2015 Q3 Economic Update from Transition Financial Advisors, Inc.
In light of the prospects for a Federal Reserve interest rate increase later this year, a June market free-fall in China, and the resurfacing of the Greek debt crisis, the U.S. stock market still managed to eke out small gains in the first half of 2015. The S&P 500 managed to gain a fraction of a percent during the second quarter with healthcare and telecommunications stocks leading the way. Federal Reserve officials said there were signs that economic growth was rebounding and seemed to indicate that once the central bank began to raise rates, it would do so at a gradual pace.
European stocks declined 4% for the quarter as the sovereign debt crisis in Greece flared up again. Despite signs of improving economic activity in the 19-member euro zone, investor worries that Greece would default on its debt and exit the currency bloc sent European stocks and bonds plunging at times, including the last few days of the quarter. The good news is growth in the euro zone is recovering faster than many expected as a result of lower oil costs and a weaker euro that is spurring exports. The Greek drama seems to have been resolved, at least temporarily, as European finance ministers are working to finalize a plan to provide funding so that Greece can pay down their debt. Euro zone GDP grew 0.4% in the first quarter, and we believe consensus forecasts will likely be revised upward.
Investment results from the Asia-Pacific region have been mixed. As you may be aware, Chinese equities have been in free-fall in recent weeks. Despite a recent rebound, the Shanghai composite is still down over 25% from its peak. Some Asian markets have responded negatively to the Chinese stock selloff, but most markets are treating this as a normal correction to a speculative bubble in Chinese stocks that has been long in the making, rather than a systemic risk to the Chinese or global economy. Despite the rebound last week, we believe the correction in Chinese stocks has not yet run its course. The Chinese government is trying everything within its power to stem the losses but their bag of tricks is pretty much empty at this point. Chinese investors continue pulling money out of China’s stock market and purchasing real estate all along the west coast of Canada and the U.S.
Japan, on the other hand, has been one of the top-performing stock markets in 2015 as the Nikkei 225 reached its highest level in more than 18 years. Financial and telecommunication stocks both recorded nice gains for the quarter. Economic data was generally positive, as Japan’s GDP grew at an annualized rate of 3.9% in the first quarter, helped by an uptick in business spending and strong exports to the U.S. and China.
MLP (Master Limited Partnership) and mid-stream energy investments declined in the second quarter, trailing most equity and fixed income indices. In addition to the poor second quarter performance, July has been horrendous for the sector as the global selloff in energy-related companies has been quite severe. This has been the second worst correction in the oil industry since 1985. In our view, we remain positive in the long-term outlook for mid-stream energy companies and MLP’s, as the U.S. continues to drive towards energy independence. Our portfolio managers continue to find investments in this area that offer the potential for attractive risk-adjusted returns, even in this period of heightened volatility.
Global real estate securities struggled as well in the second quarter, hindered by increasing bond yields, as better economic data in Europe and Japan lifted yields off their lows set earlier in the year. The Global REIT Index lost -8% as returns for all property types were negative, even though the sector continued to show strong fundamentals as reflected in first quarter results that generally met the high end of expectations. Based on the consensus view of continued expansion of the global economy, we believe commercial real estate fundamentals will continue to strengthen, driving further increases in cash flows, net asset values and dividend distributions.
More than six years after the global financial crisis, economies around the world are still reckoning with its consequences, with just about every nation’s growth rate significantly lower that it was before the downturn. The United States has led the post-crisis recovery but is still afflicted with slow growth relative to the pre-crisis norm. Though headwinds still linger, we believe the U.S. cyclical expansion is still intact. A very weak first quarter means 2015 GDP growth should come in between 2.50% and 2.75%, slightly lower than predicted at the start of the year. Given where the United States is in the business cycle, we believe recession is a low probability (without an unforeseen external shock). Economic tailwinds are evident: easy monetary policy, continued household deleveraging, low gas prices, signs of wage growth, and continued job growth.
Although our outlook for U.S. equities remains generally positive, after a six-year bull run that has seen the S&P 500 rise more than 200%, we think it is healthy for the market to take a pause in 2015. Corporate earnings growth has slowed a bit due to the rapid rise in the U.S. dollar, but we believe the economic expansion is on track and should regain some lost momentum in the next six months. This could very well lead to a pick-up in corporate earnings going into 2016, which will lead to a stronger stock market.
We hope everyone has been enjoying their summer. Please call us with any questions or concerns.
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