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2016 Q3 Economic Update from Transition Financial Advisors, Inc.

The world’s stock markets have spent the better part of 2016 on rocky ground and we expect volatility to continue into the second half of the year. Investors were confronted with the British vote to leave the European Union (“Brexit”), a “growth scare” in the U.S., the economic deceleration in China, and the introduction of negative interest rates in some foreign markets. Yet despite all these issues, and many others, U.S. stock markets hit a series of record highs in July.

Although we find much of the economic news today very discouraging, we are not surprised to see the Dow and S&P at record levels. To quote Douglas Cote, chief market strategist at Voya Investment Management, “So far 2016 is reminiscent of past stealth bull markets, climbing a wall of worry despite obstacles in its way”. Over the years, we have seen stocks rally time and again during periods of great market fear and pessimism. The recent ascent of the U.S. market to record levels, right after the hysteria surrounding the British vote to leave the EU, once again illustrates the counter-intuitive divergence between the economic/market climate and stock prices.

Ultimately, it is corporate earnings that drive stock prices higher (or lower). We believe the recent run-up in the U.S. stock market reflects the belief that corporate earnings are slowly recovering from their year-long malaise. We are in the midst of second quarter earnings season and thus far, results have been encouraging. With 25% of S&P 500 companies reporting, 68% have reported earnings above the mean estimate and 57% have reported sales above the mean estimate. Overall, second quarter earnings may still be negative, but they are improving.

We continue to be impatient with international equities after years of returns that lag the U.S.  June’s Brexit vote is one more source of uncertainty on a long list of challenges. However, it’s important to take a long-term view and understand that extended periods of trailing returns have usually been followed by periods of high relative returns.

In some of the world’s weaker economies, central banks are experimenting with negative interest rates in an attempt to stimulate growth. In January, the Bank of Japan deployed a negative rate policy and reduced its deposit rate to -0.10%. By doing so, it joined the European Central Bank (–0.40%), Denmark National Bank (–0.65%), Swiss National Bank (–0.75%) and Swedish National Bank (–1.25%) taking tentative steps into negative territory. As the U.S. economy remains relatively healthy, we believe it is unlikely, but not impossible, that negative rates would be employed by the Federal Reserve. Negative rates distort the natural flow of capital throughout the system. In addition, these policies penalize savers by robbing them of income from their savings accounts.

The U.S. continues to set the pace for the global economy as robust employment growth supports strong consumption for all types of goods. Particularly, housing and construction, which generate jobs in a wide range of industries, are gaining momentum. The number of households in the U.S. increased by 1.3 million in 2015, building on an upward trend that began in 2014.  The Great Recession had forced many Americans to delay or scale back their dreams of home ownership, or even being able to live on their own at all. But with an improving job market, the numbers tell us housing demographics are definitely improving.

One of the best performing asset classes of 2016, global real estate investment trusts (REIT’s) have returned over 16% year-to-date. We believe REIT’s continue to offer attractive return potential based on a favorable supply-demand outlook, continued access to low-cost capital, and reasonable valuations. Furthermore, in September, U.S. REIT’s will be separated from financial services and get their own Global Industry Classification Standard (GICS) sector. With the new classification, real estate will likely see a significant lift in its profile, leading to increased media coverage and greater awareness of its performance. This should attract more capital to the sector from both institutional and individual investors, potentially leading to a multi-billion dollar tailwind in incremental REIT purchases.

As markets continue to hit record highs, some investors are asking if this is a time they should be selling. Our answer is a typical one given in response to a complex question; it depends. In and of itself, the fact that stocks hit record highs is certainly not a reason to sell. More times than not, market highs are followed by more market highs. But there are individual circumstances that could warrant selling stocks such as needing to raise cash for a purchase or wanting to modify a long-term asset allocation due to a change in life circumstances. For such situations, selling at all-time highs could be a very advantageous. If you are unsure of your particular situation and how it relates to the current market environment, please call us to set up a meeting. We always look forward to speaking with you about such matters.

 

Sincerely,

Transition Financial Advisors Group, Inc.

Mitch Marenus, Chief Investment Officer
MBA, CFP® (US), CFA®

Brian Wruk, President
MBA, CFP® (US), CFP® (Canada), CIM, TEP

Lucas Wennersten, Financial Advisor
CFP® (US)