2nd Quarter 2016 Market Commentary

Despite tumultuous headlines, global markets finished the second quarter of 2016 on a high note. In the weeks since quarter end, major US stock market indices have reached new all time highs. US stocks were up 3.84% through the first half of the year, measured by the S&P 500 Index. Emerging market stocks snapped a pesky losing streak, gaining 6.41% through June. International developed stocks suffered a setback with the UK’s Brexit vote in late June. The MSCI EAFE Index was down -4.42% year to date. Interest rates plunged to new lows after the Brexit vote and global bond prices soared. The Barclays US Aggregate Index was up 5.31% for the year. Both real estate and commodities fared well during the first half of 2016. Global REITS were up 12.33%, and the Bloomberg Commodity Index was up 13.25%.

Brexit, What Brexit?

On June 23rd, the U.K. voted to leave the European Union. The “leave” vote, titled Brexit, was unexpected, and markets reacted violently. The Dow Jones Industrial Average fell more than 600 points on Friday, June 24th.  The British Pound fell more than 7% overnight, to levels not seen since the mid 1980’s.  The Pound has not recovered its loss as many other financial markets have in the weeks since the Brexit vote.

One-Year Chart of British Pound to US Dollar

Pound Chart

Source: Bloomberg.com

After a sharp two-day drop, most global stock markets recovered quickly after Brexit. Bonds rallied as interest rates dropped to new lows, in anticipation of a rate cut in the U.K. and continued delay of a rate hike by the Fed. But the U.K. economy, European banks, and the U.K. property market continue to suffer.  Michael Hasenstab, global bond manager at Franklin Templeton, expects a 2% – 7% contraction in the U.K.’s economy over the next several years.(1)  That is a brutal economic disruption, as the U.K. must negotiate every trade agreement with the European Union, presumably on less favorable terms.  Hasenstab expects a modest hit to the remaining EU economy of 0.5% and minimal negative effects for the U.S. and emerging market economies.  Markets do not like surprises, and the Brexit vote was unexpected.  However, after the steep initial decline in global stocks, cooler heads prevailed, realizing that Brexit’s impacts outside the U.K. are likely to be minimal and won’t take effect for some time.

The Fed

Perhaps someday I will write a quarterly letter that does not include a section on the US Federal Reserve. Unfortunately, we continue on a journey of unprecedented monetary policy accommodation and low interest rates.  When the Fed’s Board of Governors met in mid June, they decided against a rate increase. You will recall they raised the policy rate by 0.25% from 0.0% in December.  In their meeting minutes, the Board listed a May jobs report number as a primary concern in raising the policy rate. “Almost all participants judged that the surprisingly weak May employment report increased their uncertainty about the outlook for the labor market.”(2) Since 2010, the US economy has added 14.4 Million jobs, averaging more than 2 Million new jobs per year. Compare this to the 8.6 Million jobs that were lost during the 2008-2009 financial crisis. It’s shocking that the Fed would give such credence to a single monthly report.  Let’s look at the past 24 months (including June 2016 which came in after quarter-end) for some perspective:

Payroll Table

Source: US Bureau of Labor and Statistics

At the start of the year, the consensus forecast called for 4 rate hikes in 2016. Today, we will be lucky to get one. This poses a continued threat for retirees living off of fixed income and for the U.S. economy in the next recession. Will we see negative interest rates in the U.S.? I hope not.

Market Volatility

The new market highs we are experiencing in the U.S. are levels we reached briefly in mid 2015 before a market correction. In fact, there have been several drops of 5% or more over the past six years. The Greek debt crisis, the US debt downgrade, the Taper Tantrum, Ebola, fear of a slowdown in China, and a recession in oil have all contributed to market declines in recent memory.

Market volatility

Source: JPMorgan Asset Management Guide to the Markets

This is nothing new. There will always be another crisis lurking around the corner. Modern financial markets have survived wars, natural disasters, financial crises, government debt defaults, environmental disasters, currency crises and a myriad of other shocks. 

Sometimes volatility causes markets and account values to hover around the same value for a few years. It can feel like not making any progress, and it can be frustrating. One of our core guiding principles for investment management is: Money is Made Over Time.  It means that investors earn a return for their time in the market, not by timing the market. There are times when investors really EARN those returns. They do so by staying invested during the most frustrating times.

Investing can be frustrating because we have access to perfect information after the fact. We look at charts, and we are hardwired to identify trends in those charts. This 20/20 hindsight leads an investor to think – If only I had bought there or sold here, I would have made a killing. In reality, the future is uncertain and unpredictable.  There may be multiple strategies for capturing market returns, but investors must resist the urge to shift from one to another. Jumping around creates the potential for missed opportunities and disrupts the ability to capitalize on a successful strategy. Rather than giving in to the urge to Do Something, be patient and allow your time in the market to earn your credits.

Blair DuQuesnay, CFA, CFP®

July 2016

Footnotes:

(1) “Brexit: Key Takeaways from Templeton Global Macro,” Hasenstab and Desai, June 30, 2016.

(2) “Minutes of the Federal Open Market Committee June 14-15, 2016,” page 8.