Third quarter results were strong across the board with every major asset class earning positive returns. Markets looked past the string of natural disasters, elevated threats of war with North Korea, and increased political noise to reach new highs during the quarter. Investors continued to benefit from loose monetary conditions, solid economic data, and low inflation. This type of environment is often referred to as a “Goldilocks Economy”, one that is not too hot to spur inflation or not too cold to cause a recession. The backdrop is just right for stocks. These factors have fostered a benign environment for stocks as investors enjoy extremely low volatility. The best example of this is the S&P 500’s performance this year. The S&P 500 experienced the shallowest pullback in history with a drawdown of only 3% this year.
Investors have enjoyed a period of calm markets with stocks and bonds providing positive returns without much volatility. Through all of the uncertainty and risks in the market, it has been uncharacteristically quiet. Over the past year, we have been confronted with the threat of war, terrorist attacks, Brexit, scandals in Washington D.C, and corporate scandals. These events typically trigger fear and volatility, but the markets have shrugged it off. It has been over 250 days since the last 5% fall in the S&P 500 index. The Federal Reserve has played a major role in this anomaly. The capital markets have been supported for years through unprecedented quantitative easing – providing ample liquidity and cheap financing through low interest rates. Things are beginning to change as the Federal Reserve starts to normalize interest rates. What are the ramifications of eight years of zero interest rate policy? How will the Federal Reserve unwind their balance sheet? The outcome of this is impossible to predict, but what we can expect is for this low volatility backdrop we have enjoyed to not continue as the market adjusts to this new environment. Volatility in the market is normal and creates opportunities for investors. Warren Buffet said it well, “Look at market fluctuations as your friend.” It is a sign of a healthy and functioning market.
Political headlines continued to dominate the capital markets during the first quarter. The incoming administration promised new policies such as tax reform, infrastructure spending, and deregulation that could stimulate economic growth. Stock and bond markets had very different reactions to the news. Stocks responded with optimism and priced in the benefits of the new policies, resulting in another strong quarter. The bond market took a wait and see approach to the new administration, wanting to see some progress before responding. The interest rate environment remained stable during the quarter and performance was relatively flat for fixed income. Capital markets will continue to closely monitor activity in Washington D.C. When the American Health Care Act failed to pass in March, investors started to question the administration’s ability to deliver on the other initiatives. Will stock or bond investors be proven right in the end? Only time will tell and our globally diversified portfolios of both stocks and bonds are built for such uncertain times. Investors will be anxiously waiting to see if President Trump can deliver on his promise to boost the economy.
2016 will be remembered as the year of the “unexpected”. After a strong fourth quarter in 2015, many were surprised when the first 6 weeks of the year were the worst start in market history. The decision by the United Kingdom (UK) to leave the European Union (EU) and the election of Donald Trump were the headlines of a very unexpected year politically. The conflict in Syria, the ongoing migrant crises, volatile oil prices and continued geopolitical uncertainty created plenty of reasons to worry about portfolio returns. Yet all major asset classes finished the year with positive returns despite high volatility along the way. In short, 2016 was a reminder that basing investment decisions on current events or forecasts of future events is a fool’s errand. For disciplined investors, 2016 provided solid, if not spectacular, returns despite significant headwinds.
Stocks and bonds around the world fared well in the third quarter as the global economy continued to lumber along at a slow pace. The forthcoming presidential election, interest rates and central bank policy continued to dominate economic headlines. As the shock from the Brexit vote faded, markets settled into their familiar summer calm for most of the quarter. September brought with it a brief period of heightened volatility as news out of the US Federal Reserve’s annual Jackson Hole retreat indicated that a rise in interest rates may be on the horizon sooner than the market expected.
Both risky and safe-haven assets alike were on track to finish the quarter comfortably in positive territory until June 23rd when a majority of UK citizens voted to leave the European Union (EU). The so called Brexit rocked financial markets around the world. As a result, stock markets finished the quarter with marginally positive returns and in highly unstable fashion. The global economy continued on a sluggish path, which prompted further caution by central bankers and supported high quality fixed income assets.
”It all happened while we were sleeping, or rather while we were focused on 9/11, the dot-com bust and Enron — which even prompted some to wonder whether globalization was over. Actually, just the opposite was true, which is why it’s time to wake up and prepare ourselves for this flat world, because others already are, and there is no time to waste.” — Thomas Friedman, New York Times, April 2005
Equity markets experienced a sharp decline to start 2016, causing some investors and analysts to re-evaluate their core investment principles. One common question being asked is whether or not there is a still a need for global diversification, which is not a surprising one given the investment returns so far this decade.
Bob Dylan’s classic anthem, “The Times They Are A-Changin’,” released in 1964 seems as applicable today as it was 50-plus years ago. But the pace of change has been amplified. A 2015 report by McKinsey & Co. stated, “The pace of change is happening at 10x the speed of the first industrial revolution and the power is 300 times, which equals 3,000 times the impact of the second industrial revolution than the first one.” I think many people would agree.
If you are just now looking at market returns for the first quarter you would be forgiven for thinking that the markets experienced a relatively boring three months. Developed markets finished flat, emerging markets were finally positive, real estate bounced back from a weak 2015 and bond returns were in the low single digits. However, a lot can happen in three months and what actually transpired was far from dull. January delivered one of the worst starts to a year the S&P 500 index has ever experienced, global recession concerns spiked, oil prices fluctuated wildly and the Chinese economy continued to produce mixed signals. Selling pressure continued through the first week of February
before cooler heads prevailed and the second half of the quarter topped off a whirlwind of action with a significant recovery.
2015 provided another example of how dynamic and rapidly changing our world is. Significant events included the highest job growth since 1999, two downgrades to the global economy, the Federal Reserve raising interest rates for the first time since 2006, Russia getting directly involved in the Syrian conflict, which pushed the immigrant crisis to levels not seen since WWII, and a dramatic rise and fall of the Chinese stock market. Despite all these events, 2015 provided quite unremarkable investment returns. US markets were slightly up, European markets slightly down, global real estate and global bonds slightly up and emerging markets down double digits. Volatility is back as markets try to digest the impact of these events and we expect that to continue through 2016.