Talking Points - August 2016
Investment Markets at the Moment
Stock Markets have rebounded considerably from the two day rout following the British European Union separation vote, with the S&P 500 increasing by approximately 10% since late June. All three major U.S. Indexes (the Dow, S&P 500, and NASDAQ) hit new all-time highs simultaneously on Thursday, August 11th for the first time since December 31st, 1999. Interest rates continue to hover near historic lows generating positive returns across the bond complex. These conservative assets have worked as a strong buffer to the volatility that has consistently manifested itself in 2016. This volatility has reduced the likelihood of the Federal Reserve aggressively increasing interest rates over the short and mid-term. Markets anticipated four separate quarter percentage point rate hikes during 2016 at the beginning of the year. Consensus expectations now hover at no more than one rate hike for the remainder of the year.
The Economy : Plow-Horse Growth
Economic growth throughout the current economic recovery (which started in 2009) has persistently disappointed. Most measures of productivity and production (GDP growth rates, manufacturing activity, wage increases, etc.) have consistently trended below long-term averages over the past seven years. This disappointing growth in many ways is so bad that it’s good. Robust growth rates cannot be achieved with the economic data as is, however these trends also significantly reduce the likelihood of economic collapse due to overly optimistic sentiment. Bullish sentiment has been below 40% for a record 41 straight weeks as investors remain cautious. This caution puts households and corporations in a better position financially to weather periods of increased economic stress. While weak, data associated with GDP and jobs continues to trend positively. It would be historically unprecedented for the economy to dip in to recession (and subsequently have markets collapse too) with these key economic data points positioned as they are currently.
Investment Strategy Moving Forward
2016 has underscored the importance of a well-diversified investment strategy to offset the ramifications of any one particular market event. Scrambling into low-risk investments during these bouts of increased volatility is just as inappropriate as abandoning these same assets now as riskier assets have recovered. Investment decisions should be based around your particular risk profile, time-horizon, and circumstances. Beyond these unique individual decision-making criteria, portfolio changes should only be made based upon fundamental changes to the over-arching economic situation or investment valuations. While stock valuations appear elevated, compared to bond valuations they appear cheap. This reinforces our tactical recommendation to maintain a slight overweight to equities versus fixed-income.
The markets have been volatile throughout 2016 although some asset classes have experienced extremely strong returns. While we are happy to see these types of out sized returns in our strategies, we believe the potential future downside now outweighs the potential upside. Emerging market debt as an asset class has returned approximately 14% year-todate. The volatility associated with the British election and the subsequent decision by the Federal Reserve to reduce the likely number of interest rate hikes in the near-term worked as a tremendous tailwind for this asset class. The fact that the Mexican government can now borrow money at below 3% interest rates seems too low. Inversely, we are also removing our position in the floating rate bond space as the likelihood of interest rates moving up quickly (which is exactly what floating rate bonds are a hedge against) has diminished considerably. The proceeds from both of these sales will remain on the conservative side of our investment strategy but will be redeployed in to investments we believe provide more stability if downside market volatility materializes.