2015 Q4 Economic Update from Transition Financial Advisors, Inc.
Global stocks tumbled in the third quarter amid signs of an economic slowdown in China and uncertainty over U.S. monetary policy. Energy and material stocks incurred the greatest losses on worries over declining global demand for basic materials and the continued supply/demand imbalance in oil. Defensive sectors generally held up best and government bonds, the traditional safe-haven, rallied to reach new highs for the year.
The S&P 500 declined over 6% in the third quarter, while the Dow Jones Industrial Average and the Nasdaq Composite Index each lost 7%. Utilities rose 5% and was the only S&P sector showing positive returns. West Texas Intermediate crude fell to just over $45 a barrel, a decline of 25% for the quarter, leading energy stocks down 18%. Health care stocks were also down in late September as Democratic presidential hopeful Hillary Clinton unveiled a plan to rein in high drug prices.
European stocks fell amid the turmoil in China and mixed reports about the health of the euro-zone economy. Similar to the United States, defensive sectors held up the best with large utilities and consumer staples companies leading all sectors. Concerns about the debt crisis in Greece waned as elections solidified the power base of Greek Prime Minister Alexis Tsipras. Easily re-elected, Tsipras now has the mandate to move forward with the plan for strict austerity measures in exchange for further financial aid. Overall the MSCI Europe Index lost 9%, the worst quarterly decline since 2011.
Japan was among the worst-performing markets as the index lost 14% over concerns of slowing economic growth in China, one of Japan’s largest trading partners. Pessimism with regard to the state of Japan’s economy also weighed on shares. All the big Japanese automakers lost ground on reports of slowing car sales in China.
Emerging markets equities declined sharply for all the same reasons as the world’s developed markets. The MSCI Emerging Markets Index lost 18% as all sectors experienced double digit losses; MSCI China declined 23%, Brazilian equities lost 34%, Indonesia declined 25%, while India fared better losing 6%. Some of the losses were due to currency exchange as emerging market currencies, as measured by the J.P. Morgan GBI-EM Global Diversified index, fell 11% in U.S. dollar terms.
This summer’s market correction proved to be an unpleasant reminder that stock prices don’t go straight up. The downturn, which was the first decline of 10% or higher in more than four years, disrupted the third-longest equity rally in market history. Sharp market drops can unnerve even the most seasoned investors, but as we stated before, a decline of 10% or more occurs about once a year on average. While there have been many corrections in the last 40 years, the S&P 500 has recorded a positive return in 31 of those years. As a matter of fact, in the last 25 years (1990-2014), the S&P 500 has gained more on a total return basis during the 4th quarter (i.e., the months of October-November-December) than the index has gained during the other 3 quarters combined. Over the last 25 years, the final 3 months of the year have gained +253.1% (total return) vs. a gain of +181.3% for the first 9 months of the year. So far, the results in October seem to be lining up with historical norms as the markets have come back very strong since the end of the quarter.
Some market watchers have expressed concerns about the dampened outlook for U.S. earnings, which on the surface look like they are barely growing at all. In our view, we are in the midst of a mild earnings recession, where the stronger dollar and weaker oil prices have hurt U.S. corporate earnings even though the economy is not in contraction. Nearly 40% of S&P 500 earnings come from outside the United States and are thus susceptible to currency effects and global growth prospects. However, we do find that companies outside the energy sector are generally doing well. Most companies are beating earnings estimates, albeit estimates that have been lowered as the year has progressed.
Although global growth prospects have downshifted during the last quarter, we do not believe the global economy is headed into recession. Accommodative monetary supply is crucial for the ongoing global recovery so we expect central banks around the globe to maintain or accelerate ‘loose’ money policies. In the U.S., continued improvement in the employment picture as well as benign inflation provide a favorable backdrop for investing. European monetary policy appears to be gaining some traction, and although Europe (and Japan) face muted growth prospects, currency weakness and falling energy prices could provide an earnings tailwind for attractively priced export-oriented businesses.
China has been in the news quite often and has taken center stage in the global economic slowdown narrative. The volatility in their markets is driven by China’s long-term secular transition from a heavy manufacturing/export-based economy to a more consumption-driven one. Of course there are risks to the Chinese economy, but we believe the long-term outlook for China is still positive and that GDP growth of about 7% for the next ten years is reasonable.
For those who rely on their investments to produce income, the global dividend opportunity continues to broaden. With the recent correction in the market, yields on energy Master Limited Partnership’s (MLP’s), real estate, preferred stock, and dividend paying common stock have all risen. Although conventional wisdom suggests that rising interest rates are bad for dividend stocks, a closer look shows dividend growers and payers fare well over the whole cycle when rates tick up. And although we may get our first rate hike in December, rates are expected to increase at a very, very slow rate.
We hope everyone is enjoying autumn and as always, please call us with any particular 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