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HIGH NOTES and LOW NOTES: Q3 Market Report

John Gorlow | Oct 11, 2016
Remember the stomach-churning turbulence of January? The sky-is-falling fear mongers who advised everyone to dump stocks? Remember the shock of Brexit? And remember when everyone thought a guy named Donald Trump was an amusing diversion and couldn’t possibly secure the Republican nomination for President? 
 
The markets are doing nicely in spite of it all 
 
U.S. stocks just wrapped up their best quarter of the year. Recent gains helped lift returns on the S&P 500 to 3.85% in Q3, bringing the YTD return to a respectable 7.84% and annualized return to 10.57%. We’ll take a closer look at the numbers, but first want to offer our own election year advice. 
 
Presidential Elections and the Stock Market
 
Late in the day on November 8, we’ll learn who the next President of the United States will be. Until then, the noise is not likely to abate and the vitriol may increase.  
 
As of today, polls suggest a big advantage for Hillary Clinton. The popular statistician Nate Silver of fivethirtyeight.com predicts an 18% chance of a Trump victory and the Iowa Electronic Markets predicts roughly the same. 
 
Would the market perform better under Clinton or under Trump? Analysis of market signals after the first presidential debate suggests stocks will be worth more if Mr. Trump loses the election (Justin Wolfers, New York Times, 2-October 2016). When the prospects brightened for Clinton, the futures markets rallied. When the Trump candidacy appeared ascendant, the futures markets swooned. 
 
Paradoxically, Steven Russolillo of The Wall Street Journal (6-October 2016) notes that two portfolios constructed to benefit from the election outcome favor the Republican portfolio (bullish on energy and defense) over the Democratic portfolio (big on infrastructure and alternative energy). 
 
Does this leave you feverishly concerned about how to invest? We hope not. First, it’s obviously unwise to base long-term investments on short-term predictions. Second, financial markets often do not behave as predicted (if you need a reminder, refer back to the very first paragraph). When the Health Care Act was passed after Barack Obama’s election, most predicted a bearish impact on health care stocks. Instead, as Russolillo points out, health care has been one of the S&P 500’s best performing sectors during much of the current bull market. 
 
The Long and Short of It 
 
You’ve heard this before, but in case you’re still tempted to jigger your own pre-election portfolio, consider this: 
 
Current market prices reflect known information and aggregate expectations. Changes in pricing are triggered by unforeseen events, not by predictions. 
 
Adjusting your portfolio based on who might be “better for the market” is unwise. DFA recently graphed the growth of one dollar invested in the S&P 500 Index over nine decades and 15 presidencies (from Coolidge to Obama). The result: there is no obvious pattern of long-term stock market performance based upon which party holds the Oval Office. 
 
Investing is a long-term endeavor. Making investment decisions based on a presidential election is likely to lead to costly mistakes. We encourage you to stick to strategy, remain diversified, and stay away from the political news until November 8. 
 
THIRD QUARTER 2016 AT A GLANCE
All results in U.S. Dollars
 
World Asset Classes: Global equity markets as measured by the FTSE Global All Cap Total Return index returned a healthy 5.53% for the quarter, boosting YTD returns on the index to 7.24%. Looking at broad market indices, emerging markets outperformed all other equity markets during the quarter. The US equity market lagged developed markets outside the US. US real estate investment trusts (REITs) recorded negative absolute returns and lagged the US equity market. The value effect was negative in the US and emerging markets but positive in developed markets outside the US. Small caps outperformed large caps in the US and in developed markets outside the US, but underperformed in emerging markets.
 
US Stocks: The broad US equity market as measured by the Russell 3000 index recorded a positive 4.4% return for the quarter. YTD, it returned 7.84% and delivered a respectable 15.43% return for the trailing 12 months. Value indices underperformed growth indices across all size ranges. Small caps (Russell 2000 index) outperformed large caps (Russell 1000 index), 3.85% vs. 9.05% respectively.
 
International Developed Stocks: In dollar terms, developed markets outside the US (MSCI Word Ex-US index) returned 6.29% for the quarter, outperforming the US equity market but underperforming the MSCI emerging markets index during the quarter. Small caps (MSCI Word Ex-US Small Cap index) returned 8.00% outperforming large caps in non-US developed markets. Looking at broad market indices across all size ranges, the value effect was positive in non-US developed markets. 

Emerging Markets Stocks: In U.S. dollar terms, the Emerging markets as measured by the MSCI Emerging markets index returned 9.03% for the quarter, outperforming both the US market and developed markets outside the US.  YTD the broad Emerging market index returned 16.02%. And it returned a solid 16.78% for the trailing 12 months. Using broad market indices as proxies, the value effect was negative in emerging markets. Large cap value indices underperformed large cap growth indices. The opposite was true among small caps; small cap value indices outperformed small cap growth indices. Large cap indices outperformed small cap indices.

Select Country Performance: Austria (16.01%) and Hong Kong (11.47%) recorded the highest country performance in developed markets, while Singapore (0.77%) and Denmark (-4.12%) posted the lowest performance for the quarter. In emerging markets, Egypt (15.73%) and China (13.49%) were the top performers, while Turkey (-4.66%) and the Philippines (-4.97%) recorded the lowest performance.  
 
Real Estate Investment Trusts: US REITs posted negative absolute performance for the quarter, lagging the broad equity market. REITs in developed markets recorded positive absolute returns but underperformed broad equity indices for developed markets. 
 
Commodities: Commodities were mixed for the third quarter but remained positive for the YTD period ending September 30, 2016. The Bloomberg Commodity Index Total Return posted a -3.86% return during the quarter. Sugar gained 9.76%, cotton climbed 6.09%, and coffee was up 1.42%. Industrial metals also recorded gains, with zinc returning 12.55% and nickel 11.46%. Energy fell, with natural gas declining 8.02%, Brent crude oil down -2.22%, and WTI crude oil falling -4.96%. Lean hogs underperformed the most, returning -31.71%. Gold declined -0.82%.
 
Fixed Income: Interest rates across the US fixed income markets generally increased in the third quarter. The yield on the 5-year Treasury note rose 13 basis points (bps) to 1.14%. The yield on the 10-year Treasury note rose 11 bps to 1.60%. The 30-year Treasury bond increased 2 bps to finish with a yield of 2.32%.
 
The 1-year Treasury bill yield rose 14 bps to 0.59%, and the 2-year Treasury note yield increased 19 bps to 0.77%. The yield on the 3-month Treasury bill rose 3 bps to 0.29%, while the 6-month Treasury bill was up 9 bps to 0.45%. 
 
Short-term corporate bonds gained 0.32%. Intermediate-term corporates rose 0.89%, while long-term corporate bonds gained 2.56%. 
 
Short-term municipal bonds returned -0.21%, while intermediate-term municipal bonds were unchanged. Revenue bonds slightly outperformed general obligation bonds.