1Q16 Market Overview
The first few days of the New Year introduced another round of volatility and heightened fears. In fact, mid way through January marked the worst ever start for the U.S. equity markets. The wall of worry initially focused on China’s slowdown, then shifted to oil’s free fall before concerns turned to slowing U.S. growth.
As we moved further into the quarter, apprehension grew and the global equity market slumped by over 10% through the middle of February. Luckily, by the end of February, mixed economic reports shed light on the situation and revealed it was not as bad as projected. After considering reassuring dovish comments from Janet Yellen and the latest reports, a synchronized global recession seemed highly unlikely. This positive development helped the markets stage a powerful comeback to finish relatively flat.
Looking forward, we are encouraged by a slowly improving U.S. economy and the direction the Federal Reserve is headed. So far, they have been successful in removing stimulus and will now carefully consider the pace of further interest rate increases. As the markets continue to extrapolate this reality, we will take advantage of diverging market trends by rebalancing to target allocations while maintaining your desired risk level. This process typically involves harvesting gains or losses in the most tax-efficient manner and then re-allocating the proceeds to out of favor asset classes that offer more attractive long-term opportunities such as international equities.
U.S. Equity Markets
The U.S. equity markets surged to the finish line in the first quarter as volatility carried over into the New Year; the Russell 3000 return was up nearly 1.00% for the quarter. The accommodating Fed seemed to boost the equity recovery more so than mixed economic data. On a more positive note, the economy added 215,000 jobs in March and the unemployment rate held steady at 5% according to the U.S. Bureau of Labor Statistics. The Commerce Department also reported that the U.S. economy grew at a 2.4% annual rate in 2015, however, the annualized growth pace slowed to 1.4% in the fourth quarter. The decelerating recent growth can be attributed to softening private businesses purchases and reduced state and local government spending which wasn’t entirely offset by healthy consumer spending gains. U.S. corporate profit margins fell slightly from record levels in 2015 as U.S. multinational companies felt the weight of a stronger U.S. dollar considering that one-third of the S&P 500 earnings are generated overseas. According to Thomson Reuters, earnings are projected to decline 2.9% in the final quarter of 2015 considering the damaging 74% retraction in energy earnings. Consumers, in contrast, continue to benefit from the steep decline in fuel prices which also seems to be adding to personal consumption.
International Equity Markets
International developed equity markets disappointed investors with a quarterly loss of 3.0% for the MSCI EAFE. The U.S. dollar lost ground against most major currencies to start the year which helped lessen the pressure on dollar-based investors. Given Europe’s anemic inflation, the European Central Bank (ECB) extended its current stimulation program to boost their recovery. Although this program isn’t likely to solve the euro zone’s problems overnight, it is a step in the right direction to help offset gloomy forecasts. In Japan, the “Abenomics” ambitious turnaround plan stalled and inflation flat lined near zero. Japan is struggling with soft retail sales, lower household spending and overall growth that is lower than forecasted levels. China also struggled as it suffered a credit rating downgrade by Standard & Poor’s as they transition from an export to consumer driven economy. Fortunately, the MSCI EM bucked the downward trend with a healthy 5.7% quarter gain. After underperforming relative to the U.S. markets by more than 5% per year for the past ten years, both developed and undeveloped international markets continue to look more attractive for patient long-term investors as we move further into 2016.
Fixed Income Markets
Safety-minded investors gained ground during the quarter as the Barclays Aggregate added a surprising return of 3.03%. After digesting the first Federal Reserve interest rate increase in nine years the previous quarter, the 10-year Treasury yield declined from 2.27% on January 1 to 1.77% on the final trading day of the quarter. As yields decrease, bond prices with longer durations typically outperform since their existing yields become more valuable compared to newly issued lower yielding securities. This is exactly how the markets priced in this new reality during the first quarter, by rewarding the Barclays U.S. Government Long with a 8.1% gain, Intermediate with a 2.3% gain and Short with a slight gain of 0.89%. In the international fixed-income arena, the JPM Non-US Unhedged posted an exceptional 9.1% gain with the assistance of a weaker U.S. dollar. The Barclays Municipal continued to please tax sensitive investors trying to lessen the drag of new investment related taxes, gaining 1.7% during the quarter.