Q3 2016 Up Next - Elections and a Rate Hike?
“Bull markets are born on pessimism, grow on skepticism, mature on optimism and die on euphoria” – Sir John Templeton.
One could look at the above quote by the famous John Templeton and could probably figure out where we might be in the current cycle. Investors remain very skeptical as to the nature of this market move over the previous several years. Optimism is hard to come by given feelings about the upcoming elections and sluggish economy that remains with us. Euphoria seems non-existent which would make these times a difficult comparison to the high flying days of the dot.com era. If the above holds true, then one might conclude that the positive results of the third quarter probably are not that surprising.
In the third quarter, we saw the Dow finish the quarter with a +2.78% return and the S&P 500 also posted a positive return of +3.85% including dividends. The NASDAQ 100 was up +10.71% and the Russell 2000 finished the quarter with a +9.05% return, as high beta and cyclical market preferences led the charge. Value investing lost some traction this quarter as dividend and dividend yield preferences paused. The Russell 1000 Value Index was up a respectable +3.48% but underperformed the Russell 1000 Growth Index with a return of +4.58%. Volatility spiked this quarter as the election draws closer. Economic data released was largely mixed and the Fed held steady on additional rate increases. On the employment front July posted 255,000 in job gains, August came in at 151,000 jobs and September came in at 156,000 with the unemployment rate hovering around the 5% level. The Fed’s concern over the lack of inflation was the main reason for not hiking, stating that they would be willing to let the economy “run hotter.” The USD strengthened versus many of its counterparts mainly due to global central banks continuing their stimulus programs. Renewed concerns over “Brexit” sent the Sterling tumbling to $1.29/pound. Housing paused in the quarter as most of the indicators remained flat or mixed. Across the pond the performance of some of the major indices outpaced their U.S. counterparts. The MSCI EAFE index was up +6.43% in the quarter and the MSCI Europe Index returned +5.40%. Emerging markets were one of the better performing regions returning +9.03% for the quarter as commodities remained stable and valuations continue to be at multi-year lows.
Regarding fixed income, treasury yields rose from the abyss as chatter of the next fed funds rate increase gained traction with various Fed speaking engagements. The 10-year yield in the U.S. climbed to 1.80% from the 1.35% level. Most global sovereign bonds saw yields rise as the ECB and Bank of Japan signaled less aggressive monetary stimulus. High yield fixed income participated in the “risk-on” rally with the Barclays U.S. Corporate High Yield Index returning +5.50% for the quarter. Emerging markets fixed income rallied in tandem with high yield finishing the quarter with a +4.04% return according to the JP Morgan EM Bond Index.
2016 ASSET ALLOCATION UPDATE
As we approach the end of the year, TIC will begin to evaluate 2016 and contemplate direction for 2017. The value over growth preference we initiated at the end of 2015 has been directionally correct. Our adjustment towards a higher fixed income weight in our target allocations has also proven timely. Towards the end of August, the TIC voted to add the Vanguard GNMA Bond Fund to the models to reinvest the proceeds from the Blackrock Long/Short Credit Fund sold previously. We also added the MFS International New Discovery Fund to replace the Artisan International Investor Fund which was a disappointing performer for us. The MFS International New Discovery manager brings additional diversification by way of a medium capitalization bias and has demonstrated solid downside protection over time. Our view is that equities will have support in the short to medium term due to central bank support and lack of other alternatives. However, we remain mindful of valuations going forward.
With our blended equity and fixed income models performing about the same this year, our asset allocation models have produced competitive results thus far. Fixed income returns have been better than average in 2016 due to our overweight to credit fixed income. We have begun analysis and discussions with our fixed income managers to gauge strategy and positioning in what could be a more muted 2017. Monetary policy will continue to be accommodative this year into next, however, expectations for higher rates are increasing. The third quarter was more challenging, on average, for our managers as markets preferred lower quality attributes over high quality. We refuse to play the Wall Street game of chasing the hot button and remain grounded in the fundamental high quality discipline we are known for. In any market, we tend to have a number of managers that perform well regardless of market conditions. Listed below are results from some of our managers vs. their benchmarks in the quarter.
|Manager||* Q3 2016 Return||Benchmark|
|Granite Investment Partners SC Growth||+10.24%||+9.22% Russell 2000 Growth|
|T. Rowe Price LC Growth||+8.03%||+4.58% Russell 1000 Growth|
|Oakmark Fund||+8.53%||+3.48% Russell 1000 Value|
|AB Discovery Value Fund||+7.77%||+6.18% Russell 2500 Value|
|Principal Preferred Fund||+2.55%||+0.74% S&P Preferred Index|
*Returns are expressed as composite returns. Results may vary. Past performance is no guarantee of future returns
We look forward to speaking with all of you regarding our views and the performance of your respective portfolios. For additional information or questions please contact Mason Williams, Chief Investment Officer, at 786-497-1214 or Gerardo Rodriguez, Investment Officer, at 786-292-0310.