3rd Quarter 2016 Market Commentary

The third quarter finished strong for most global stock and bond markets. U.S. stocks, measured by the S&P500 Index, were up 7.84% for the year. Markets have pulled back a bit since the end of the quarter, however. Most of the economic news in the U.S. was positive over the summer, and corporate earnings recovered from last year’s decline in energy profits. International developed stocks fared the worst, yet the MSCI EAFE Index ended the quarter in positive territory year to date up1.73%. This is despite a rate cut by the Bank of England and a lackluster GDP report from Japan. Emerging market stocks soared. The MSCI Emerging Markets Index was up 16.02% year to date at quarter end. Despite painfully low interest rates, even bonds posted healthy returns. The Barclays Aggregate Bond Index was up 5.80% year to date. Both real estate and commodities had strong returns. Global REITs were up 12.35%, the Bloomberg Commodity Index was up 8.87% through the end of the quarter.

No One is Talking About Emerging Marketspicture1

Quietly, emerging market stocks and bonds have outperformed US and International developed
countries by a wide margin this year. Yet, this is getting practically zero coverage in the media. For almost 6 years, emerging market stocks underperformed, and investors lost interest. Fair weather fans rarely have the opportunity to bask in their team’s glory. So far in 2016, emerging market investors who have stuck to their discipline, were handsomely rewarded. The MSCI Emerging Market Index is up 16.02% versus 7.84% for the S&P500 Index and 1.73% for the MSCI EAFE Index.

The table to the right illustrates the dispersion of stock returns across various emerging market countries. Strong performance is not limited to a particular geographic region. Countries in South America, Asia, Eastern Europe, and the Middle East all exhibited double digit returns.

The story is similar for emerging market bonds. The JPMorgan EMBI Global Index of dollar-denominated emerging market sovereign bonds is up 15.04% versus 5.80% for the Barclays US Aggregate Index and 6.68% for the Citigroup World Government Bond Index (hedged to the US Dollar).

While we knew that emerging markets were undervalued, we had no way to predict the timing of a turnaround. What’s most surprising is the lack of coverage by the financial media. We are happy to keep this secret to ourselves for now.

U.S. Economy

U.S. household wealth hit a new all-time high of $89.1 trillion during the second quarter. The statistic was published in the Federal Reserve’s report, Financial Accounts of the United States.[1] The value of household holdings in publicly traded stocks rose $452 Billion and real estate rose $474 Billion. But asset appreciation does not tell the entire story. Wages and employee pay are rising as well. According to the September jobs report from the Bureau of Labor and Statistics, average hourly earnings have risen 2.6% year over year. [2]  Second quarter GDP (gross domestic product), a measure of US economic output, increased at an annual rate of 1.4%. This third estimate was revised up from 1.2% on September 29.[3] While these growth numbers may be lackluster, there are no negative reports or indicators on the U.S. economy to be found.

So far this year, the Federal Reserve has held back on raising interest rates. The Fed began 2016 expecting to raise rates by ¼ point at least four times. They haven’t raised once, and current market expectations are for one rate hike in December. If the Fed does raise rates in December, the U.S. policy rate will be 0.50% to end the year. Extremely low interest rates continue to punish savers and fixed income investors. There are currently $12.2 Trillion in savings accounts and money market funds earning close to zero interest. Relief for savers will be welcome and cannot come soon enough.

The Election

Americans are understandably nervous about the Presidential election. The encouraging news for long-term investors is that the occupant of the White House doesn’t control private enterprise or the stock market. The markets tend to be up in election years; 81% of the time since World War II. Stocks have helped investors grow and preserve wealth through all types of U.S. Presidents, foreign wars, recessions, and natural disasters. The chart below shows the growth of the S&P500 Index since 1926, highlighting all the Presidential terms. Remember that the media’s primary job is to boost ratings. Negative and outrageous news stories help them on this quest. We expect volatility in the markets leading up to and following the election, but we do not recommend trying to trade in advance of any movements, which are likely to be short-lived. Just like every major news event, there is no crystal ball to predict how the markets will react to election results. There are as many opinions as pundits willing to share them on 24/7 television news coverage. Our strategies are designed to weather all types of storms. We accept that risk is inherent to investing, and we know that discipline is rewarded over the long-term.

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“I don’t care too much for money, money can’t buy me love.” – John Lennon, Paul McCartney

 

Planning and investing are an important and prudent part of modern life. Sometimes investors become so engrossed in the minutia of the markets, they lose sight of their end goals. Are we here to earn the highest return or to live our most enjoyable life? Of course it’s important to track investment performance, measure outcomes, and make adjustments to stay on course. Investors should care for their finances just as they care for their health. But these chores are on the sideline of living real life. Don’t let your investments keep you up at night, and if they do, perhaps it’s time to reconsider your risk tolerance. A long-term, disciplined investment strategy allows investors the freedom to enjoy life knowing that short-term hiccups and downturns will not destroy their financial plans.

 

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Blair duQuesnay, CFA, CFP®

October 2016

 

 

 

[1] Financial Accounts of the United States: Flow of Funds, Balance Sheets, and Integrated Macroeconomic Accounts; Board of Governors of the Federal Reserve System, September 12, 2016.

[2] The Employment Situation – September 2016; Bureau of Labor and Statistics, October 7, 2016: http://www.bls.gov/news.release/empsit.nr0.htm

[3] National Income and Product Accounts Gross Domestic Product: Second Quarter 2016 (Third Estimate); Bureau of Economic Analysis, September 29, 2016, http://www.bea.gov/newsreleases/national/gdp/gdpnewsrelease.htm