Market Watch - October 2016
Written by Rick Welch on October 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 July 2016 Market Watch are noted in italic.
US Large Cap Sectors –
Overweight – Health Care and Technology
Neutral – Consumer Discretionary, Consumer Staples, Energy, Financial and Real Estate (New)
Underweight – Industrials and Materials
No Weighting - Utilities
US Mid and Small Cap – Maintain all weightings.
International Developed Markets – Maintain all weightings.
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 – In July the initial surprise of BREXIT faded as US investors began to focus more on Q2 earnings, monetary policy (both here and abroad) and the upcoming US presidential election. The markets rallied until July 21st and then went into a bit of a summer slumber not awakening until the week before the September FOMC meeting. Moving into Q4 we see the following year-to-date results: US Large Cap – DJIA (+5.06%) and S&P 500 (+6.08%), US Small Cap - Russell 2000 (+10.54%) and International - ACWX (+4.72%). Volatility (as measured by VIX) peaked on September 12th at 20.13, only to fall back to 12.85 at quarter end, below the long run average of 20.0. Domestic economic data for Q3 was generally good, leading many analysts to believe that economic growth and corporate earnings both improved in Q3. After five consecutive quarters of declining earnings, the upcoming reporting season could be a critical one in discerning the strength of the current bull market. GDP, the broadest measure of economic output, for Q2 showed an annualized rate of growth of 1.4%, above the 1.1% growth seen in Q1. During Q3, the yield on the benchmark 10-year US Treasury rose from 1.49% to 1.60%. Thus far in 2016, the Barclays US Aggregate Bond Index is +4.06%. After a disappointing May (11,000 new jobs), job growth increased nicely in the summer averaging 231,000 new jobs in the months of June, July and August with the national unemployment rate holding at 4.9%, below the mandate of the Federal Reserve. New weekly unemployment claims averaged a low 259,500 in Q3 (compared to 267,150 in Q2) providing a positive outlook for the domestic job picture. Consumer confidence, as measured by the Conference Board, rose to a 9-year high mark in September as consumers grew more optimistic about the labor market. The September Business Outlook Survey by the Federal Reserve Bank of Philadelphia “reported that manufacturing conditions continued to improve as indicators for general activity and new orders were positive.” The index for current manufacturing activity reached 12.8, a 2016 high mark and also the first time since last summer that the index has registered two consecutive positive readings. Retail sales data was uninspiring in both July (+0.1%) and August (-0.3%). Data from the housing sector was mixed in July and August with new home sales (+13.8 and -7.6%) and housing starts (+1.4% and -5.8%) again failing to create positive momentum. Thus far in 2016, new home sales are up 13.3% compared with the same period in 2015. CPI rose 0.2% in August and over the last 12 months the all items index increased 1.1%, a level below the Fed target of 2.0%.
Election – As the anticipation of selecting a new President intensifies this fall many investors will be focused on how the stock market may be impacted both by the long campaigns and eventual outcome. In the 14 presidential election years since 1960, the S&P 500 has fallen just three times: 1960 (-3.0%), 2000 (-9.1%) and during the most recent recession in 2008 (-37.0%). The average annual return for the 14 presidential election years is +9.1%, slightly better than the overall period average annual return of +8.8%. This data suggests that 2016 could yet provide above average market returns, however, we must acknowledge the tight cluster of election years (2000 and 2008) in which the market declined. The prevailing wisdom is that presidential elections add political instability and uncertainty to the mix of other factors (like GDP growth, interest rates and unemployment) that may already be impacting the broader market. In the final, frenetic weeks before the election, we will be bombarded with anecdotal evidence that if considered in isolation can be misleading. Suggestions that a win by a Republican candidate (often considered more business-friendly) over a Democratic candidate would be better for the stock market are not supported by history. Investors often find comfort in establishment candidates like Hilary Clinton who are viewed as experienced in the nuances of governing and are considered to be more predictable, if elected. Political newcomers, like Donald Trump, bring energy and excitement to the campaign and some apprehension as to how they might actually govern should they be elected. Stock price performance in the summer leading up to a presidential election can offer some insight into which candidate will be successful in November. When the market climbs from August through October the incumbent party has a great track record winning 82% of the time. In contrast, a falling market during the same time period is predictive (over 86%) of a win by the replacement party. In August, the S&P 500 fell slightly (-0.12%) which was followed in September by a similar loss (-0.12%).
Monetary Policy – At the September FOMC meeting, policymakers chose to leave short-term interest rates unchanged, with the federal funds target rate still in a range of 0.25% to 0.50%. The Committee acknowledged that “the case for an increase in the federal funds rate has strengthened but decided, for the time being, to wait for further evidence of continued progress toward its objectives.” This suggests to us that while there is no specific time frame for raising rates, that the use of the phrase “for the time being” hints that a rate hike is soon, probably at the December 13-14 FOMC meeting, assuming that economic data continue to show moderate growth and improving trends in employment and inflation. The path to interest rate normalization will be a challenging one for the Fed as it must proceed carefully so as not to adversely affect economic growth. The financial markets will watch closely and react to the perceived path of the Fed funds rate over time. At the September meeting, Fed Chair Yellen emphasized (as she has done since the first rate hike last December) that monetary policy will remain accommodative in the early stages of normalization and that the longer term pace of rate increases will be gradual.
