2Q16 MARKET OVERVIEW
The second quarter global equity market recovery suddenly reversed course after the surprising June 23rd Brexit results were revealed. With 52% of United Kingdom voters in favor of leaving the European Union (EU), equity investors reacted with strong emotion and also headed for the perceived safety exits.
Fixed income markets benefited from this flight to safety and pushed global yields even lower in the days following the vote. Fortunately, equity investors realized that they may have overreacted to the unknowns and recovered most of the short term losses to close out the quarter.
Looking forward, we are sure to face more speed bumps as global markets react to the economic and global implications of the Brexit decision. Broad diversification will continue to protect investors during these turbulent times. We are encouraged by our resilient U.S. economy and direction the Federal Reserve is headed. So far, they have been successful in removing stimulus and will 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 strategically 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 cautiously approached the finish line in the second quarter as eurozone volatility overshadowed generally more positive news; the Russell 3000 return was up 2.6% for the quarter. Coming off a weak May jobs report, the economy added an impressive 287,000 jobs in June and the unemployment rate ticked up slightly to 4.9% according to the U.S. Bureau of Labor Statistics. The Commerce Department also reported that the U.S. economy grew at a 1.1% annual rate in the first three months of 2016. The decelerating recent growth can be attributed to softening fixed business purchases and elevated levels of business caution due to sluggish global growth and the U.S. presidential election uncertainties. The growth detractors were partially offset by healthy consumer spending attributed to encouraging job and wage growth. U.S. corporate profit margins are expected to fall slightly for the fifth quarter in a row from record levels. Investors will be keeping a close eye on whether this earnings trend continues or look for signs of more encouraging future earnings guidance that might reverse this trend.
International Equity Markets
International developed equity markets disappointed investors with a quarterly loss of 1.5% for the MSCI EAFE. The U.S. dollar lost further ground against most major currencies in the second quarter which helped lessen the pressure on dollar-based investors. Uncertainty about Brexit’s long-term impact weighed on European markets, especially banking shares, which will need to endure even lower rates for the foreseeable future. The European Central Bank (ECB) will likely extended its current stimulation program to boost their recovery, fight anemic inflation and to maintain confidence as Britain exits the EU. In Japan, the “Abenomics” ambitious turnaround plan stalled further as the Japanese yen strengthened against the U.S. dollar which weighed on equity valuations. The expected slowdown in the Federal Reserve interest rate increases helped the MSCI Emerging Markets buck the downward pressure with a .66% 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 were rewarded during the quarter as the Barclays Aggregate added to their year-to-date gains with an additional return of 2.2%. After shrugging off the first Federal Reserve interest rate increase in nine years at the end of last year, the 10-year Treasury yield declined from 1.77% on March 31 to 1.49% 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 second quarter, by rewarding the Barclays U.S. Government Long with a 6.4% gain, Intermediate with a 1.2% gain and Short with a slight gain of 0.52%. In the international fixed-income arena, the JPM Non-US Unhedged posted another solid 4.5% gain as bond yields ticked down to zero or slightly negative on roughly $10 trillion of global government debt. The Barclays Municipal continued to please tax sensitive investors trying to lessen the drag of new investment related taxes, gaining 2.6% during the quarter.