2016 Mid-Year Update
By Jason@vigilarewealth.com on July 8, 2016 in Investor Lounge
The second quarter continued to be volatile with yet another wave of fear- selling, followed by a sharp recovery rally. This time the culprit was the universally unanticipated “Brexit” referendum passing in favor of the U.K. leaving the EU. This caught many global market participants by surprise and the ensuing panic wiped $3 trillion in global stock market value in two days. The sell-off however was short lived because of the realization that the financial repercussions of this vote would take months/years to observe (we live in a short term thinking world, right?) and more importantly this removed the pressure from the U.S. Federal Reserve to follow through with a second rate hike this summer.
Markets ended the quarter on a high note: U.S. stock market up 2.5% overall, while NASDAQ tech was down 3.3%, International Developed markets were down 4%, and the Bond Index was up 5%.
Bonds interestingly were the standout performer for the first part of the year and we want to discuss this asset class in a little more detail. In our prior commentary we mentioned how interest rates were persistently low and reinforced the need to include more interest sensitive investments as a result. We believe interest rates could continue to move lower, especially in the U.S. where the relative yield is much more favorable (if you can believe that) than the rest of the world. Currently, there is over $13 trillion of negative yielding sovereign debt in the world! The QE policies around the world (buying up all the bonds) along with the scarcity of bonds with a positive yield, can continue to put downward pressure on rates, at least in the near term. Even with this momentum of declining rates, it makes little sense to “lock” in at these rate levels for the long-term when you do the math. The negative interest rate paradigm is vexing economists and challenging conventional economic theory. For now, juxtaposing bonds with stocks makes stocks look more attractive. This is a positive for stocks. A more ominous implication is that negative rates are killing the global banking system. We have to keep a watchful eye on European banks (especially Italian and German) as the next crisis could spawn from a surprise bank failure.
Looking back at the stock markets over that last seven years, the U.S. stock market has outperformed the international markets consistently, and it’s not even close. Will it continue to be as lopsided in the future? Our U.S. bias for stock investing is well documented and we still feel strongly about it. Moving forward however we believe the outperformance of U.S. over international will continue to be strong in times of market weakness, however not as strong (if at all) during times of market strength. To be clear we are not advocating a shift to international investments, simply if markets move higher from here the international markets may keep up with their U.S. counterparts.
The S&P 500 has been in a range of 1900 to 2100 for the last couple years. We are near the high-end of the range, closing in on new highs even though earnings are looking at their 5th consecutive quarterly decline. Markets have tested the high end of this range a few times already and failed to hold the high. Low interest rates and Central Bank monetary policies have created buoyancy in stock markets levels. However, to definitively punch through to new highs and beyond, we need to see an improving earnings picture and a pick-up in global economic growth.
There are also still too many unknowns to be anywhere near confident that we have arrived at a new plateau in the equity markets.