Quarterly Investment Commentary, July 2016Submitted by Harvest Asset Group, LLC. on July 26th, 2016
The U.S. has continued to chug along at a decent pace under favorable economic conditions (full employment, low inflation, low energy costs), and is on track to produce growth of about 2% this year. Despite some scary headlines, and resulting short term volatility, U.S. companies have produced strong earnings. U.S. equity markets mostly eked out small gains during the quarter and for the first half of the year.
In the short run, news events that create uncertainty can trigger sudden and dramatic price swings for equities. Such events, and the market volatility that follows, get a lot of attention. However, in the long run, the key driver of equity values is company earnings.
We have had an abundant supply of market moving headlines - the most recent being a vote in the U.K. to exit the European Union. This created a classic opportunity for investors to panic and sell - many did. This event created another real life example where those who kept their heads sailed through just fine, and those who let panic make their decisions lost money.
The U.S. has been a standout in the global economy. Many other regions of the globe are working through difficult economic challenges. International investments are not performing as well as U.S. currently, but it is reasonable to expect them to come to the rescue when the American bull market finally turns.
When will that be? Interestingly, only 22% of individual investors in the U.S. consider themselves bullish on equities, which is well below the historical average. This brings to mind a famous quote by Sir John Templeton:
“Bull markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria”
On that basis, this bull market in U.S. equities seems to be a long way from death’s door.
Today’s Economic Perspective
The American economy is on track to grow at a 2% rate this year. This is not particularly strong, but is sustainable and not likely to overheat different sectors and lead to a recession. A wide array of economic data, as captured by the latest index of leading economic indicators, suggests continued growth ahead despite some recent weakness in the forward looking economic data.
On the positive side of the economy:
- Manufacturing activity is robust and expected to grow
- New job formation has been strong. Unemployment has fallen to below the Federal Reserve target
- Inflation is low and expected to stay that way
- Low oil prices have lowered the price of doing business and the cost of living across the American economic landscape
Economic question remaining:
- Will the European Union break up now that its second-largest economy has voted to exit? Active political movements in at least a dozen Eurozone countries are pushing for an exit. Is the UK just the first domino?
- Have oil prices bottomed out or will they just bounce around unpredictably?
- Will the good news on employment create wage pressure and thus weigh on corporate profit margins?
- Will the Fed successfully navigate back to more normal interest rates?
Today’s Market Perspective
The U.S. has been a haven of stability in a very messy world. Large U.S. company stocks (as measured by the S&P 500 index) posted a gain of 1.9% in the second quarter and are up 2.69% for the first half of the year. Small U.S. companies (as measured by the Russell 2000 small cap index) posted gains of 1.96% for the quarter, erasing losses in the first quarter and posting moderate gains for the year.
Internationally, companies in developed foreign countries (as measured by the EAFE index) have lost 6.28% for the first half of the year. European Union stocks lost 7.6%, and emerging markets are still posting gains for the year.
Attempting to predict the future in markets can be perilous, and this is abundantly clear as it relates to the fixed income market. Prognosticators have been expecting significant rate increases for more than half a decade now. However, bond yields have been declining, not rising. Inflation has remained more subdued than even the Fed had been predicting. Demand for bonds has been heavy in the face of declining net issuance of new U.S. Treasury bonds.
There will be plenty of other opportunities for panic in the future where terrorism, a continuing mess in the Middle East, a refugee crisis in Europe and premature announcements of the demise of the European Union will deflect attention away from what is actually a decent economic story in the U.S.
Volatility can be expected with each new headline, and investors who rely on investments for income should have processes in place to help reduce the risks caused by sudden changes to security values.
Remember that volatility is normal and cannot be avoided if you are investing in equities to achieve long term growth. Risk, on the other hand (best understood as the probability that you will lose money or fall short of meeting your goals or needs) can be managed through a disciplined process, and by avoiding behaviors that can impede attainment of your financial goals.
As an investor it pays to stay focused on long term appreciation, which is driven by the day to day process of companies employing their creative resources and ingenuity to produce revenue, growth and profits.
We help clients build investment strategies driven by financial planning. We stay rigorously focused on integration with the other elements of a successful financial plan, including asset protection, retirement sustainability, and estate planning.