Download The End of The World Is Off The Table

“A Bumpy Road to Nowhere”
Alex Thompson
Lance Hollingsworth
John Laughlin
Sarah Haizlip
Amery Staub
Leslie Drummond
Dear Clients & Friends:
April 19, 2016
It was a quarter for the ages, but if one were to just look at the starting and ending
points for stocks you’d wonder what all the fuss was about. Equity markets plunged
early on, recording the worst start to a year in Wall Street history. Then, just as
quickly, sharply reversed, staging a furious rally into the quarter-end. For all of its
drama, the first quarter performance of the S&P 500 was a subdued 1.3% (dividends
included). Yet it felt like a major victory as this was a 13% rebound from its midFebruary low. Higher quality bonds also managed to eke out slightly positive returns
while U.S. smaller cap and developed international stocks were slightly negative.
Major Market Indexes
Dow Jones Industrial Average
S&P 500 Index
MSCI EAFE Foreign Equity
MSCI World Index
Barclay’s Aggregate Bond Index
1Q
2.1%
1.3%
-3.0%
0.2%
3.0%
YTD
2.1%
1.3%
-3.0%
0.2%
3.0%
After the terrible selloff to start the year, the stock market rebounded based upon four
powerful factors: a reversal in the incredibly negative investor sentiment that had
built up, the weakening U.S. Dollar, the surprisingly “dovish” Federal Reserve, and
the stabilizing price of oil. Each of these factors, in and of itself, is a meaningful
market catalyst and can drive stock prices higher (or lower). Because these four
factors all came together at once, the resulting rebound in the market was quite
breathtaking.
The year started with a series of poor global economic numbers, sending investor
sentiment to very pessimistic levels. Fear was renewed that an economic slump in
Europe and emerging markets would infect the U.S. economy and that central banks
would be unable to provide appropriate policy countermeasures. This terribly
negative sentiment ultimately became a contrarian indicator, attracting buyers of
stocks as they held their noses and took advantage of the cheaper valuations.
The Dollar’s strength over the last 18 months has been a thorn in the side of large
U.S. companies. The 20% rise has made their exports less competitive and wreaked
havoc on foreign earnings when they were reported back home. The perception has
been that this trend would only continue. However, halfway through February, the
Dollar suddenly reversed course, ending the quarter 4% lower. This weakness
instantly created value which brought about a jolt to the upside in major exporters’
stock prices.
At the December Federal Reserve meeting, the Fed appeared determined to hike rates
four times during 2016. Markets choked, believing this was too much too quick. As
has been the case over the last several years, various Fed officials were promptly
paraded out during the quarter. They gave speeches and interviews painting a more
dovish stance and promising the markets they were aware of the situation. This
accommodative posture was ultimately confirmed by Chair Yellen’s latest speech
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where she emphasized the importance of global market stability. To many Fed watchers,
this newfound concern was shocking. For stock investors, however, it was yet additional
confirmation that the Fed will be very cautious and slow when increasing rates.
The Fed also seems to have found itself in a “Policy Feedback Loop.” Its policy decisions
have become directly tied to global macro dynamics, not just the U.S. economy’s
idiosyncratic performance. When the Fed speaks of raising rates, the hawkish narrative
fuels Dollar strength and equity and credit market weakness. This in turn fuels tighter
financial conditions, raising downside risks to the U.S. growth and inflation outlook. The
Fed responds by softening the rhetoric. This triggers a rebound in markets, which by
definition eases financial conditions again, paving the way for the Fed to restart talk of
lifting rates. Markets riot again, and the loop recirculates. This feedback loop exists
because of the perception that easy Fed policy is the major factor sustaining financial
markets in a growth and income-starved world.
Lastly, oil, and the rest of the commodity complex, stopped falling. In the midst of OPEC
talk of a production freeze and evidence of a U.S. shale output slowdown, crude appeared
to bottom. Since then, it has rebounded to trade near $40. The daily price swings have
reduced in volatility as well as correlation with stocks. In the first half of the quarter, as
oil traded to the $26 low, global stock markets traded tick for tick with the movement of
oil prices. After the rebound, stock prices seem to be moving slightly more independently
and based more on their own fundamentals.
Outlook
Although there are cases to
Top of Range
be made for a continuation
of these four bullish factors,
S&P 500
there is also a case to be
made that they have run
their course. Sentiment is
much better now, Dollar
weakness has stabilized and
the Fed is likely to turn back
to the hawkish part of their
feedback loop. Moreover,
while improving, crude oil
markets still face the
Bottom of Range
supply/demand conundrum
that has forced prices this
low to begin with. The S&P
500 also appears to be in a trading range, 1860 on the low end and about 2120 at the top
end. The chart to the right shows that we’re back trading near the top. It also demonstrates
the violent swings, both up and down, we’ve experienced over the last couple of years.
Staying in this range seems highly likely for the time being. Positives include U.S.
economic growth continuing to plod along at a “muddle through” pace, a slight pickup in
Europe and emerging market economies, and a corporate earnings cycle where year-overyear comparisons will become easier. These factors will help keep us near the top of the
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range. However, many challenges still exist that could draw markets lower. The
unemployment rate has fallen to a level where much more improvement seems
problematic, inflation will likely tick up as oil and other commodity prices stabilize, and
the ever concerning U.S. political environment heats up for the Fall election. We may well
be stuck in a low growth, low rate world for a while, implying lower than normal
investment returns for the near term. As always, patience, discipline, and fortitude remain
key to achieving one’s long-term investment goals and avoiding being swept away by the
market’s unceasing swings.
A Couple of Other Notes
We wanted to get in front of a headline that will likely become a bigger issue during the
current quarter, “Brexit.” On June 23rd, citizens of Britain will hold a referendum on
whether or not to exit the European Union (EU). The EU is a political/economic union of
28 primarily European member countries bound together through laws and regulations that
“aim to ensure the free movement of people, goods, services, and capital.” This Union
includes both the 19 countries that use the Euro and nine others that benefit from the free
trade agreements while maintaining their own currencies, Britain being one of the latter.
Why would they consider leaving the European Union? Many Brits consider the EU
regulations to be burdensome to their economy while others believe their sovereignty is
threatened by taking orders from others. At the root of their concerns is the limited ability
to control, due to EU rules, the free flow of immigrants into the country. This is especially
worrisome in a time of heightened terrorist activity.
Britain leaving the EU is analogous to past concerns of Greece leaving the Euro: it has
never been done and comes with much confusion and uncertainty. Current polling suggests
a narrow victory for the “stay in” crowd. However, as we approach the referendum date,
expect more of the usual media sensationalism associated with these events and the noise
and market volatility that accompany it.
Finally, the Department of Labor is rolling out the long-anticipated “Fiduciary Rule.”
Simply stated, this rule will require anyone offering investment advice on retirement
accounts to be obligated to put their clients’ interests ahead of their own. Summit, as
a Registered Investment Adviser, has ALWAYS operated under this standard. From the
beginning, we have felt our fee only and client only compensation structure is the single
best way to treat clients fairly and avoid conflicts of interest. On the other hand, traditional
“brokers”, usually paid with commissions, have operated under a “suitability” standard.
This standard only requires the investment or strategy be suitable, whether or not it really
advances the client’s long term goals and objectives or is in their best interests. All we can
say is, “Welcome to the higher standard.”
As always, we thank you for your continued confidence and trust. If you have any
questions, please don’t hesitate to contact us.
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