Quarterly Market Commentary – Third Quarter 2016

SUMMARY

The U.S. Presidential election may cause short-term market volatility, but do not let it dictate your long-term investment goals

U.S. oil rig counts continue to climb as oil prices break through $50 per barrel

The U.S. Federal Reserve left rates unchanged, but forecast a possible increase by year's end

Everyone loves the long days of summer. You can sit on your couch watching a mid-afternoon baseball game then take a two-hour nap only to wake up and find out you haven’t really missed that much. That was how a good portion of the third quarter went for financial markets. After a quick start in early July that saw the markets rebound following the Brexit vote, the “middle innings” of the period were relatively flat. That’s quite a different picture compared to the first six months of the year, when volatility was at an all-time high.

The focus of our previous quarterly market commentaries hinged largely on international themes. The main drivers were the shocking results of the Brexit vote, questions about China’s economic growth and wide-sweeping negative interest rates in global monetary policy. However, as the third quarter drew to a close, we have shifted our focus back to domestic matters, to say the least. Oil prices, stagnant interest rates and a certain election are getting most of our attention.

Both U.S. political parties have not been shy about making dire economic forecasts in the case of their opponent’s victory in November. Very few (if any) pundits or citizens are saying the country will be in great shape no matter who wins. It seems like “none of the above” would be the most popular answer on this examination so far.

That being said, as investors focused on saving for retirement, it is most important to concentrate on the long-term view. MFS Investment Management highlighted the financial market impacts of various presidential scenarios from 1900 to 2012 in their research paper titled “Primaries, Caucuses, and Elections – Oh My!”

Presidential Election Result

Market   Return (DJIA)

Presidential election year

7.4%

Incumbent party wins (Democrat or Republican)

14.6%

Incumbent party loses (Democrat or Republican)

-4.4%

Democrats win

4.2%

Republicans win

10.3%

Political Control

Market Return   (DJIA)

Democratic President / Republican Congress

8.6%

Republican President / Democratic Congress

2.4%

White House / Congress controlled by same party

7.1%

Democratic President / Split Congress

10.4%

Republican President / Split Congress

-4.3%

As is always the case, past performance is not indicative of future results. And neither are the various investment narratives that begin to take shape as we approach Election Day. As MONEY magazine illustrated in its article “How the Election will Really Affect your Investments” in June, it was widely thought that during the 2008 presidential race, an Obama win would severely damage gun makers, and alternative energy would finally overtake traditional energy sources. Well, Smith & Wesson is up over 400% since mid-2008 and alternative energy (as measured by the S&P Global Alternative Energy Index) is down more than 60% over the same period.

The lesson here: Whether you are making America great or are standing with her, it is important not to politicize your investment portfolio or lose focus on long-term goals.

Outside of the election, the Organization of Petroleum Exporting Countries (OPEC) agreed to cut production for the first time in eight years. The agreement would reduce production by 1% to 2% of the current 33 million barrels per day. Oil markets responded favorably to the announcement, as U.S. crude prices broke above $50 per barrel for the first time since June. Additionally, Baker Hughes reported that the U.S. oil rig count climbed to a total of 522 rigs (on and offshore), which is up 11 from a week before and up 118 from the low recorded in May 2016. Any stability in this sector would be a welcome change; lately its most consistent attribute has been volatility.

In the fixed income markets, the Fed made the decision to leave rates unchanged again. However, Fed Chair Janet Yellen indicated that the case to raise rates has strengthened over the recent months, citing better employment and inflation targets. We expect the Fed to act before the end of the year and increase the rate by a quarter point. It is unlikely they will make a change in November, just days before Election Day. Long-term revisions anticipate two additional rate hikes in 2017 and three in 2018 and 2019.

Equity Market Review

The third quarter equity markets were led by small cap growth with a return of 9.2% for the quarter. Large cap growth, which significantly underperformed to start the year, returned 4.6% for the quarter, bringing its year to date total to 6.0%. Year to date, value continues to outperform growth across every category, though growth narrowed the gap during the quarter. The technology sector significantly outperformed all other S&P 500 sectors for the quarter, with a QTD return of 12.9%. Meanwhile, the more defensive sectors like telecom and utilities (which both had a hot start to the year) gave back some of their gains this quarter with returns of -5.6% and -5.9%, respectively.

 Emerging markets continued to lead the way from an international equity standpoint, with another quarter of strong positive returns. Emerging markets (as measured by the MSCI EM Index) were up over 9% for the quarter (now up over 16% year to date). International developed markets (as measured by the MSCI EAFE Index) also posted strong returns for the quarter (6.4% QTD) but had a lot of ground to make up for the first half of the year.

Fixed Income Review

Interest rates across the yield curve increased ever so slightly for the quarter, with increases anywhere from two basis points to 17 basis points. The yield on the 10-year U.S. Treasury note increased from 1.49% on June 30 to 1.60% on September 30. The yield curve is expected to continue to gradually steepen as the Fed raises rates.

The Barclays Aggregate Bond Index, a measure of investment grade debt, experienced more muted returns for the third quarter (0.5%) compared to the 2.2% return in the second quarter. The Index is still up over 5.8% for the year. High-yield debt continued with its upward pace; it has returned over 15% year to date.

Diversification2

A diversified asset allocation portfolio is meant to smooth out returns over the long term without having huge positive or negative swings. Diversification is a topic that we stress to retirement plan participants through communication and education meetings.