Download “You can`t build a wall around a village. The sun and the wind will

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“You can’t build a wall around a village. The sun and the wind will always find their way in.”
– Igor Goldkind, American author and poet
U.S. financial markets enjoyed a mild, pleasant rally for
most of the second quarter, leaving behind the anxieties of
the first. A better outlook for the U.S. economy and the
Federal Reserve’s shift to a benign attitude triggered
several positive impacts: the U.S. dollar eased, the S&P
500 approached its record high and Treasury bond yields
slowed their descent. Late in the quarter, financial markets
were shaken when the citizens of the U.K. surprisingly
voted to leave the European Union (EU). Global investors
quickly turned away from risk, sending equity markets
sharply lower and prices for safe assets higher. By quarter
end, some of the referendum-induced anxiety had calmed
such that the S&P 500 recovered and earned a modest
gain for the quarter. High quality fixed income also had
positive returns since prices for Treasury bonds continued
to rise (taking yields lower).
off until 2030 due to business disruptions. We are watching for early indications that British and European
businesses and consumers are cutting back on spending
during this limbo period.
THE U.S. REASSURES
Our portfolios are predominately invested in U.S. assets
and thus have some insulation from the upset in Britain.
During the quarter, investors became more confident in
the U.S. economy which helped draw more global capital
into our financial markets. Consumers remained upbeat as
unemployment remained low and retail sales grew briskly
in April and May (rising 2.4% over the prior year and
beating expectations). Housing prices are up in general and
workers may start to see wage increases both of which
should keep consumers in a positive mood through the
balance of 2016. Manufacturing, which has been lagging,
also reported good news – recent surveys indicated a mild
upturn remains intact. Investors were pleased to see the
U.S. economy demonstrate resilience from poor conditions overseas.
BRITAIN’S VOTE TRIGGERS POLITICAL UNCERTAINTY
Although the referendum was only advisory, the
domestic political climate turned unstable in the wake
of the result. Leaders of both the campaign to stay
(Prime Minister David Cameron) and the campaign to
leave (Boris Johnson and Nigel Farage) stepped down from
their roles. Plus, the leader of the opposition party (Jeremy
Corbyn) lost a confidence vote within the Labour party.
Some forward progress was made subsequent to quarterend; Home Secretary Theresa May became Britain’s new
prime minister in mid-July. Ms. May will decide Britain’s
next steps to leave the EU and address Scotland’s and
Northern Ireland’s strong preference to stay.
It’s very difficult to anticipate the timing and the terms
of Britain’s potential exit, if it occurs. An actual exit, or
progress towards one, is widely expected to pull the U.K.
into recession for at least two years while new trade and
cross-border investment policies are renegotiated. Some
economists believe the U.K. economy would not be better
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RETURNS FOR U.S. EQUITIES LEAD GLOBAL
DEVELOPED EQUITIES
When the week of the British referendum began, the S&P
500 Index opened near 2095, within 1% of its all-time high,
and returned to that level within five trading days, after a
quick two day drop. For the quarter, the S&P gained 2.5%.
For the same period, the MSCI EAFE Index lost 1.5% and
the MSCI Emerging Market Index earned 0.7%.
Several factors contributed to the favorable performance
of U.S. equities. Stock prices rose as the economy regained
strength and corporate earnings were generally better than
expected. Sentiment for equities improved due to the rise
in crude oil prices and the slightly lower U.S. dollar.
An unusual boost came from bond investors turning to
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stocks for their dividend yield. Areas of the stock market
which tend to pay rich dividends - utilities, REITs and
preferred stocks - outperformed the S&P 500 for both the
quarter and year to date. We believe this trend may persist
since currently two-thirds of the equities within the S&P
500 have a dividend yield above 1.36% (the 10-year
Treasury bond yield on July 8, 2016).
Looking ahead, we expect U.S. equities to stay in a
broad range, but with increasing bouts of volatility.
Interest rates are low and inflation is subdued. The U.S.
economy is growing, but slow enough and with enough
uncertainty from overseas to keep the Fed on the sidelines.
overseas central banks combining to push overseas yields
below zero.
DEVELOPED OVERSEAS MARKETS DISAPPOINT
The MSCI EAFE Index showed a loss for the quarter
(down 1.5% in U.S. dollar terms) from its direct exposure
to British and European equities. Bank stocks were
especially volatile due to the anticipated strain on
earnings from the negative interest rates in Europe and
Japan. Since the EU and Japan have massive banking
sectors (as a percent of GDP), the fall in bank stocks had
a material impact on investment returns from developed
overseas markets.
HIGH QUALITY BONDS BUFFER
Japanese stocks earned a small 1.0%
PORTFOLIO RETURNS
gain in U.S. dollar terms for the quarter,
The fixed income classes we follow
but this was due to exchange rates (in local
“We expect U.S.
generated broadly positive returns for the
currency, the MSCI Japan Index lost
equities to stay in
quarter with the Barclays U.S. Treasury
7.8%). Contrary to the longstanding
5–10 Year Index delivering a 2.3%
a broad range, but
efforts of the Japanese government and
quarterly return. Fixed income gains
central bank, the yen has rapidly strengthwith increasing bouts
were earned since the U.S. Treasury
ened in 2016 as investors sought safe
of volatility.”
prices rose (with yields declining) over
havens and unwound foreign currency
the course of the quarter. Safe-haven
positions predicated on a weak yen. In late
demand (especially after the surprise
June, the yen tested its strongest level
British referendum results), negative
against the U.S. dollar in nearly two years,
interest rates in Europe and Japan and the Federal
reversing a good portion of its drop under Prime Minister
Reserve’s shift to a dovish attitude also contributed to
Abe’s 4-year economic program.
lower U.S. interest rates. At the beginning of the second
In light of the higher uncertainty for Britain and
quarter, the benchmark 10-year Treasury was 1.78%.
Europe, plus the unabated rise in the yen, we are reviewing
In the days following the referendum, it dropped as low
our holdings of developed international equities.
as 1.42% and, after a brief increase, fell to a new record
SHORT-TERM THREATS TO EMERGING MARKETS EASE
low in the first week of July.
We don’t see a catalyst to reverse the trends of
Emerging market equities, as measured by the MSCI
“low and slow” in the global economy and interest rates.
Index, gained 0.7% for the second quarter in U.S. dollar
In fact the trend toward low (or lower) interest rates may
terms, bringing the year to date gain to 6.4%. Similar to
intensify since the Bank of England has started to signal
developed market equities, the U.S. dollar boosted returns
an interest rate cut and the ECB and Bank of Japan stand
in emerging market equities.
ready to provide more liquidity if needed. We believe
Emerging market equities have performed better in the
longer-term rates are likely to stay range bound but with
last six months as several significant sources of risk have
pockets of volatility - due to the outlook for slowing
dissipated. Relative to January, the threats to emerging
global growth, very low inflation and easing from
market equities from a looming hard landing in China,
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rising U.S. interest rates, falling crude oil prices and
declining commodity prices generally have each been
reduced. Plus, the U.S. dollar is also off its peak, relieving
another pressure point on emerging market nations.
An allocation to emerging market equities can benefit
investment portfolios over the long term through their
diversification properties and their prospects for faster
growth relative to developed economies. However,
volatility can be quite high with China and Brazil as the
best examples. China’s debt level concerns us, particularly
since struggling industrial companies owe a large part of it.
Ideally, Beijing will gradually restructure the debt while
the Chinese economy very slowly shifts towards consumption and services.
rebalance, we continue to emphasize best-in-class MLPs,
with intact growth opportunities, low leverage, and high
distribution coverage.
Real estate investment trusts (or REITs) outperformed
the S&P 500 returning 6.8% for the quarter (using the
MSCI US REIT Index). The industry is currently benefitting from low vacancies and a rise in rents. REITs have
been in demand by investors searching for yield as REITs
offer income with some growth potential.
INVESTMENT OUTLOOK
The surprising result of Britain’s referendum has elevated
uncertainty for its business outlook and to a more modest
degree in Europe. However, the U.S. economy has improved largely through continued positive developments
for consumers. The combination of rising uncertainties
overseas, U.S. growth around 2% (annually) and low
inflation will likely keep the Federal Reserve on hold into
early 2017. These conditions should offer relative support
for U.S. equity prices. However, valuations are full and
thus we expect volatility to continue. In fixed income,
with tepid domestic growth and foreign investor preferences for safety, we favor government and municipal
securities for their low credit risk. Fixed income will be
valuable as well to ballast to diversified portfolios.
As always, please reach out to your portfolio manager
with any questions or to update your strategic asset
allocation. Staying disciplined and focused on your
long-term wealth objectives as opposed to short-term
market movements is the best strategy for a successful
investment plan.
PRECIOUS METALS AND MASTER LIMITED
PARTNERSHIPS STAND-OUT WITHIN REAL ASSETS
The Bloomberg Commodity Index posted 12.8% for the
quarter with very strong gains on natural gas, sugar and
precious metals. Precious metals compete for safe haven
flows and thus it is not surprising to see gold and silver as
cash alternatives in extremely volatile markets and particularly with the preponderance of negative interest rates
around the globe.
General commodity exposure is relatively unattractive
to us as softening demand relative to abundant supplies is
putting downward pressure on most commodity prices.
Demand for industrial commodities is falling as China
shifts from infrastructure and manufacturing towards
services and consumerism. Prices for agricultural commodities could be significantly affected by a shift in the
weather pattern from El Niño to La Niña.
The crude oil market is very gradually moving towards a
balance. Supply is gradually tightening through lower U.S.
shale oil production and the serious wildfires near oil sand
facilities in Canada. Political struggles within Nigeria and
Libya are limiting oil exports from each country.
Consequently, Master Limited Partnerships (MLPs), as
measured by the Alerian Index, had a very strong 19.7%
quarterly return and have rebounded by more than +50%
off the February 11 lows. As oil supply and demand slowly
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FINANCIAL MAR K ET R ETUR NS
annualized
U.S. Equity
Q2 2016
YTD
1 Year
3 Year
5 Year
10 Year
2.1%
4.3%
4.5%
9.0%
10.4%
7.7%
-1.1%
-3.2%
-1.8%
16.4%
15.2%
11.9%
S&P 500 TR Index
2.5%
3.8%
4.0%
11.7%
12.1%
7.4%
Russell 1000 Index
2.5%
3.7%
2.9%
11.5%
11.9%
7.5%
Russell 1000 Growth Index
0.6%
1.4%
3.0%
13.1%
12.3%
8.8%
Russell 1000 Value Index
4.6%
6.3%
2.9%
9.9%
11.4%
6.1%
Russell Mid Cap Index
3.2%
5.5%
0.6%
10.8%
10.9%
8.1%
Russell Mid Cap Growth Index
1.6%
2.2%
-2.1%
10.5%
10.0%
8.1%
Russell Mid Cap Value Index
4.8%
8.9%
3.2%
11.0%
11.7%
7.8%
Russell 2000 Index
3.8%
2.2%
-6.7%
7.1%
8.4%
6.2%
Russell 2000 Growth Index
3.2%
-1.6%
-10.8%
7.7%
8.5%
7.1%
Russell 2000 Value Index
4.3%
6.1%
-2.6%
6.4%
8.1%
5.2%
MSCI US REIT Index GR
6.8%
13.6%
24.1%
13.5%
12.5%
7.4%
Bloomberg Commodity Index
12.8%
13.3%
-13.3%
-10.6%
-10.8%
-5.6%
Alerian MLP
19.7%
14.7%
-13.1%
-5.4%
3.2%
9.5%
Q2 2016
YTD
1 Year
3 Year
5 Year
10 Year
-1.5%
-4.4%
-10.2%
2.1%
1.7%
1.6%
Dow Jones Industrial Average
NASDAQ 100 Index
annualized
International Equity
MSCI EAFE Index ($USD, net)
MSCI AC World Index ($USD, net)
1.0%
1.2%
-3.7%
6.0%
5.4%
4.3%
-0.6%
-1.0%
-10.2%
1.2%
0.1%
1.9%
MSCI Emerging Markets Index ($USD, net)
0.7%
6.4%
-12.1%
-1.6%
-3.8%
3.5%
MSCI BRIC Index ($USD, net)
3.1%
4.5%
-16.5%
-1.0%
-5.6%
2.9%
Q2 2016
YTD
1 Year
3 Year
5 Year
10 Year
Barclays US Treasury 1– 3 Year Index
0.5%
1.4%
1.3%
1.0%
0.8%
2.5%
Barclays US Treasury 5 –10 Year Index
2.3%
6.5%
7.8%
4.5%
4.5%
6.1%
Barclays US Long Treasury Index
6.4%
15.1%
19.3%
10.5%
10.3%
8.8%
Barclays US Treasury US TIPS Index
1.7%
6.2%
4.4%
2.3%
2.6%
4.7%
Barclays US Govt/Credit Intermediate Index
1.6%
4.1%
4.3%
3.0%
2.9%
4.5%
BofAML Municipals 1–12 Year Index
1.4%
2.6%
4.8%
3.5%
3.3%
4.3%
Barclays US Corporate High Yield Index
5.5%
9.1%
1.6%
4.2%
5.8%
7.6%
BofAML Preferred Stock Fixed Rate Index
3.4%
5.1%
10.6%
7.8%
7.1%
3.9%
JPMorgan GBI EM Global Diversified Index
3.0%
14.3%
2.2%
-3.5%
-2.2%
5.7%
JPMorgan EMBI+ Index
6.0%
12.3%
13.2%
7.1%
6.4%
8.0%
MSCI AC World Ex US Index ($USD, net)
annualized
Fixed Income
Source: Morningstar
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INDEX DEFINITIONS
Russell 2000 Growth Index®: measures the performance
of those Russell 2000 companies with higher price-to-book
ratios and higher forecasted growth values
U.S. EQUITY
Dow Jones Industrial Average: is a price-weighted
average of 30 actively traded blue-chip U.S. stocks
Russell 2000 Value Index®: measures the performance of
those Russell 2000 companies with lower price-to-book
ratios and lower forecasted growth values
NASDAQ 100 Index: measures the performance of the
100 largest domestic and international non-financial
companies listed on The NASDAQ Stock Market based
on market capitalization
MSCI US REIT Index: is a free float-adjusted market
capitalization index that is comprised of equity REITs.
The index is based on MSCI USA Investable Market Index
(IMI) which captures large, mid and small cap securities
S&P 500 TR Index: is a type of equity index that tracks
both the capital gains of the equities in the S&P 500 and
assumes any cash distributions (dividends) are reinvested
back into the index
Bloomberg Commodity Index: tracks the futures
contracts on over 20 different physical commodities on
the commodity markets. The Index is weighted to account
for economic significance and market.
Russell 1000 Index®: measures the performance of the
1,000 largest companies in the Russell 3000
Russell 1000 Growth Index®: measures the performance
of those Russell 1000 companies with higher price-tobook ratios and higher forecasted growth values
Alerian MLP: is a composite of the 50 most prominent
energy Master Limited Partnerships (MLPs) that provides
investors with an unbiased, comprehensive benchmark for
the asset class
Russell 1000 Value Index®: measures the performance of
those Russell 1000 companies with lower price-to-book
ratios and lower forecasted growth values
FTSE NAREIT All REITs: is a comprehensive family of
REIT-focused indexes that span the commercial real estate
industry, providing market participants with a range of
tools to benchmark and analyse exposure to real estate
across the U.S. economy at both a broad industry-wide
level and on a sector-by-sector basis
Russell Mid Cap Index®: measures the performance of
the 800 smallest companies in the Russell 1000 index
Russell Mid Cap Growth Index®: measures the
performance of those Russell Midcap companies with
higher price-to-book ratios and higher forecasted growth
values. The stocks are also members of the Russell 1000
Growth index
INTERNATIONAL EQUITY
MSCI EAFE Index: is a free float-adjusted market
capitalization index that is designed to measure the equity
market performance of developed markets, excluding the
US & Canada
Russell Mid Cap Value Index®: measures the performance of those Russell Midcap companies
with lower price-to-book and lower forecasted growth
values. The stocks are also members of the Russell 1000
Value index
MSCI AC World Index: is a free float-adjusted market
capitalization weighted index that is designed to measure
the equity market performance of developed and
emerging markets
Russell 2000 Index®: measures the performance of the
2,000 largest companies in the Russell 3000 index
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INDEX DEFINITIONS
MSCI AC World Ex US Index: captures large and
midcap representation across 22 of 23 developed marketing countries (excluding the US) and 23 Emerging
Markets countries
Barclays US Corporate High Yield Index:
measures the USD-denominated, high-yield, fixed-rate
corporate bond market. Securities are classified as high
yield if the middle rating of Moody’s, Fitch and S&P is
Ba1/BB+/BB+ or below. Bonds from issues with an
emerging markets country of risk, based on Barclay’s
EM country definition, are excluded
MSCI Emerging Markets Index: is a free float-adjusted
market capitalization index that is designed to
measure equity market performance in the global emerging markets
BofAML Municipals 1–12 Year Index: is a subset of the
BofAML U.S. Municipal Securities Index and includes all
securities with a remaining term to final maturity greater
than or equal to one year and less than 12 years and rated
AAA through AA3, inclusive
MSCI BRIC Index: is a free float-adjusted market
capitalization weighted index that is designed to measure
the equity market performance across the following 4
emerging market country indexes: Brazil, Russia, India
and China
BofAML Preferred Stock Fixed Rate Index: this index
is designed to replicate the total return of a diversified
group of investment-grade preferred securities
FIXED INCOME
Barclays US Treasury 1– 3 Year Index: measures the
performance of U.S. Treasury securities that have a remaining maturity of at least one year and less than three years
JPMorgan GBI EM Global Diversified Index: is an
investable benchmark that includes only those countries
that are directly accessible by most of the international
investor base. This index exclude countries with explicit
capital controls, but does not factor in regulatory / tax
hurdles in assessing eligibility
Barclays US Treasury 5 –10 Year Index: measures
the performance of U.S. Treasury securities that have
a remaining maturing of at least five years and less than
10 years
JPMorgan EMBI+ Index: tracks total returns for traded
external debt instruments (external meaning foreign
currency denominated fixed income) in the emerging
markets. The regular EMBI index covers U.S. dollardenominated Brady bonds, loans and Eurobonds. The
EMBI+ expands upon J.P. Morgan’s original Emerging
Markets Bond Index
Barclays US Long Treasury Index: includes all publicly
issued, U.S. Treasury securities that have a remaining
maturity of 10 or more years, are rated investment grade,
and have $250 million or more of outstanding face value
Barclays US Treasury US TIPS Index: the index
includes all publicly issued U.S. Treasury inflationprotected securities that have at least one year remaining
to maturity, are rated investment grade, and have $250
million or more of outstanding face value
Barclays US Govt/Credit Intermediate Index: the
index measures the performance of the USDdenominated U.S. Treasuries, government-related and
investment grade U.S. corporate securities that have a
remaining maturity of greater than one year and less than
ten years
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DISCLOSUR E
First Republic Private Wealth Management encompasses First Republic Investment Management, Inc. (“FRIM”), an SECregistered investment advisor, First Republic Securities Company, LLC (“FRSC”), Member FINRA/SIPC, First Republic Trust
Company (“FRTC”) and First Republic Trust Company of Delaware LLC (“FRTC-DE”). FRIM, FRSC, and FRTC-DE are
wholly owned subsidiaries of First Republic Bank. FRTC is a division of First Republic Bank. Investment advisory services are
provided through FRIM. Securities brokerage services are provided through FRSC. Trust and fiduciary services are provided
through FRTC and FRTC-DE.
This document is for information purposes only and is not intended as an offer or solicitation, or as the basis for any contract to
purchase or sell any security, or other instrument, or to enter into or arrange any type of transaction as a consequence of any
information contained herein.
All analyses and projections depicted herein are for illustration only, and are not intended to be representations of performance or
expected results. The results achieved by individual clients will vary and will depend on a number of factors including prevailing
dividend yields, market liquidity, interest rate levels, market volatilities, and the client’s expressed return and risk parameters at
the time the service is initiated and during the term. Past performance is not a guarantee of future results. Investors should seek
financial advice regarding the appropriateness of investing in any securities, other investment or investment strategies discussed
or recommended in this report and should understand that statements regarding future prospects may not be realized.
Investors cannot invest directly in an index. The indexes referred to do not reflect management fees and transaction costs that are
associated with some investments. Although information in this document has been obtained from sources believed to be reliable,
we do not guarantee its accuracy, completeness or fairness, and it should not be relied upon as such. This document may not be
reproduced or circulated without our written authority.
Investment, Insurance and Advisory products and services are not deposits of, or guaranteed by, any bank, are not
insured by the Federal Deposit Insurance Corporation, the Federal Reserve Board, or any other government agency,
entity or person and are subject to investment risks including the possible loss of principal.
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