Market View (October 2016) – Eyes on the Fed
Central banks around the world took the stage during the Third Quarter of 2016 with the U.S. Federal Reserve having prominence. As various Fed Governors gave speeches, each talk was dissected to see if the Federal Reserve would raise rates in September. Ultimately, they did not, but since they did not change their language for another increase in rates this year, the expectation is that they will raise rates in December. Certainly economic data softened during the quarter. ISM Manufacturing fell below 50 in September, an indication of contraction, and while ISM Non-manufacturing (Services) declined, it remained above 50, which indicates expansion. Also, Services is a much larger portion of our economy. While housing sales slowed, the inventory of houses remains tight. Wages and personal income continued to show year over year growth, and we continued to see job creation. Despite the mix of economic data, we continue to see and expect positive economic growth.
Perhaps what is most telling has been comparing 2015 performance of the different asset classes to this year. For the first nine months, many of the assets that performed poorly last year have been the best asset classes to own in 2016. This comparison illustrates the benefits of owning a broadly diversified portfolio, reducing the risk in portfolios while allowing investors to focus on long-term goals and objectives.
Against the backdrop of low interest rates, equities continued to climb both during the quarter and year to date. The S&P 500 had a quarterly total return of 3.85%, which is more than half of the year to date total return of 7.84%. Emerging market equities (MSCI EM) had a strong return for the quarter (9.03%) and are now up 16.02% year to date, making it the leading asset class for the first three quarters of the year. Concerns over European economic growth weighed on many developed overseas indices. Year to date developed market international equities (MSCI EAFE) are up 1.73%, but only after a relatively strong third quarter return of 6.43%. 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, there could be potential buying opportunities. Corporate fundamentals are strong, and valuations remain reasonable in light of low inflation and low interest rates. However, we would not be surprised by a volatile Fourth Quarter given the contentious U.S. presidential election and the expectation of the Federal Reserve raising interest rates.
Federal Reserve Chair Janet Yellen remains motivated to normalize rate policy. Most expect the Federal Reserve to increase interest rates in December, with steady inflation and job growth serving as a solid rationale. In terms of asset class returns, last year’s fears over the decline in oil and the subsequent impact on high yield reversed, with high yield gaining 5.55% in the quarter and 15.11% year to date. The bellwether 10-Year Treasury also trended downward throughout the year and now stands at 1.6%.
Despite being a leading asset class in the second quarter, commodities fell in the third quarter 3.86%, but remain up 8.87% year-to-date. Some expect the price of oil to stabilize near $50 per barrel, as it is reported that Saudi Arabia will agree to production cuts to help increase the price of oil. Additionally, Real Estate Investment Trusts (REITs) declined in September with the quarter being negative 1.21% (FTSE NAREIT). However, REITs continued to be a leading asset class year to date with a total return of 12.31%. During times of increased volatility (such as the Second Quarter), managed futures help to reduce volatility in a portfolio.
Against the backdrop of steady but below average economic growth, we continue to expect every piece of news to be thoroughly examined and capital to move around the globe in response. This movement of capital can result in increased volatility, illustrating that diversification tends to work best in times of heightened volatility. For example, many of the worse performing assets classes for 2015 (e.g., high yield and emerging markets) are the best performing asset classes in 2016. Unfortunately, diversification does not “feel” great because it usually means that some part of your portfolio is declining or just not performing as well as some other part. That is why it is best to focus on the big picture of your portfolio, your present financial situation, and your future goals. Please reach out to your relationship manager to discuss your thoughts on your portfolio or if you 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.