Third Quarter 2017 Market Recap

The third quarter of 2017 again posted positive returns for domestic, European and emerging market equities. Global growth is back for the first time in a decade, with 45 economies monitored by the Organization for Economic Cooperation and Development (OECD) in economic expansion. As Jim Paulsen, Chief Investment Strategist of the Leuthold Group, has stated we are in a sweet spot with low inflation, low interest rates, and higher earnings all resulting in higher valuations and rising stock markets around the world. In addition, for the first time in eight years we have a President who is pro-business and whose agenda includes increased fiscal spending, less regulation and lower corporate taxes which if enacted could result in even higher earnings.

However, we are watching the Federal Reserve’s actions as they have started to slowly normalize monetary policy by gradually lifting interest rates. If inflation increases and the Federal Reserve takes on a more aggressive role in raising rates, it could provide a problem for U.S. equities.

We have currently positioned our portfolios to reflect a slight over-weight in both the international and emerging markets versus the U.S. domestic market. As for bonds, we are positioning the portfolios for a gradual rise in interest rates thus, we remain with shorter maturities on the yield curve.

Second Quarter 2017 Market Recap

The first half of 2017 brought predominantly positive returns for all markets and our portfolios. In the U.S. strong equity markets saw earnings improve dramatically not only in the first quarter, but all indications are the second quarter as well. Overseas earnings improved even more as developed and emerging economies continued to grow. After five years of neglect international stocks are finally in the sweet spot because they are producing strong earnings growth from a low valuation starting point.

Some would say that 2017 has been a goldilocks year so far with stocks and bonds up amid record low volatility. One looming concern is a disconnect on monetary policy, with the Fed penciling in seven more rate hikes in the next two years versus the market’s expectation for one or two. So far, the rate hikes have not had material effect on the U.S. equity markets even though the yield curve (spread between the 3-month and the 10-year treasury yields) has been flattening (a sign of a potential recession). If the flattening were due to a deteriorating growth outlook it would likely be detrimental to stocks, but most of the fall in longer term yields appears to be lower inflation (a positive for stocks).

So, are risks growing or will the current bull market last through the second half of 2017 and longer? According to Strategic Research it has been 268 trading days since the last 5% pullback, the fourth longest streak since 1950. Despite political bumbling and geopolitical tensions, the bull market continues to proceed ahead largely ignoring the noise around it. The possibility of a correction in the second half is probably greater than it was in the beginning of the year. Any combination of the Fed raising rates too quickly and earnings growth slowing would have an impact as valuations have risen in an era of artificially low interest rates.

With global GDP (Gross Domestic Product) currently at 3.6% (vs. 2.1% for the U.S.), for the first time in many years we have a global expansion fueling stock prices. This is dramatic as the last few years have seen the U.S. be the primary engine for global growth. This is also positive because it allows for better diversification and more opportunities for gain.

First Quarter 2017 Market Recap

The primary driver of markets in the first quarter was the continuing coordinated global economic recovery which began last fall. Stocks around the world are starting to show earnings growth. For example, in the U.S. the earnings projections for the first quarter of 2017 show an increase of 9% versus a year ago which would be the highest growth rate since 2011. The stock market rallied following the November election, largely on the belief that fiscal stimulus in the form of tax cuts and a large-scale infrastructure spending package would spur growth. However, achieving these goals is certain to be more difficult than was initially assumed. Given lofty valuations in the U.S. the timing and size of fiscal policy will be a key influence on earnings growth and market movements in the coming years.

In addition, to a large degree the first quarter of 2017 marked a time of reversal for international markets in a good way for the first time in years. Reversals of some influential trends that had worked against the global markets the fourth quarter of 2016 turned in a more positive direction in the first three months of this year. Most noticeable was the broad decline in the U.S. dollar. The dollar had risen in the fourth quarter, especially after the U.S. election results as investors reasoned that the new administration’s policy would attract investment to the United States and boost the dollar. Since the opposite has happened, the currency translation has been a positive for international equities. In addition, many of the region’s economies have been showing long awaited signs of recovery.

We remain optimistic on the markets, with renewed economic growth and solid earnings this long-running bull market should continue. With global expansion in play for the first time in many years we see contributions to the portfolio’s return coming from the U.S., international developed, and emerging markets.

Fourth Quarter 2016 Market Recap

2016 markets began the year with a six-week downturn, as concern over plummeting oil prices and an economic slowdown in China manifested in investor concern for a looming recession. On January 20th oil sold for a twelve-year low of less than $27 a barrel (currently $52 a barrel), and the Standard & Poor’s 500 Index was down 9% from the start of the year. By mid-February the S&P 500 was down a total of 10.5%, representing the stock market’s worst start to a year. Ultimately, investor sentiment shifted with an increase in the price of oil and the realization a recession was not imminent. The year ended on a positive note with the S&P 500 Index up approximately 9.46%. It should be noted that the third quarter of 2016 marked the end of four straight quarters of negative earnings which we think was in part responsible for basically a flat market for the past one and a half years.

Welcome to 2017. The current economic recovery turns nine this summer, making it the third longest in U.S. history, however this calendar-old recovery still appears young at heart, and a recession from several indications appears to be a few years away. We expect the U.S. real GDP growth of about 3% this year. As mentioned above, the third quarter marked the end of negative earnings growth and earnings began rising again the fourth quarter of 2016 and estimates suggest a healthy gain in 2017. In addition, consensus has the U.S. dollar rising as interest rates rise going forward. However, we think the U.S. dollar will actually weaken as has been the case in all interest rate hike cycles in the past..

As far as the bond market is concerned, we think the recent rise in bond yields will continue throughout the year. The combination of an incoming U.S. president promising a pro-growth and pro-business agenda, with economic growth accelerating, we think interest rates along with inflation will rise throughout the year. Since this is the case, we feel the best place to be is in the short maturity (1-3 years) range.

Elsewhere there are signs of a global economic bounce for the first time in years. This should help developed and emerging markets throughout the world. Throw in a weak dollar and we may get an additional bump in terms of market prices.

Finally, since we are in the latter stages of this bull market, we do not expect either a severe bear market or a strong bull market, but somewhere in between, meaning most likely a modest advance. We base this on the fact that we are in the mature part of the U.S. earnings cycle, where earnings are not likely to grow as fast as they did earlier in the recovery. In addition, stocks are no longer cheap and interest rates are no longer declining.

All in all, we remain optimistic on the markets and especially in view of the fact of a new pro-business presidency, whose policies can only add to the performance of the economy and the stock market (lower taxes, less regulation, more jobs, etc.).

Third Quarter 2016 Market Recap

With the close of the third quarter 2016, stock markets around the world failed to find firm direction in one way or another. The quarter began with equities in full bull market mode, owing to a rebound from post-Brexit declines that notably occurred because so few investors actually expected the Brexit vote to pass. In July and August generally modest gains continued due primarily to generally positive earnings. In September, however, the appetite for risk loosened amid volatility from steeper valuations, weaker economic data, the potential Fed rate rise, and the uncertainty of the presidential race that has been the very definition of the unexpected. That said, while U.S. equities dropped somewhat they still remained positive for the quarter, however international equities outperformed U.S. equities for the first time since early 2015, thus for the first time in a long time markets other than the U.S. participated in our portfolios. In addition, despite the equity market fluctuations bond yields remained low across the globe, a reflection of an accommodative monetary policy by central banks.

In much the same way people are uneasy with change, the markets are uncomfortable during times of uncertainty. The extreme nature of elections and/or referendums is a source of discomfort at home and abroad. In addition, it appears the Federal Reserve is prepared to raise interest rates for the first time in December of this year. To us that translates into a transition period where we think the market is moving from an interest rate bull market to an earnings-driven bull market. While this has been a historically long recovery of over seven years we think this next phase will allow for this bull market to continue for some time.

Second Quarter 2016 Market Recap

Second Quarter 2016 Highlights

• Bond yields continued to drop, especially with the “flight to safety” from Europe and the Fed’s decision not to raise rates.
• Oil prices and the dollar have stabilized creating a rebound in commodities and emerging markets.
• U.S. stocks continue to advance albeit with the lowest level of bullish sentiment in more than ten years.

The markets continue to recover from their first quarter lows, especially with the volatility accompanying the United Kingdom’s decision to leave the European Union, which was the most recent speed bump in a sideways market now over 18 months in duration. The U.K.’s disentanglement from the European Union will be a long and uncertain process, but the impact on the U.S. economy should be small. Recent data suggests a pickup in the U.S. economic growth in the second quarter, led by a rebound in consumer spending. The contraction in energy exploration (rig counts drop) should be near an end and no longer a drag on overall growth.

A major stumbling block for U.S. equities is the continued negative corporate earnings growth, while low interest rates and inflation continue to be supportive of higher-than-normal valuation levels. Without increased earnings, stock prices are most likely to stay within the narrow trading range they have been in over the last year and a half.

Until recently, global diversification has not added value to overall portfolio returns as the markets of Europe, Japan, and emerging markets have been wrestling with the same issues the U.S. did in 2008. However, with the recent stabilization of the dollar and the drop in energy prices, emerging markets and, in particular, commodities have had a resurgence. Thus, we are selectively adding to the portfolio investments in these areas.

Overall we remain cautious, with a slight emphasis on bonds and are positioned within the portfolios for future volatility, especially with the presidential election in November 2016.

First Quarter 2016 Market Recap

A quarter ago investors harbored concerns about declining oil prices, an economic slowdown in China, and the potential for recession looming in the U.S. prompting the first double-digit loss and resulting double-digit gain ever in one quarter, with the markets essentially going nowhere for the first three months of the year.

Will this be a year of dips and rallies, as opposed to a large upward or downward move in the market? Probably. Why—you may ask? Lots of uncertainty, from low GDP (economic growth), to flat-to-down corporate earnings projects, to an election year, and to the Fed’s potential for raising rates. The market (S&P 500) does not like uncertainty, so it’s apparent that until we can see resolution on some of these areas, the market most probably will be in a trading range (1800-2100 S&P 500).

There are two significant bright spots developing. The first, the increase in the stability in the price of oil, now over $42 a barrel. The U.S. markets have been correlated with the price of oil for the past year so this is a positive. Secondly, the U.S. dollar has been a major headwind for corporate earnings over the past year rising significantly. However, it appears to have peaked and thus, the combination of a weaker U.S. dollar and strong industrial prices should lead to faster growth in S&P earnings through the last half of the year. We continue to believe that we are still in a bull market, but most probably now in the “mature phase” of the cycle (last year or so).

Thus, while the environment for stocks appears more positive than negative, due to low inflation, low interest rates, modest economic growth, etc., we remain cautious and under-weighted in equities at this point, and instead favoring bonds and more of a preservation-of-capital approach until we see more evidence that some of the uncertainties have cleared (other developments we are watching include the rise of gold and emerging markets).

Fourth Quarter 2015 Market Recap

The domestic equity markets seemed to be telling investors a story about resiliency in 2015. The S&P finished 2015 flat at -0.7%, but it was anything but a calm year. What is interesting is that even though the S&P 500 was flat for the year, the average stock in the index did considerably worse, returning -3.8%, according to Bespoke Investment Group. Another interesting point is that stocks nicknamed “FANG” (Facebook, Amazon, Netflix and Google), were up over 60% on a cap-weighted basis. If one excluded those four stocks, the S&P was actually down -4.8% last year. One can point to any number of events that proved to be triggers for market sell-offs. Amongst those being, a valuation adjustment of the market due to a slow-down in earnings growth, the Fed normalizing rates (i.e. raising them), the drop in oil due to the over-supply by the Saudis, and the Chinese devaluing of their currency. All of these indicate that, while we are on the longest expansion (entering year six), we have entered the stage where more volatility is happening with more regularity.

The current correction began the first of the year and is very similar to last August’s with a swift price decline and most probably due to the devaluing of the Chinese currency. While there are concerns, and some are professing a recession is around the corner, the evidence is not there. The larger services segment of the economy is showing very-sustained growth. Another point is, if a recession is coming it would not be brought on by a crash in oil prices. More often than not, it would be a surge in oil prices that would help trigger a recession.

“What we are facing now is an environment where the headwinds associated with weak oil have a higher miles-per-hour than the tailwinds, which have yet to pick up.” Oil prices likely have to stabilize for the market to do the same. (I might add that during the earnings season all company buybacks are suspended, thereby removing the potential floors for equity prices in the short term.) In addition to the stability in oil prices, we think that the Fed will have to postpone its rate hikes thereby providing more certainty for the markets.

It should be noted that years following flat years (the market has been flat six years since the end of World War II) that each year following the flat year the market was positive by double-digits. If earnings, without the negative effects of a reclining energy price and a strong dollar, can rebound, the market could very well end up on a positive note.

We should remember the words of John Templeton, “Bull markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria.” We are probably somewhere between skepticism and optimism and, in our minds, the bull market continues after this correction.

Some information provided by: Raymond James Financial and Liz Ann Sonders of Charles Schwab

Third Quarter 2015 Market Recap

Global stock markets experienced a number of low-scale tremors in August and September that seemed to shake the confidence of many investors. As with geological tremors, the events of the third quarter—increasing concern about China’s economy accompanied by a surprise Yuan currency devaluation, a subsequent tumble in global stock markets, and the Federal Reserve’s decision not to increase rates—are indications of a global economy that is not without its fault lines.

It is also the case that ups and downs should be expected as a typical part of any market cycle. In fact, the current market stands out for the unusually long time (six and a half years, to be exact) it has lasted without a bear market decline, defined as a drop of 20% or more. So while this round of market bumps has triggered the usual fear-driven news headlines, in our view nothing has broadly changed, except that foreign markets have gotten a bit cheaper and are a bit more appealing from a valuation standpoint. We would also note that while we’re not in the business of predicting downturns, we think it’s prudent to be prepared for them nonetheless. The reality of owning stocks is that occasionally, inevitably, we will experience declines of varying severity over time. For the quarter overall, stocks were down 6.5% while bonds rose 1.2%.

Another key ingredient in managing through market declines is helping you accurately assess your risk tolerances and investment objectives. If you are in an appropriately structured portfolio, there is no benefit to selling in a downturn. In fact, by doing so you risk selling nearer to the bottom and then missing the subsequent recovery.
We are likely to view downturns as potential buying opportunities—exemplified by our tactical moves since the end of September. This is based on our tactical asset allocation approach that centers on analyzing long-term fundamentals and valuations, while remaining sensitive to shorter-term portfolio risks. For example, emerging-markets stocks may have been the biggest losers in the recent downturn, but our return estimates indicate they are now poised to outpace U.S. stocks materially over the next five years across a wide range of economic scenarios.

In an uncertain world, it is impossible to confidently predict the direction of financial markets. But we can more confidently evaluate a range of possible scenarios in order to understand the scope of potential returns for one investment or asset class relative to another. Our objective is to always emphasize undervalued investments and de-emphasize overvalued investments while building a portfolio that we believe will deliver the highest long-term return in line with each client’s risk tolerance.

Second Quarter 2015 Market Recap

The second quarter concluded with a flurry of global economic news that rattled stock markets and cut into the quarter’s gains. Stocks are struggling to post gains in 2015. Very little price progress has been made as each quarterly closing price for the S&P 500 is near the preceding quarterly closing price. Greece was a major cause of market jitters at various points during the quarter, and particularly during the last few days of June as the country announced it would default on its month-end debt repayment to the IMF.

China was another source of news at quarter-end as the People’s Bank of China undertook a surprise rate cut, along with other easing measures. China’s economic growth has slowed as policy makers seek to contain overall credit growth and redirect the economy toward a more sustainable path. Closer to the United States, Puerto Rico announced at the end of June that it would be unable to handle full repayment of its municipal debt. All of these situations outside the U.S. were responsible for the increased volatility in the U.S. markets at quarter-end.

As we enter the third quarter, Greece will most likely move away from dominating investor attention, and the focus will likely shift to Fed policy and interest rates. With an improving, but still moderately growing U.S. economy (that is not triggering inflation), the pace of the Fed increase in interest rates would appear to be measured. Also, absent inflation, a sharp move higher in bond yields should not develop, in which case a premium valuation for equities is warranted. However, in an effort to avoid being a “blind bull”, our caution has admittedly increased with a multitude of issues at hand (The Fed and interest rates, European Union, current valuations, slowing earnings), leaving the market vulnerable to pullbacks and could be a catalyst for a correction, something on the order of a 10% decline. Based on history alone we are overdue for one. The S&P 500 has now gone almost four years or 45 months without at least a 10% decline, making this the third longest such stretch since World War II. Prior to this recent run, market corrections occurred roughly once a year on average. We note all of this, not as a short-term market prediction but as a plausible shorter-term scenario to be aware of and be prepared for.

Although investors should be aware of the vulnerabilities of a market in the current state, they should likewise not become too defensive or complacent.

It’s important to note that having a long “time horizon”, when owning stocks, is critical because inevitably there are going to be shorter-term negative surprises, and when these surprises occur investors should be prepared for increased market volatility given that markets often over-react to transitory shorter-term news or outcomes. In those moments, it is useful to remember that volatility is the shorter-term discomfort an investor must experience in order to earn attractive longer-term returns from owning stocks. For it is exactly those volatile market environments that can create compelling long term investment opportunities, in the form of tactical asset allocation opportunities for us and great stock and bond picking opportunities for the managers we use.