, we are also being measured and mindful of the implications on our portfolio holdings. The projections on a lower tax regime, in particular, have already provided significant boosts to shares in highly taxed industries like industrials. However, we expect the implications to be more widespread and also impact many companies that pay relatively low (or no) tax rates today but would have been slated to pay higher rates in the future due to an improved earnings profile. It is these long-term winners that we favor. We are also balancing the positive implications of proposed policies with the potential negatives, like a detrimental impact on trade and a move toward protectionism. In our opinion, investors have priced in most of the positives, with few weighing the potential pitfalls. Overall, we remain cautiously optimistic and steadfast in our long-term goal to invest in a broad, diverse mix of small- to mid-cap growth and value U.S. equities with valuations that underestimate the durability of growth or turnaround potential within the company.