19 Oct Market and Economic Update – Fall 2016
Posted at 13:10h
We have not written a market update since August of this year. This is because markets have remained ominously quiet since then. There have been some important developments that have flown under the radar that are worth mentioning. We believe these developments will have an impact on our clients’ investments.
The main question we have been receiving from clients is what effect the election will have on markets and the economy. The easy answer is no one knows and any who claims they do is full of you know what. Our best guess is that volatility will pick up leading to the election then things will settle down for the better regardless of who wins. It is critical to remember that the economy is much bigger and more resilient than any one person and their ideas. This is even truer today as we live in a global economy where the largest 500 US publically listed companies generate half of their business from outside US borders. Moving on….
Looking at a chart of the S&P 500 index (this index represents the largest 500 US company stocks); you can see that stocks have not gained much if any ground since the beginning of 2015 with a lot of gyrations in-between.
This is indicative of the low to no return environment of the last couple years. The graph below shows the 12 month global equity returns of the last 5 years with returns going to basically zero the last 3 years.
Source: BlackRock Investment Institute, MSCI and Thomson Reuters, June 2016. Notes: Global equites are based on the MSCI All-Country World Index. Earnings growth is based on aggregate 12-month forward earnings forecasts. Multiple expansion is represented by the share of return not explained by earnings growth or dividends. The 2016 returns are for the first quarter only. You cannot directly invest in an index.
The other culprit of lower returns has been the lowering of interest rates by the Federal Reserve. Their actions have been deemed a war on savers by many in the investment industry. Their low rate polices have affected traditional savings tools of retirees and conservative investors such as high quality bonds and CDs. This is much more important and impactful to Americans than who wins the election.
The chart below needs no explanation. It shows the yield (interest rate) of high grade corporate bonds since the late 90’s. The average yield over the last 30 years has been around 5.5%. It has since moved down to 2.5% since 2012. This means the average investor has lost an average of 3% interest from their bond investments. This is especially critical since most pre-retirees and retirees have large portions of their portfolios in bonds. You couple this with low stock returns and it has been a frustrating environment.
Future return expectations have certainly shifted downward for advisers and their clients. Most clients will not be willing to take on the extra risk to boost returns. Investing in riskier assets such as emerging markets, real estate, and alternative investments can provide higher returns but will subsequently suffer large losses during times of market stress. After reading through much research we believe an appropriate target return for a moderate investor will be around 4% over time.http://news.morningstar.com/articlenet/article.aspx?id=736083
So what could drive returns higher? The best answer is faster economic growth however that seems elusive for the time being. The International Monetary Fund just lowered their global growth outlook to 3.1% for 2016 and 3.4% for 2017. They expect the US to grow at 1.6%. These growth rates are low but will be supportive of our return forecasts. There does not appear to be an imminent recession on the horizon and most parts of the economy continue to be solid such as housing, jobs, and consumer spending.
The one bright spot we are seeing is potentially better inflation numbers. Inflation is not necessarily bad. It can also mean that wages are rising and growth is picking up a bit. This can feed into higher interest rates and investment returns by forcing the Federal Reserve to raise rates. As always, we will continue to monitor the markets and be prepared for some positive surprises.
Source: Macrobond and Variant Perception
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