Market View (July 2016) – Navigating the Brexit
So what happened during the second quarter 2016? Well, the elephant in the room was the United Kingdom’s (UK) referendum to leave the European Union (EU), also known as the Brexit. The referendum was set by British Prime Minister David Cameron to appease a national populist movement concerned by fears that the UK was losing its national sovereignty to the European Union. An overwhelming majority of political observers and economic analysts predicted a ‘Stay’ vote as the result of the upcoming referendum. This confidence led to a rally in global financial markets leading into the days before the vote, clearly in anticipation that the United Kingdom continue as a member of the EU. However, the majority of Britons voted to leave the EU, which shocked the entire financial markets and resulted in Prime Minister Cameron’s resignation.
Global equity markets declined sharply on the news. Media experts opined that the vote would spark a chain reaction of adverse events that would lead to the eventual breakup of the European Union. However, two days after the vote, cooler heads prevailed and equity markets started to recover from their initial reaction. How the vote will ultimately affect European, British, and Global markets remains to be seen, as events are very much in a state of flux and new nuances of the Brexit seem to appear daily.
Despite the Brexit-borne fireworks, the S&P 500 closed the end of the second quarter 2016 at 2098 for a total return of 2.4% and a year-to-date return of 3.8%. On the overseas front, non-U.S. equity performance was mixed. Emerging market equities (MSCI EM) had a small positive return for the quarter and the index remains up 6.4% for 2016. As expected with the Brexit, developed market international equities (MSCI EAFE) posted a negative return for the quarter of 1.4%. Overall, we maintain our view that equities can continue to outperform bonds, cash, and inflation over the long term, and during these periods of market weakness we see potential buying opportunities. After Brexit, United States (US) stocks are now seen as a less risky holding compared to their European counterparts. Corporate fundamentals are strong and valuations remain reasonable in light of low inflation and low interest rates.
Federal Reserve Chair Janet Yellen remains motivated to normalize rate policy. Regardless of her motivation, any rate increase this summer is highly unlikely. The bond markets are even suggesting that a rate cut might now be more likely than a hike. In June, U.S. Treasury bonds were the beneficiary of a post Brexit flight to quality with the 10 Year Bond yield falling to 1.49% from 1.84% from the month before (remember, as yields fall, bond prices rise). Despite the flight to quality in Treasury bonds, corporate bonds (credit) continued to perform well. During the second quarter, high yield bonds led the way with the Barclays High Yield index posting a 5.5% return, while Barclays intermediate and short term bond indices returned 1.4% and 0.9%, respectively. Overall, bond prices remain strong and fundamentals stable.
Commodities led the way for alternatives in the second quarter of 2016 with the Bloomberg Commodity Index posting a return of 12.7%. Commodity markets have recovered through 2016 largely due to the rebound in oil prices. Factors such as a weakling dollar and falling supply have led to the first sustained rally in two years. Oil is near $50 a barrel which is roughly half the price of the highs from two years ago. In addition, Real Estate Investment Trusts (REITs) continue to perform well with the FTSE NAREIT index posting a second quarter return of 7.4%. REITs remain strong as investors are looking for higher yields in a low rate environment and we believe the demand to own REITs will continue as the S&P Dow Jones Indices give REITs their own industry classification later this summer. Lastly, managed futures performed as expected during the quarter, especially as the Brexit news hit the markets. Prior to the Brexit news, managed futures had a negative return for the year and as the equity markets fell sharply, the AQR Managed Futures fund posted a strong positive return and ended the quarter with 2.1% return for 2016. Fortunately, our alternatives allocations performed relatively well in the second quarter, benefiting portfolios by reducing risk and increasing return.
As odd as this may sound, what we are not surprised by is the fact that a global, economic and political event caught everyone by surprise. The market volatility we’ve experienced in the last two weeks reinforces the importance of properly allocating one’s investments to reflect both their current and future needs. Over the last few years, as the last week of June will certainly reinforce, we have experienced a market environment increasingly driven by headline risk. As tempted as one might feel to make sweeping investment changes in the face of market turmoil, it’s critically important to remember daily market conditions are short term and ever-changing, while the need for your investments to remain productive and diversified remains constant.
It’s easy to heed the advice of so-called media experts or feel the need to make trades based on the current environment, however, many of last year’s poorest performing investments are delivering the strongest returns of 2016. It’s the long-term perspective that delivers solid performance. We welcome you to reach out to us should you have any thoughts or concerns about your investments or would like to discuss the markets in general. We remain committed to exercising the highest standards of care when managing your investments and value your confidence in us.
Copyright 2017 REDW Stanley Financial Advisors, LLC. All Rights Reserved. This publication is intended for general informational purposes only and should not be construed as investment, financial, tax, or legal advice.