2016 Q2 Economic Update from Transition Financial Advisors, Inc.
Fears of a global recession hit markets hard at the start of the year, making it the worst start to any year in history. Weakening corporate earnings, continued evidence of sluggish global growth, and the drama surrounding the election of the next leader of the free world (which oddly is both entertaining and frightening) all weighed heavily on investors’ minds. However, by mid February, the anxiety waned. Stabilizing growth, a more dovish Federal Reserve, and a pause in the U.S. dollar’s rise helped bring confidence to investors. Markets rallied, overcame the historical drop and our portfolios ended with small gains for the quarter. This was the second consecutive quarter of portfolio gains after a very difficult third quarter of 2015.
Taking a slightly longer view, it has been a difficult couple of years for markets. Over the last 24 months, the total investment return on the MSCI All Country World Index (ACWI), the most widely recognized benchmark for global stock market performance, has been a mere 1%. Foreign markets have been particularly bad losing almost 11% over the 2 year period. All these return numbers are inclusive of dividends.
On the fixed income side, central banks have continued to push their low rate, easy money policies, keeping bond yields near all-time lows. Actually, in Europe and Japan, many government bonds ($7 trillion) are now carrying negative yields. Although negative interest rates have made safety deposit boxes quite popular, they do not help investment returns on bonds, a core asset class of many retirees and near-retirees. Under-performing equity markets coupled with historically low yields on many fixed income securities have made this an extremely challenging investment environment.
But despite all these economic and market concerns, there are some bright spots on the horizon. First, the persistent deflationary decline in oil prices since mid-2014 may finally be ending. From its February low of $28, the price of crude oil has jumped more than 50% to $44/barrel. The second positive development, perhaps more important than the higher price of oil, is the surge in raw industrial commodity prices. The CRB Raw Industrial Commodity Price Index has risen about 12.5% from its low in November. This is indeed a very encouraging sign as industrial commodity prices are a good indicator of increasing economic activity and have been rising now for the last four to five months.
The final positive economic theme pertains to monetary policy divergence, the expectation of tighter money conditions here in the U.S. contrasted with further easing from the European Central Bank (ECB), the Bank of Japan, and many other central banks around the globe. Monetary policy divergence has been a clear market theme since 2014, and has sparked a persistent appreciation of the U.S. dollar. The rise of the dollar has led to a de-facto tightening of global financial conditions as it is the world’s premier funding currency. It has pressured commodity prices and weighed on U.S. corporate revenues and earnings. However, further dollar appreciation appears less certain from here. The dollar has recently suffered its largest pullback against both developed and emerging market currencies as the Fed has signaled a slower pace of interest rate increases throughout 2016. We believe the dollar’s appreciation will continue to slow in the near term which bodes well for global markets.
We have written much on the theme of the new emerging market consumer and the important role they play in the global growth story. The emerging market consumer is alive and well and shopping! Emerging market consumption is estimated to reach $30 trillion in 10 years, or roughly half of all global spending. The business opportunities available to companies with a global focus have never been better. Several of our investments focus squarely on this theme and we expect these funds to yield excellent results in the years to come. One of the big catalysts is China moving from a manufacturing based economy to a personal service economy, providing all of the wants from Chinese consumers like restaurants, vacations, banking, investing, etc.
For the first time since the Global Industry Classification Standard (GICS) was created in 1999, a new sector classification will be added. In September 2016, real estate will be separated from financials and will be given their own GICS sector. This change will have a far-reaching impact, as nearly everyone in the investment community uses GICS as a framework for portfolio planning and construction.
The decision to elevate real estate in equity indexes is a testament to the increasing role of real estate in global equity markets. Despite the importance of real estate to the economy, investors have generally shied away from REIT’s and other real estate stocks. With the new classification, real estate will likely see a significant lift in its profile and should therefore attract more capital. Furthermore, broader ownership of real estate stocks should lead to greater liquidity which ultimately should reduce the high level of volatility currently seen in this sector.
We would like to end this note with a quote from Eddy Elfenbein, taken from his Crossing Wall Street Blog. He states that “stocks are completely different from other classes of investments. It’s the only one that captures human ingenuity, which is the ultimate asset.” We agree with this point whole-heartedly as it describes in a nutshell the reason we are long-term stock market investors. Wishing everyone a pleasant May.
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