Perspectives

Second Quarter Market Update

Prepared by Zach Ivey

The 2nd Quarter has continued the unwelcomed trend of market volatility. The 3rd Quarter of 2015 experienced a selloff in the S&P 500 of -12.4% followed by a quick turnaround. The 1st Quarter this year started off as the worst start to a year ever, dropping -13.3% on the S&P 500 (even worse overseas), but rebounded sharply to turn positive for the year within about a month’s time. Then on June 23rd, Britain surprised markets with a referendum vote to leave the European Union, sparking yet another selloff in stock markets around the globe. Once again, however, markets have started to rebound somewhat as fear subsides (see our blog article on Brexit).

A few main takeaways from these recent events. First, markets are inherently emotional because they reflect people voting with their dollars as they try to process information about the future. When markets are surprised or uncertain about an outcome, many investors who are short-term in nature tend to sell first and reassess later; ready, fire, aim. Some of this is exacerbated by computerized trading and some is attributable to average investors making emotional decisions. Economies, industries, and companies are far more complex than the headlines that we read. Unfortunately, these emotional overreactions occur, driving prices to be much more volatile than actual economic fundamentals would warrant. Warren Buffet famously references the allegory in The Intelligent Investor of the manic depressive Mr. Market who shows up every day to the shareholder’s door offering to buy or sell his shares at a different price. As the investor, you can choose to ignore him when his prices seem unreasonably low, or take advantage of him when they are unreasonably high…you just have to wait as he will change his mind quite often. While it’s hard to remember now, the market rise from 2009 until last year was marked by fairly low volatility; we think those days are behind us and Mr. Market may continue his erratic ways.

The list of anxieties of the market seems pretty long these days: U.S. Presidential politics, oil, China, the Fed, Brexit, terrorism, immigration, and the list goes on and on. What is not making headlines is an improving employment picture in the US and in Europe, new technologies, pharmaceutical breakthroughs, product development, cheap energy, growing housing market, and major improvements in lifting people out of poverty around the globe. For those of us with fresh memories of the 2008-2009 market drop, it is also important to know that the worldwide banking system and corporate balance sheets are far healthier today and better able to handle market stress than the last time around. Similarly, as you hear people use terms like “bubble”, you should recall that asset bubbles occur when optimism is high and is accompanied by risk taking; things we haven’t seen in quite a while.

In our 1st Quarter market review, we discussed that China, low oil prices, and interest rates were big drivers of returns for the markets.   As anticipated, many of these issues’ grip on market sentiment has cooled a bit. News of slowing China has dissipated and emerging markets have been the best performing asset class this year. Low oil prices have moved higher and have “stabilized” (hovering around the current $45-50 barrel range) for the time being. Lastly, all the emphasis on the Fed and rate increases has lessened as global market volatility and global rates appear to heavily influence future rate increases by the Fed.

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Source: Blackrock/Bloomberg

U.S. Stocks

The U.S. stock market has been the best looking house on the block for quite a while now. Being a consumer led economy that imports goods from around the world, we are far more insulated from economic hiccups that occur outside our borders than other countries. The market has shown this resilience with the S&P 500 up 3.84% year to date. Mid and smaller companies have fared well too. As an investor, we recognize that as investments go up in value, they often get more expensive which could lead to lower future returns. We do expect the drag from oil company earnings to become less of a negative factor, and a patient Fed may provide U.S. stocks a favorable environment for the near future. We do recognize that the tailwind of declining unemployment may be near the end of the road, but are hopeful that slight rises in wages may lead to a more optimistic consumer. As J.P. Morgan’s Chief Investment Strategist, David Kelly states, “the U.S. is a healthy turtle, not a sick dog.” He means that low, but steady growth in the economy is expected.

International and Emerging Market Stocks

Approximately 50% of the world’s stocks are outside the U.S. and, while the U.S. market has enjoyed a continued grind higher over the past 7 years, international and emerging markets have not had the same positive experience. This has resulted in a gap in valuations that is much higher today, meaning international and emerging stocks are cheaper on a relative basis. In today’s global economy, many of these companies represent some of the largest companies and brands in the world, but they may trade at a discount due to the location of their headquarters. The UK’s Brexit vote does highlight one of the reasons that International investments have struggled recently, which is political uncertainty. While we don’t see this dissipating any time soon, we do see a very accommodative Central Bank, declining unemployment, weaker currencies (which is good for exports), and low energy prices. This doesn’t ensure short-term performance, but does provide an environment that is positive for longer-term growth. When combined with lower prices (cheaper stocks), this encourages conviction to stick with investing outside the U.S., despite what network TV and talk radio pundits might say. The EAFE Index is down -4.42% year to date.

One highlight for the year is the change we have seen in emerging markets. We often use the illustration of valuations being like a spring. If negative sentiment pushes the spring of valuations low enough, it creates significant pressure for them to go back up…as long as you just don’t get any new bad news. This is the case thus far in 2016, we just haven’t gotten any new bad news about China or other emerging countries and there has been a little good news for them as fears of a U.S. interest rate hike have reduced. The Emerging Market index is up 6.41% year to date.

Bonds

Bond returns are dictated by Central Bank policies that control the short-term rates as well as demand for safety and yield by global investors.   In unprecedented fashion, foreign governments have pushed their interest rates negative (NIRP: Negative Interest Rate Policy) in an effort to stimulate economic activity and to weaken their currency to further stimulate exports. As you might expect, global investors search for yield (interest) wherever they can find it and this has led to a large demand for U.S. bonds, which yield historically low rates, but look attractive to foreign investors who can only find low or even negative rates in their home countries. This, combined with a desire to park money somewhere other than stocks in times of stress, has led to bonds in the U.S. experiencing very good performance in the short run. This has also helped our portfolios as stock returns have been very volatile. We do expect some of these gains to fade as investors calm down and move back into stocks; however, we expect the NIRP policies around the world to keep U.S. bonds looking attractive on a relative basis. We also think the Fed will be very patient in raising rates.  The Barclay’s Aggregate bond index returned 5.31% year to date.

Final Thoughts

As investors, it is easy to be impatient, pessimistic, and skeptical of virtually everything. Human nature amplified by daily media coverage has conditioned us to do all the wrong things when it comes to investing. It is quite hard to be patient (which requires a time frame of years, not days), optimistic, and convicted about fundamental investment principals. One quote that provides me great comfort is this: “As long as people have babies, capital depreciates, technology evolves and tastes and preferences change, there is a powerful underlying impetus for growth that is almost certain to reveal itself in any reasonably well-managed economy”- Dr. Tim Duy, Professor of Economics at University of Oregon. Investing does not require that we have to have confidence in every country or government, or that every company or country will be successful. Rather, it only requires that most people get up every day and try to make a better life for themselves and their family. Despite news media reports to the contrary, I think this is true across the globe. As investors, we look to areas of the market where growth opportunities exist. A quick look at my normal routine at work and at home reveals that a large number of the products and services I now enjoy did not exist five years ago, and I feel like I couldn’t live without them now. This innovation will continue regardless of who is President and what central bankers do. Other things like energy, banking, food, etc. are just basic necessities that will always exist. Politics and policies are certainly important and do influence the levels of returns and risk, but we believe the march of progress will continue as it always has. It is our job to help clients navigate the investment markets to help reach their long-term goals.

We thank you for your trust. Please contact your advisor if you have questions about your portfolio or financial plan.

This commentary is provided for information purposes only and does not pertain to any security product or service and is not an offer or solicitation of an offer to buy or sell any product or service. Any opinions expressed are based on our interpretation of the data available to us at the time of the original publication of the report. These opinions are subject to change at any time without notice. Bridgeworth, LLC does not undertake to advise you of any changes in the views expressed herein. Unless otherwise stated, all information and opinions contained in this publication were obtained from sources believed to be accurate and reliable as of the date published or indicated and may be superseded by subsequent market events or other reasons.

 Any securities, indices, and other financial benchmarks shown are provided for illustrative purposes only, and reflect reinvestment of income, dividends, and other earnings. They do not reflect the deduction of advisory fees. Investment products are subject to investment risk, including possible loss of the principle amount invested.

Past performance is no guarantee of future results. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this material is at the sole discretion of the reader. Investment involves risks. International investing involves additional risks, including risks related to foreign currency, limited liquidity, less government regulation and the possibility of substantial volatility due to adverse political, economic or other developments. The two main risks related to fixed income investing are interest rate risk and credit risk. Typically, when interest rates rise, there is a corresponding decline in the market value of bonds. Credit risk refers to the possibility that the issuer of the bond will not be able to make principal and interest payments. Index performance is shown for illustrative purposes only. You cannot invest directly in an index.  Neither Bridgeworth nor its content providers are responsible for any damages or losses arising from any use of this information.

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