First Quarter 2018 Market Recap

After becoming accustomed to consistently robust equity returns throughout 2017, the first quarter of 2018 ushered in a bout of volatility unlike the low volatility of 2017, with the markets experiencing two 10% drops and ending the quarter about where they started. In our judgement, the playing field in 2018 has changed. We are now in a rising interest rate and potentially rising inflation environment.

The recent Federal Reserve minutes indicate that the Fed is on a fairly aggressive path of hiking interest rates. It should be noted that one of their main mandates is to control inflation and with the recent rise in oil and gasoline prices, as well as the CRB Broad Commodity Index, it appears that inflation is rising. Thus, it is quite possible we will see four rate hikes from the Federal Reserve in 2018. In addition, it is quite possible that the 10-year bond yield will creep up to 3.2% by the end of the year.

The recent passage of the tax bill and the continued de-regulation across many industries have been a tailwind for corporate earnings and equity prices. However, higher levels of inflation and higher interest rates represent a possible risk for equities, creating a sort of tug-a-war between the two.

One concern we have is that the U.S. market generally is a discounting mechanism. It is quite possible that the tax cut and enhanced earnings projections were discounted and paid for in 2017. Evidence of this can be seen from 2016 to January 2018, when the market was up 44% versus 14% growth in earnings thus, market gains may be muted until it is possible to see continued future earnings gains.

That being said, we have always been proponents of global diversification and this year is no exception, where we see international markets, both developed and emerging, as well as other asset classes like international real estate, commodities, and certain hedge fund type strategies, as being a complement to our existing portfolios.

As for bonds, while the siren call for a bond bear market continues, the Fed’s recent move to raise interest rates, and the flattening of the yield curve, all are signals to us to position our portfolios in a conservative risk posture, maintaining a focus on short maturities, as well as investments in rising interest rate vehicles like floating rate bonds.

As always, we think that a well-diversified portfolio in line with your long term goals should allow you to participate in upside potential as well as serve as a ballast for any short term volatility that may arise in the coming months.

Fourth Quarter 2017 Market Recap

In 2017, we were again reminded of the importance of following an investment approach based on discipline and diversification vs. prediction and timing. In fact, last year provided several interesting, and unexpected, examples on how best to achieve the long-term return the capital markets offer. For example: What do you get when you combine a tumultuous year for a new US president and divisive political trends in many global markets? Answer: A new record for the US stock market.

For the first time since 1897, the total return for the US stock market was positive in every single month of the year. As you may recall, a great deal of media coverage was focused on markets at all-time highs, and some investors braced themselves for a sharp drop in stock prices. Not only did the much anticipated “correction” never occur, financial markets remained remarkably calm. Out of 254 trading days in 2017, the total return of the S&P 500 Index rose or fell over 1% only eight times. By comparison, in a more rambunctious year such as 1999, it did so 92 times.

North Korea issued threats of a nuclear missile strike throughout the year and boasted that even mainland US cities were vulnerable to its newest warheads. Next-door neighbor South Korea would seem to have the most to lose if such a catastrophe occurred, but Korean stocks were among the top performers in 2017, with a total return of 29.5% in local currency and 46.0% in US dollar terms.

To many experienced analysts, Chinese stocks appeared alarmingly vulnerable as well. A gloomy November 2016 article warned that “China’s debt addiction could lead to a financial crisis.” In the article, a prominent Wall Street strategist observed: “It’s scary that China seems to be continuing its debt binge to achieve its unrealistic growth targets.” How did these dire predictions turn out? China was the third best-performing stock market in 2017 with a total return of 51.6% in local currency and 50.7% in US dollar terms.

These “surprises” from 2017 reinforce the challenge of drawing a direct link between positive or negative events in the world and positive or negative returns in the stock market.

However, it is really nothing new that financial markets surprised many investors in 2017, as they have a long history of surprising investors. For example, from 1926–2017, the annualized return for the S&P 500 Index was 10.2%, but returns in any single year were seldom close to this figure. In fact, returns for the S&P 500 Index for this time period were anywhere between 8% and 12% only six times, but experienced gains or losses greater than 20%,40 times (34 gains, six losses).

Clearly, attempting to pick only winning markets in any given period is a challenging proposition. By pursuing a globally diversified approach to investing, one doesn’t have to attempt to pick winners every time to achieve a rewarding investment experience.

Some Commentary provided by Weston Wellington, V.P. of Dimensional Fund Advisors

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