Market Insights: Market Review and Outlook Q3 2016
Global Markets: Neutral with Caution
By all accounts the first three quarters of 2016 have been very good from a performance standpoint, notwithstanding some periods of intense volatility. The S&P has delivered a return of approximately 7.8%, with the Russell 2000 at 11.4%. MSCI EM have delivered a remarkable 16.4% year to date. However, all around the world tensions have run high this year as the Middle East remains unstable, refugees continue to move across Europe, Brexit threatens to disrupt all of Europe, and terrorist attacks throughout the world erupt. China has the world confused, as the official state report on their economy shows strong recovery, while other analysts say China continues to slow. Nonetheless, the global markets have performed very well this year. Low interest rates, coupled with recovering oil prices have meant good companies can make money regardless. In addition, valuations remain below average indicating that the returns we have seen still have some room to continue.
U.S. Economy: Good with Caution
There’s very little to change since the last few quarters regarding the U.S. Economy. The key factors we track, unemployment, housing, and inflation, are all favorable. Unemployment remains very low, hovering around 5%, while wage inflation is increasing slightly, meaning the worker has some leverage to move up in wages. This also indicates that employers may be reaching the limits of the employable labor pool. Housing figures have held in the average range, but are trending toward increasing home prices, increase in new sales, and in new home starts. The consumer keeps saving, with a savings rate at the end of August of 5.7%, nearly triple the low reached in 2005. Yet the consumer is also spending, posting a rising rate in the low single digits for 2016, and headed in that same direction for 2017. Despite the political talk about the economy suffering, the data points do not paint a dire picture, but rather a picture of an economic expansion that is healthy, but possibly in the later stages. The caution here is due to the same vulnerabilities we have faced over the last years, namely world events, political disruption, a surge in inflation and other factors that we know can happen, but are not yet in our line of sight.
Inflation is an important part of economic and market health. Periods of stagflation and deflation can be just as painful as periods of runaway inflation. We look for inflation to proceed within a normal range. For some time we have flown just below that range. Only now are we seeing signs that it could creep above the 2% mark, into what would be normal and healthy territory. In that range it seems more likely that interest rates will rise and wages will rise. With some inflation we also experience corporations feeling able to raise prices where needed without fear of losing the customer. A key factor in the increase in inflation is the underlying price of oil, which affects the cost of most things. In addition, the slight increase in wage inflation will also be reflected in the components of CPI.
Interest Rates: Good
Hand in hand with inflation predictions are interest rate predictions. While it seems unlikely that Yellen will raise rates in advance of the elections in order to separate the Fed from the political process, the rise in inflation, and fall in unemployment are the factors that we would expect to indicate a small move by the Fed at the end of the year marking the only change in interest rates for 2016, and continuing cautiously through 2017.
U.S. Stock Market: Neutral
The market has already delivered more than was expected for 2016. If only we could hit “pause”, and then hit “play” again after the U.S. elections were completed in November. But, we can’t do that responsibly. So we will likely experience more volatile trading days as we head into and through the election. A Clinton win could signal that corporate America and the consumer should expect a continuation of Obama’s agenda. While this may not be the regulatory and tax environment corporations want, it is one they understand and can prepare for. This would seem to indicate that the market might sell off some and only temporarily. However a Trump victory could mean a more dramatic sell-off until it is clear what direction his leadership will take us in. The market abhors uncertainty, which the first 100 days of a Trump presidency could deliver.
U.S. Bonds: Neutral
We are neutral about U.S Bonds in the coming months. With no change in rates, and only a very small change potentially on the near term horizon, it is likely that bonds will trade around world events and economic data. The 10 year moved up in value to a 1.6% yield by the end of Q3. There is no sign of stopping in the ever increasing demand for U.S. paper. Therefore the feeling is that very small increases in rates will be counterbalanced by demand, which should protect prices.
With the wide variety of returns in all markets this year, if you have not rebalanced your portfolios, now is a good time to do so. In particular, if you hold assets that have surged, like emerging markets or real estate, you will want to capture those returns from these more volatile segments, and reinvest in the slower performers that have lower volatility. This is how you can manage risk through volatile markets.
How We Can Help You: Are you doing what you need to do to give yourself the best chance for success? Will you live your retirement as you would like? If you have not reviewed your Investments, or do not have a succinct game-plan in place, now is the time to change that and take control of your financial future. We would encourage you to schedule a time to meet with us to review your account and give yourself the peace of mind knowing you are on the right path. Please feel free to contact me directly at email@example.com.
 YTD 2016 Total Return data sourced from www.Morningstar.com , www.MSCI.com, and JP Morgan Guide to the Markets Q3 2016