3Q16 Market Overview
After digesting the late June Brexit vote results, the third quarter proved to be extremely positive for global equity investors while fixed income returns were relatively flat. Volatility was virtually non-existent as the Federal Reserve (Fed) postponed further rate hikes.
Looking forward, the markets are sure to encounter a bumpy ride to close out the year as the they react to U.S. election headlines and potential repercussions of the election results. From a tax perspective, we are anxiously awaiting the election results to get a jump start on future tax planning opportunities. In the meantime, broad diversification will continue to protect and reward investors during turbulent times.
We are encouraged by our resilient U.S. economy, improving economic conditions and general direction the Fed is headed. So far, they have been successful in removing stimulus and will carefully consider the pace of further interest rate increases.
Markets will continue to anticipate and adjust to the long-term reality of higher interest rates on the horizon. 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 overcame late September outflows and the U.S. election fears by advancing 4.4% for the Russell 3000. Coming off stronger mid-summer job growth figures, the economy added a modest 156,000 jobs in September and the unemployment rate ticked up slightly to 5.0% according to the U.S. Bureau of Labor Statistics. The Commerce Department also reported that the U.S. economy grew at a 1.4% annual rate in the first three months of 2016. This growth figure is up a bit from their previous estimate due to business construction strength. Consumption remains strong and consumer confidence is at the highest level since 2007. This confidence has carried over into the housing market by pushing sales up 20% over the past year. As we close out the year, investors will be keeping a close eye on U.S. corporate profit margins which are expected to fall slightly for the sixth quarter in a row from record levels. Any significant deterioration in earnings could re-accelerate outflows and derail the bull market until earnings increase.
International Equity Markets
International developed equity markets rewarded patient investors with a healthy quarterly gain of 6.4% for the MSCI EAFE. The weaker U.S. dollar enhanced returns for dollar-based investors across the globe. In Europe, uncertainty about Deutsche Bank’s survival weighed on markets as the U.S. Justice Department proposed a $14 billion fine to settle mortgage-backed security claims. This news overshadowed more positive and encouraging second quarter corporate earnings figures. In Japan, their economy experienced mixed results with an increase in industrial production and slowdown in consumer spending. Japan’s market rose 7.1% as Prime Minister Abe won a landslide victory to help further his economic growth plans. MSCI Emerging Markets outpaced the developed markets with an impressive 9% gain as the Fed maintained a dovish policy backdrop. 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 long-term investors.
Fixed Income Markets
Safety-minded investors experienced relatively calm results during the quarter as the Barclays Aggregate added to their year-to-date gains with a slight gain of 0.46%. After waiting for the second Fed interest rate increase in nine years, the 10-year Treasury yield drifted from 1.49% on June 30 to 1.60% on the final trading day of the quarter without an official increase. As yields increase, bond prices with longer durations typically underperform since their existing yields become less attractive compared to newly issued higher yielding securities. This is exactly how the markets priced in this new reality during the third quarter although the divergence was muted. The Barclays U.S. Government Long lost 0.29%, Intermediate posted a 0.24% loss and Short with a slight loss of 0.10%. In the international fixed-income arena, the JPM Non-US Unhedged posted another 0.46% gain to add to the healthy year-to-date return of 14.5%. The Barclays Municipal lost a bit of ground for tax sensitive investors trying to lessen the drag of investment related taxes, losing 0.30% during the quarter.