CLIMBING A WALL OF WORRY

 

We lived through exciting times in July. The fallout from the Brexit vote was dramatic, causing equity prices around the world to plummet. As the flight from risk to safety accelerated, bond yields plunged too. Some policymakers warned of cascading shocks similar to those that led to the fall of Lehman brothers in 2008 and the subsequent near-collapse of global financial markets. 

 

A month later, many experts say that fears of global contagion may be exaggerated. The main U.S. and continental European stock indexes have recovered. And emerging market stocks have been amazingly resilient. 

 

Even so, there is a sense of unease, stirred by historically low interest rates and Central Bank economic policies, not to mention terrorism, political unrest, and the upcoming US election. Let’s take a look at July numbers, then look at the economic climate from two different perspectives. 

 

 

US STOCKS: The S&P 500 Stock Index broke a record it set more than a year ago, capping a recovery that has been one of the most uneven in recent memory. The rally that took the index above the high set in May 2015 was derailed at various points by plunging oil prices, currency devaluations in China, and most recently the UK vote to leave the European Union. In a telling sign, mutual fund investors pulled a net $66.9 billion from US equity funds this year (per Lipper data)—not exactly a sign of confidence. Yet the broad index of US stocks rebounded 20% from its low point in February when it dove by -10.51%. For July, the index returned 3.69%, its fifth consecutive monthly gain. Along the way, it posted seven new closing highs to drive YTD returns to 7.66%. Meanwhile, the S&P Small Cap 600 posted a 5.09% return for the month, bringing YTD returns to 11.63%.

 

INTERNATIONAL DEVELOPED STOCKS: International developed markets returned 5.00% for the period. In the major markets, New Zealand did the best, returning 10.5% and 31% YTD, followed by Australia, which returned 8.16% and 11% YTD. Singapore did the worst for the month, returning 0.23%. For July, Germany returned 7.44%, Japan returned 6.48%, and the UK added 2.77%. Worldwide developed markets returned 4.9% YTD.

 

EMERGING MARKET STOCKS: Emerging market stocks rebounded from 2015’s second-half decline to handily beat their developed market peers, with the MSCI emerging markets index returning 5.03% for July and a surprising 11.77% YTD.

 

REAL ESTATE INVESTMENT TRUSTS: REITs had strongly positive returns for July. US Reits returned 4.37%. REITs in developed ex-US markets returned 4.80%, outperforming broad ex-US developed equity markets.

 

COMMODITIES: Commodities moved lower during the month with the Bloomberg Commodity Total Return Index finishing down -5.11%. Oil prices retreated to near multi-month lows closing at $41 a barrel. Precious metals continued to perform well, with silver posting a solid 9.11% return and gold adding 1.60%. Timber rebounded 7.22%. The Commodity Total Return Index finished July with 7.46% YTD return.

 

FIXED INCOME: The yield on the 10-year Treasury note ended higher at 1.45% after hitting its lowest yield (1.31%) since 2012. The 30-year Treasury bond finished with a yield of 2.18%. Barclay’s US Aggregate Bond Index gained .63% bringing YTD returns on the index to 5.98%.

 

 

Against the backdrop of healthy year-to-date stock and bond returns, another story is taking shape. Some believe it will end poorly; others see a turning point. 

 

The International Monetary Fund downgraded its projections for growth in the Euro Area to 1.6% this year, and 1.4% in 2017. And the Commerce Department reports that the US economy expanded at a significantly slower pace than expected in the first half of 2016. This adds to concerns that global weakness and trouble in the oil industry may be having more negative effects than forecasted. 

 

It also raises questions about Central Bank policies. Among those expressing concern is Mohamed El-Erian, who believes we’re being “…pulled ever-deeper into the uncharted waters of monetary policy experimentation” by central banks around the world (Financial Times, 26-July 2016). He warns, “A cocktail is brewing that risks future financial volatility.” Not exactly comforting words. 

 

Then again, it is a good time to recall the adage, “Markets climb a wall of worry.” 

 

John Authers suggests that if we “cut out the noise, ignore events we cannot predict and examine the information of which we can be certain when we invest,” things may not be so dire (Reuters, 29-July 2016). Look instead to what we can count on: news during earnings season. While not glossing over the lousy profits in Europe and recent -2.8% average earnings from US companies, Authers notes that “In markets it is the rate and direction of change that matters, as the previous outright level of earnings should already be reflected in prices.” Hence, “after four consecutive quarters in which the rate of change worsened,” the economic environment is improving. Authers concludes that “It is thus just about possible to read this as an inflection point, and Wall Street brokers cheerfully expect profit growth to be back in double figures next year.” 

 

Whether you see the glass as half-full or half-empty, it should not change your investment philosophy. Our advice? Carefully consider your objectives and risk tolerance, and maintain a diversified approach. Never trade on fear, bad news or a gut feeling. For some it may be prudent, El-Erian suggests, to “barbell fixed income with cash allocations.” As always, the point is to remain disciplined with a long-term perspective.