If we had fallen asleep at the beginning of this year and woke up on June 30, we might think the global capital markets had been very calm. We would've been mistaken. Following the worst start to the year in U.S. market history, stocks recovered most of their losses by the end of the first quarter. The second quarter was calmer until Great Britain's vote to leave the European Union (Brexit) shook things up. By the time we reached the end of the second quarter, stocks in the US and many other countries had again recovered from the sell off and had set new, all-time highs in the past few days. However, when factoring in the currency conversion, European stocks are still approximately 25% below their 2014 highs.
All in all, even after the Brexit vote had taken its toll, the S&P 500 is up 3.8% year-to-date (S&P 500 Index). The following numbers are as of quarter end, since then markets have trended up. Large international stocks are down almost 3%, and large emerging market stocks are up 6.4 % (Large Cap International (MSCI World ex USA Index), Large Cap Emerging Markets (MSCI Emerging Markets Index). With a strong recovery in energy, commodities were the strongest asset class gaining 13.3% (Bloomberg Commodity Index). Global real estate, aided by falling interest rates gained a strong 12.3% (S&P Global REIT Index).
While stocks had a volatile first half, bonds continued their upward price march, with yields dropping around the world. Currently, there are approximately $13 trillion in bonds which actually pay negative yields (when the bonds mature, holders will receive less than they paid for the bonds). Recently we've seen Germany's 10-year bond post a yield of -.14% and a recent auction in Switzerland saw bonds maturing in 2058 (42 years) sell at the unbelievable yield of -.023% (http://finance.yahoo.com/).
The 10-year US Treasury bond ended the second quarter much higher at a yield of 1.48% but hit an all- time low of 1.33% soon after quarter's end. The further decline in yields comes at a time when many economists around the world had expected rising rates. In the US, the Federal Reserve did increase short-term rates in December for the first time in many years. However, continued economic weakness elsewhere has prompted central banks in Europe, England, and Japan to either leave rates unchanged or drop them further. This has impacted the Feds ability to raise rates due to fear of the dollar appreciating too rapidly against other currencies (http://data.cnbc.com/quotes/US10Y).
Since the beginning of the third quarter, we’ve seen continued strength in both stocks and bonds. Favorable earnings and economic reports along with a continuation of favorable monetary policy around the world seem to be fueling this strength. As we go forward toward the remainder of 2016, we see very little that will change partially due to the upcoming presidential election.
Over the longer term, it seems we have a mixed bag of improving conditions and obvious risks. Also, there are always those risks that are less obvious which can arise, seemingly from nowhere, and be very impactful. In the US, our economy is showing continued signs of improvement. Unemployment is low and labor force participation is improving. We think this may be driven, in part at least, by the maturing Millennial or Gen-Y generation. At approximately 86 million strong, these children of the baby boomers are the largest generation ever. After experiencing the financial crisis with their parents, many of them found it difficult to find gainful employment and have delayed buying homes and other types of spending. That is beginning to change.
On the risk side of the equation, our growing debt to GDP ratio is concerning. Research shows that rising debt has a negative impact on GDP. Without addressing federal entitlements, the US government will find it more and more difficult to stimulate the economy through infrastructure and other types of discretionary spending. It may also impair private sector spending as people and business historically tend to save and invest less during periods of excess debt. Of course, this isn’t a new topic, and it may be years before our political leadership is willing or able to address the situation. Since this is an election year, it will be interesting to see to what degree this topic comes up in the campaign.
During the quarter we moved to a fully invested position in most portfolios and are seeing positive results from that positioning. We continue to believe that diversification is the best path to favorable results over time. With that in mind, our client portfolios are generally a blend of stocks, bonds, real estate, commodities (real assets), and quantitative hedge funds. With stocks, we also utilize different strategies to reduce the possibility that one style or another goes out of favor for an extended period. We will continue to monitor and attempt to improve on our approach without departing from our foundational tenets.
We are in the process of bringing on an experienced CPA and anticipate this happening by year-end. This growth is another step aligned with our vision to be available to analyze our client’s state of affairs in a holistic manner. We look forward to telling you more about the depth and services this will add in the coming weeks. In the meantime, we would appreciate hearing from you with questions or comments on any issue.
One operational note. You may have recently received notice from Charles Schwab that they will be changing the frequency they send statements on certain accounts from monthly to quarterly. Beginning with July statements delivered in August, Schwab will issue monthly statements only for accounts that have a qualifying transaction. A qualifying transaction is a deposit or withdrawal within the reporting month. Accounts that do not have a qualifying transaction will receive statements on a quarterly basis. The goals of this change are to reduce expenses and unnecessary paper while streamlining the process overall.
These changes will apply to monthly statements delivered electronically via mail and bundled paper statements. If you receive bundled statements, you will only see balances for accounts that have a qualifying activity in your summary. Most accounts tend to have a qualifying activity; therefore, the change may not affect you at all. Enclosed is a FAQ document regarding these changes.
As always, we are grateful for your trust and confidence.
Your CCA Investment Team
Cravens & Company Advisors, LLC is a wholly-owned subsidiary of Progressive Savings Bank. Investing involves risk including the potential loss of principal. International investing involves additionalincluding risks associated to foreign currency, limited liquidity, government regulation, and the possibility of substantial volatility due to adverse political, economic and other developments. The two main risks associated with fixed income investing are interest rate and credit risk. Typically, when interest rates rise, there is a corresponding decline in the market value of bonds. Credit risks refers to the possibility that the issuer of the bond will not be able to make principal and interest payments. Investments in commodities may entail significant risks and can be significantly affected by events such as variations in the commodities markets, weather, disease, embargoes, international, political, and economic developments, the success of exploration projects, tax and other government regulations, as well as other factors. No investment strategy can guarantee a profit or protect against loss in periods of declining values. Past performance is no guarantee of future results. Please note that individual situations can vary. Therefore, the information presented here should only be relied upon when coordinated with individual professional advice. Any opinions or forecasts contained herein reflect the subjective judgments and assumptions of the authors only and do not necessarily reflect the views of FSC Securities Corporation. There can be no assurance that developments will transpire as forecasted and actual results will be different. Data and analysis do not represent the actual or expected future performance of any investment product. We believe the information, including that obtained from outside sources, to be correct, but we cannot guarantee its accuracy. The information is subject to change at any time without notice. Indexes are unmanaged and do not incur fees. It is not possible to invest directly in an index. Standard & Poor's (S&P 500®) Index is a market capitalization-weighted Index of 500 common stocks chosen for market size, liquidity, and industry group representation measure broad US equity performance. S&P 500® is a registered service mark of McGraw-Hill Companies, Inc.