U.S. stocks had their best performing quarter of the year, reaching an all-time high in August. The S&P 500 Index gained 3.85% for the quarter and is up 7.84% for the year through September. A majority of the gains occurred during the first few weeks of the quarter as fears of Brexit subsided and expectations of a rate rise by the Fed decreased. The initial gains were then followed by unusually low volatility. The S&P 500 Index went approximately two months without a daily gain or loss of greater than 1%. This string was broken in early September as comments by members of the Fed rekindled concerns of a Fed rate increase.
For most of the quarter, investors showed a marked increase in appetite for riskier assets. U.S. small cap stocks, which had been underperforming the first half of the year, rallied strongly. The Russell 2000 Index was up 9.05% for the quarter and is now outperforming large cap stocks this year. Another notable change during the quarter was the rotation out of high dividend-paying stocks. Relatively safe sectors that pay higher than average dividends such as Utilities (-5.91%), Telecommunications (-5.60%) and Real Estate (-1.24%) all underperformed for the quarter. The Technology sector benefitted the most from the move out of dividend-payers as the sector rose 12.86% during the quarter.
Developed market foreign stocks outperformed U.S. stocks during the quarter. Stocks in Japan rose sharply (+8.60% in U.S. dollar terms) as the Bank of Japan announced it will remain committed to an accommodative monetary policy even after inflation reaches their targets. Stocks in the Eurozone (+7.34%) and the United Kingdom (+3.98%) also rallied as fears related to Brexit declined. Developed foreign stocks in total, as measured by the MSCI EAFE Index, rose 6.43% for the quarter and are up 1.73% for the year. Emerging markets continued to outperform developed markets for the quarter and the year. Improving commodity prices and a stable U.S. dollar have been a tailwind for emerging market stocks. The MSCI Emerging Market Index was up 9.03% during the period and is up 16.02% year-to-date.
U.S. bond yields ended relatively flat for the quarter. The yield on the U.S. 10-year Treasury ended the quarter at 1.61%, about 10 basis points higher than the prior quarter-end. The Fed met twice during the quarter, but made no substantive change to monetary policy. However, expectations for a rise in rates later this year increased as economic data became more supportive of a rise. In addition, a few members of the Fed publicly communicated a greater willingness to raise rates. The Barclays Aggregate Bond Index rose 0.46% for the quarter and is up 5.80% for the year. Treasury Inflation Protected Securities (TIPS) outperformed during the quarter (+0.96) as CPI data showed a slight pick-up in inflation. Hedged foreign bonds slightly underperformed U.S. bonds during the quarter, but have outperformed the U.S. so far this year.
Commodities gave back some of their gains from earlier in the year. The Bloomberg Commodity Index was down -3.86% for the quarter, leaving its year-to-date gain at 8.87%. Crude oil had a particularly volatile quarter, but ended strong on news of a possible production freeze by OPEC.
With the election just a few short weeks away, there is no shortage of strong opinions about the two remaining candidates and how this election is going to play out. There is also no shortage of opinions about how this election will affect the markets and your investments. In the last week alone I have come across multiple articles explaining why markets will rise/fall depending upon whether Trump or Clinton wins the presidency. These articles, though sometimes entertaining, are not of much use for long-term investors.
There are generally two approaches forecasters are taking to predict the impact of the election on stocks. One approach uses historical election results and stock market returns to predict post- election returns. The other approach predicts post-election market moves based on each candidate’s communicated policies.
The problem with using historical election results to predict post-election stock market returns is the small size of the data. Historical data for the S&P 500 Index goes back as far as 1926, but there have been only 22 presidential elections since then. Republicans won 10 of those elections and Democrats won 12. Even if the results showed a significant difference in stock returns when one party was in office, there isn’t enough data to have any confidence in the result. The same is true for studies that look at various combinations of Republicans and Democrats in the executive branch, the house, and the senate. There just aren’t enough instances of each possible combination to have any predictive power.
The second approach to analyzing the potential impact of the election is to assess each candidate’s polices and to try to determine the impacts the policies will have on the markets. This is particularly of interest this election year given what some believe are extreme policies held by both candidates. For instance, some believe that the stock prices of energy and pharmaceutical companies will crash if Clinton is elected. Others believe that President Trump’s populist policies would lead to a broad stock market decline. But does it make sense to change your portfolio now to reflect these or other views about the election? Probably not. Even if you were able to correctly predict the outcome of the election, it remains very difficult to predict how stock prices will react. The fact is there are many other forces that have an impact on stock prices besides what is going on in Washington. Monetary policy, corporate earnings, or some unforeseen event might well have a greater impact on stock prices than the immediate results of the election.
But what if Trump gets elected? Won’t his unpredictable style cause the markets to sell-off? They might, at least initially. But the fact is that we do not know with certainty what the impact would be in the longer-term. The most recent shock the markets experienced was the Brexit vote in the United Kingdom, which was also a populist referendum. Stocks in the UK dropped sharply after the vote was passed, but have since rebounded to an all-time high.
There is no way to know with certainty how the markets will respond to the results of the election, and repositioning your portfolio based on short-term predictions can lead to disastrous results. That does not mean that repositioning may not be necessary in the future, but for now, we believe it makes more sense to focus time on how you are going to vote the election, instead of how to trade it.
Written by Jeffrey Blanchard, CFA, Investment Analyst; [email protected]
|Index||Market||Last 3 Months||Year-to-Date as of 9/30/16|
|Standard & Poor’s 500||Large Co. U.S. Stocks||3.85%||7.84%|
|Russell 1000 Value||Large Co. Value U.S. Stocks||3.48%||10.00%|
|Russell 2000||Small Co. U.S. Stocks||9.05%||11.46%|
|MSCI All-Country World ex U.S.||Foreign Stocks||6.91%||5.82%|
|Barclays 1-5 Year Gov’t/Credit||U.S. Shorter-Term Taxable Bonds||0.04%||2.64%|
|Barclays Aggregate Bond||U.S. Taxable Bonds (Broad-based)||0.46%||5.80%|
|Barclays 1-5 Year Muni Bond||U.S. Shorter-Term Tax Exempt Bonds||-0.21%||1.15%|
|JPMorgan Global Ex-U.S. Bonds||Hedged Foreign Bonds||0.06%||7.78%|
Key economic indicators compiled by Jeffrey Blanchard, CFA, Investment Analyst; [email protected]
Enclosed with this Quarterly Summary are performance reports for your consolidated accounts, portfolio appraisals, and a billing statement. You will also receive a statement(s) from your custodian summarizing your account activity this quarter, which we encourage you to review.
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Data Sources: Morningstar; Econoday; Bloomberg.com
(1) Source: MSCI. MSCI has not approved, reviewed or produced this report, makes no express or implied warranties or representationsandisnotliablewhatsoeverforanydatainthereport. MSCIdatamaynotberedistributedorusedasabasisfor other indices or investment products.
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