“Instant Karma's gonna get you / Gonna knock you right on the head” John Lennon
Much like the first quarter of 2016, investors stomached another mini-correction in Q2 as a result of the U.K.’s vote on whether to remain in or leave the European Union (EU). A misreading of the poll data led to political and market turmoil at the final tally to leave the EU on June 23. Markets reacted accordingly, and stocks and currencies plunged while government bonds and the U.S. dollar rose over the next two days. Markets then reversed direction, and rebounded so that the quarter ended in the black for most asset classes. Unsurprisingly, U.K. risk assets such as stocks and currencies were hit hardest and have the murkiest outlook. As John Lennon wryly noted in Instant Karma, Britons shouldn’t have been surprised that the ‘instant karma’ of the markets provided a knock ‘right on the head.’
Following is a summary of 2nd quarter and year-to-date performance for various asset classes. A rebound in oil prices and a stabilizing of the U.S. dollar pushed risk assets such as U.S. stocks, high-yield bonds and real estate, as well as oil and gold, into positive territory.
In our recent webcast, we identified four issues that the markets were processing: the ‘Brexit’ vote; the Fed’s interest-rate-hike cycle; the fall U.S. elections; and the ongoing transition of China’s economy. Let’s look briefly at these issues now that the Brexit vote has passed.
“Say you want a revolution / We better get on right away” Power to the People
The Brexit vote: The long-term implications of the “leave” vote are unclear; the short-term results will be harmful to U.K.’s currency, stock market, labor market and economy. Three major political figures have resigned from their party or withdrawn from the selection process for a new prime minister. Negotiations to structure the exit and write new treaties will take years. The economic effects, however, will mostly be confined to the U.K., particularly since the nation is not part of the euro currency. The EU has signaled that they will not offer favorable exit terms to the Britons in order to set an example to other populist movements across Europe (notably in France, Spain and Italy). Most harmful will be the effects on immigration and on the younger members of the work force, who provide the skills and labor necessary to keep the U.K. growing in today’s economy.
The Fed’s interest-rate hikes: These have understandably been delayed. In what has become a long-running dramedy (drama and comedy), the Fed has clearly signaled a desire to raise short-term rates. Each time the opportunity presents itself, however, a market or political event occurs that delays the increases. The graph below highlights the Fed’s intentions (the blue data) and what the market expects (brown data). Clearly, there is a wide gap between intentions and expectations. If expectations are accurate, then investors might expect slower growth, continued job creation, and a tick up in inflation. These translate into more ‘lower for longer’ rate assumptions.
The U.S. elections: In a general election stunningly devoid of policy discussion, investors are left to parse the candidates’ comments that reflect almost exclusively on personality traits. We often remind clients that ‘the market hates uncertainty,’ and the recent populist vote in the U.K. in favor of the Brexit has raised some issues about the underpinnings of the vote and its relevance to the U.S. elections. Here’s a brief estimate of some important election issues and how the market might see them:
China’s economic transition: Recent events in Europe and the U.S. have taken the spotlight off China. In recent months, the yuan has been further devalued to a level close to its recent high from January 2016; this helps China’s trade balance, but hurts other EM countries. Further, China’s debt keeps growing (left graph) to a level that is dangerously high, and state-owned enterprises (SOEs, right graph) are crowding out private investment, also not a good indicator. The markets are expecting a ‘soft landing’ for the Chinese economy, but these data suggest the landing might be harder than hoped for.
“People asking questions lost in confusion / Well I tell them there's no problem / Only solutions,” Watching the Wheels
These issues have introduced a new market solution: TINA. This is an acronym for ‘there is no alternative,’ a reference to the fact that much of the data we watch – interest rates, global GDP growth, earnings, corporate governance – point investors to stocks, particularly U.S. large-caps. Recently, some energy assets, emerging-markets stocks and investment-grade bonds have become attractive as well. We’re still modestly bullish on stocks, have globally diversified fixed-income allocations, and expect growth to be low but positive. We’re hopeful that the summer will see more clarity around these issues. In the meantime, we remain invested with a focus on a long-term outlook, and will not allow short–term volatility or market emotions to affect our long-term decisions.
As always, we welcome your comments and questions.
-Your Wealth Management Team at JJ Burns & Company
Disclosure: J.J. Burns & Company, LLC is a registered investment adviser with the U.S. Securities & Exchange Commission and maintains notice filings with the States of New York, Florida, Pennsylvania, New Jersey, Connecticut, and California. J.J. Burns & Company, LLC only transacts business in states where it is properly registered, or excluded or exempted from registration. Follow-up and individualized responses to persons that involves either the effecting or attempting to effect transactions in securities, or the rendering of personalized investment advice for compensation, as the case may be, will not be made absent compliance with state investment adviser and investment adviser representative registration requirements, or an applicable exemption or exclusion.
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2016: 2nd Quarter Summary