Market Watch - July 2016

Submitted by Academy Wealth Advisers on July 5th, 2016

Written by Rick Welch on July 1, 2016

We are pleased to provide you with our quarterly newsletter featuring the status of our investment class weightings, our interpretation of recent data and our outlook for the future. If you have any questions about any topic, we hope you will not hesitate to contact us.

Status of our Investment Class Weightings

Changes from our April 2016 Market Watch are noted in italic.

US Large Cap Sectors –

Overweight – Health Care and Technology

Neutral – Consumer Discretionary, Consumer Staples, Energy and Financials (↓)

Underweight – Industrials and Materials

No Weighting - Utilities

US Mid and Small Cap – Maintain all weightings.

International Developed Markets – Reduce weightings (↓) and await clarity on BREXIT.

Emerging Markets – Maintain all weightings.

Alternative Strategies – Maintain all weightings.

Multi-sector Bond Funds – Maintain all weightings.

Investment Grade US Corporate Bonds – Maintain all weightings.

High Yield US Corporate Bonds – Maintain all weightings.

Investment Grade Municipal Bonds – Maintain all weightings.

Data – During June investors focused on a more dovish Fed and BREXIT, both of which resulted in marked periods of increased volatility and plenty of headlines. After rising for much of Q2, global financial markets declined dramatically on the first two trading days following the BREXIT leave vote, only to rally even stronger over the last three days of June. For the quarter, the major equity indices were generally flat and now at the mid-point of 2016 we see the following year-to-date results: US Large Cap – DJIA (+2.89%) and S&P 500 (+2.68%), US Small Cap - Russell 2000 (+1.41%) and International - ACWX (-1.56%). Volatility (as measured by VIX) peaked on June 27th at 26.72, only to fall back to 15.63 at quarter end, below the long run average of 20.0. Domestic economic data for Q2 was generally ok, showing improvement over Q1. GDP, the broadest measure of economic output, for Q1 showed a quarter-over-quarter annualized rate of growth of 1.1%, revised upward from the 0.8% and 0.5% expansion which was previously reported. During Q2, the yield on the benchmark 10-year US Treasury fell from 1.79% to 1.49%, reaching a 2016 low point of 1.45% on June 27th. Thus far in 2016, the Barclays US Aggregate Bond Index is +4.25%. Job growth in May was below expectations, registering just 38,000 new jobs for the month as the national unemployment rate fell to 4.7%, below the mandate of the Federal Reserve. New weekly unemployment claims averaged a low 267,150 in Q2 (compared to 273,900 in Q1) providing a positive outlook for the domestic job picture. Consumer confidence, as measured by the Conference Board, rose nicely in June to a level not seen since January. The June Business Outlook Survey by the Federal Reserve Bank of Philadelphia “reported little growth for the month and a general weakness in business conditions as indicators for both employment and work hours remained negative.” Retail sales data demonstrated the resilience of the American consumer showing increases in both May (+0.5%) and April (+1.3%), the latter figure which was the strongest monthly advance since 2009. Data from the housing sector was volatile again in April and May as both new home sales (+12.3% and -6.0%) and housing starts (+4.9% and -0.3%) were unable to show positive momentum. CPI rose 0.2% in May and over the last 12 months the all items index increased 1.0%, a level below the Fed target of 2.0%.

Outlook – LEAVE. On June 23rd, the voters of the UK were heard around the globe as they voted to leave the European Union. With this surprising outcome comes a significant amount of uncertainty as there is no precedent of a member country leaving the EU. The process for leaving is uncharted territory that will test the mettle of leaders both from the UK and the EU and will provide an interesting backdrop for the global financial markets in the weeks and months to come. A key question is when Article 50 of the Lisbon Treaty (which defines the process for a member country to leave the EU) will be invoked, giving notice that the UK intends to leave the EU. This action then sets in motion a two-year time frame for negotiations to take place, after which the UK would cease to be a member of the EU, unless an extension is unanimously agreed upon by all member countries. The triggering of Article 50 is unlikely to occur before the UK installs a new prime minister to replace David Cameron who plans to step down by October.

The impact of BREXIT could be far reaching and cover many issues, including trade policy, foreign direct investment, government regulation, industrial policy, immigration, budget and international influence. Within the UK, changing business regulations could result in sharp declines in foreign direct investment and business investment as the attractiveness of the UK as a business domicile is reconsidered. Existing trade relationships between the UK and the EU members (there are over 50 free trade deals between the parties) will have to be renegotiated and some estimates suggest that these negotiations alone could last for years. The resulting uncertainty surrounding the status of existing trade agreements will negatively impact trade flows and economic conditions, particularly in the UK. Nearly 45% of UK exports go to EU countries, while just 7% of EU exports end up in the UK. One sector to watch is the financial services sector which has long made London a leading financial center both within the EU and across the globe. London benefits from a large network of financial and professional services that could be difficult to replicate elsewhere. However, existing EU regulations could make it harder for an independent UK to serve European markets, particularly for retail banking and euro trading. German Chancellor Angela Merkel set the tone recently suggesting that “the UK will not be able to gain full access to the single market of EU goods and services unless it shares some of the obligations of membership”, including many obligations (for example – worker migration) that are unpopular with Britons who voted to leave.

Overall, the macroeconomic impact of BREXIT is difficult to determine. We agree with many published studies that suggest that the impact on the UK could be significantly negative (at least in the short term) and that the impact on the rest of the EU should be smaller. The long term effects on the UK’s economy are an area of considerable uncertainty, and are dependent on timing (how soon the process to leave begins and how long the process takes) and the terms of the new agreement with the European Union. Some of the tensions in the UK regarding the EU also exist in other member countries. As the process becomes clearer other member countries will be watching closely to better assess the political and economic ramifications of their own considered exit. A smooth BREXIT may be a liberating message for others and result in a form of political contagion that could disrupt economic growth going forward.