July 11, 2016
Investment returns in the second quarter followed a similar pattern to that of Q1. Domestic stocks fared well, foreign stocks less so. Bond returns continued to surprise to the upside as interest rates globally reached multi-decade (if not all-time) lows on the heels of sluggish global GDP growth and tepid inflation.
Asset class returns of note:
- Small-cap stocks rebounded from their Q1 losses as the overall “risk on” environment was a boost to performance.
- Investors’ insatiable appetite for yield led to significant gains for REITs, high-yield bonds and emerging market bonds.
- Master Limited Partnerships (MLPs) surged following the lead of oil. The dollar and the yen continued to be two of the world’s “safe haven” currencies.
Asset class returns in the days leading up to Brexit and the days after the vote were very interesting—prices rose initially on the misguided belief of a “remain” vote occurring. This was followed by a sharp “risk off” sell-off for two days after the vote, and then a grind back towards pre-vote levels in subsequent days for most asset classes with the exception of the British pound.
For the immediate future, all eyes will be focused on the near-term and long-term implications of Brexit. As mentioned earlier, investors should expect a period of increased asset price volatility in the wake of the decision and the arduous, complicated proceedings which lie ahead. As a result of the vote, Fed fund interest rate futures are now indicating that the Federal Reserve will hold off on any further rate hikes until December at a minimum, with the possibility of none at all for the remainder of the year.
We are waiting for the Q2 GDP report scheduled to be released on July 28 for confirmation that the sluggish 1.1% growth of Q1 GDP was a fluke. The current consensus estimate is that growth reached 2.7% for the quarter. We will be scrutinizing the second quarter earnings releases of U.S. corporations for an indication of the end to the “earnings recession” we have seen over the last four quarters and for any potential negative impact on earnings from the recent strength of the dollar.
With less certain global conditions and the U.S. moving toward a later-stage phase of its business cycle, we will be looking to reduce the risk profiles of portfolios going forward. This will be accomplished by decreasing stock exposure and increasing exposure to bonds over time, while still remaining well diversified across many asset classes.