Quarterly Investment Commentary, October 2016Submitted by Harvest Asset Group - Fee-Only Financial Planner on November 1st, 2016
The market once again confounded the instincts of nervous investors and went up, instead of down, during Q3 2016. What worried investors last quarter included the Brexit scare and potential Fed rate hikes.
You may recall, on June 24th (not very long ago) headlines read:
“Brexit Stuns Markets, Dow Falls 600 Points”
Yet 100 days following this “catastrophic” news, the market was up, not down. Again, recent market history can serve to clarify the value of employing a disciplined investment strategy. Those nervous investors who reacted to concerns in the markets and economy did so at a cost.
Recently, Fed Chairperson Janet Yellen told the world that the U.S. economy is healthy enough to weather a rise in interest rates, but the Fed governors met in September and declined to serve up the first rate hike since last December. This was reassuring news to Wall Street traders and investors, and helped drive yet another quarter of gains in U.S. stocks.
Presidential politics is a concern for many investors today. This election cycle is producing both high intensity emotions and uncertainty, which can be expected to trigger volatility in markets.
So should you take your investments off the table and move to cash as some pundits have suggested? The rhetoric flowing from politicians and other sources predicting either financial ruin or unprecedented prosperity can be dangerous distractions to your financial resolve. Now is an ideal time to renew your commitment to a well-planned, long term approach to managing your investments.
Today’s Economic Perspective
A deeper look at the U.S. economy suggests that the economic picture isn’t nearly as gloomy as it is sometimes reported by the press. Economic growth for the second quarter has been revised upwards from 1.1% to 1.4%, due to higher corporate spending, particularly in research and development.
The slow, steady growth we have been experiencing since 2008 is showing no visible signs of ending.
Positive economic news:
- America’s trade deficit shrank in August
- Consumer spending, which makes up more than two-thirds of U.S. economic activity, rose a robust 4.3% for the quarter
- The economy gained 151,000 more jobs in August, and unemployment remained below 5% for the third consecutive month
- Average wages for American workers have risen 2.4% so far this year
- Economists at the Federal Reserve Bank of Cleveland have estimated the chances of a recession next year at a low 11.25%
- Corporate profits (which drive stock prices) have been on a long term upswing
- Corporate profit margins could narrow further as labor costs rise
- Europe may be vulnerable to another crisis phase, driven by Brexit negotiations and general elections in France and Germany in 2017
- The U.S. Presidential election can usher in a period of greater-than-average stock market moves
- We don’t yet know how effective the extraordinary monetary policy measures, like negative interest rates and quantitative easing, will be. They could potentially distort financial markets and undermine the bank recovery in Europe and Japan
- Will the Fed successfully navigate back to more normal interest rates?
Today’s Market Perspective
The U.S. remains a haven of stability in a very messy global investment scene:
- The Wilshire 5000 Total Market Index (the broadest measure of U.S. equities) gained 4.53% for the third quarter, and is now up 8.39% for the first three quarters of the year
- Larger companies posted the lowest gains. The S&P 500 index of large company stocks posted a gain of 3.31% in the third quarter and is up 6.08% for the year so far
- Small company stocks, as measured by the Wilshire U.S. Small-Cap index, gave investors a 7.67% return during the third quarter, up 13.03% so far this year
Among international markets, performance varied widely among regions:
- The broad-based EAFE index of companies in developed foreign economies gained 5.80% in dollar terms in the third quarter of the year, but is still down 0.85% for the first three-quarters of the year
- European stocks have lost 2.67% so far in 2016
- Far Eastern stocks are up just 1.73% for the year
- In contrast, a basket of emerging markets stocks domiciled less developed countries, as represented by the EAFE EM index, gained 8.32% for the quarter, and are sitting on gains of 13.77% for the year so far
On the bond side, the interest rate story is essentially unchanged: rates are still low, once again confounding all the experts who have been expecting significant rate rises for more than half a decade now. 10-year U.S. government bonds are currently yielding 1.59%. Three-month notes were yielding 0.27% at the end of the quarter, while 12-month bonds were paying just 0.58%. You would need a 30 year duration to get a 2.32% annual coupon yield.
The economy and markets continually evolve and change. For example, the U.S. has evolved from an economy dominated by manufacturing and personal consumption of goods, to a service economy.
Markets change, and the changes tend to surprise investors. Any asset classes can do well or disappoint during different periods of time. For example, in recent history, Large U.S. companies have provided greater returns than international stocks. However, since 1970, foreign stocks have outperformed domestic stocks almost exactly 50% of the time. The long trend we’ve become accustomed to with large U.S. companies could reverse itself at any time. This is why diversification is an indispensable tool for long term success.
Our investment process is guided by financial planning, and time proven investment principles such as diversification, periodic rebalancing, controlling expenses, and investing according to when you need the money.
Given the current backdrop of uncertainty and change, now is a good time to renew your commitment to a well-planned, long term approach to managing your investments. Don’t let the news and rhetoric be distractions to your financial resolve.