2016 2nd Quarter Outlook

April 21, 2016

Review of 1st Quarter

2016 began with a tremendous amount of volatility – based on fears of slowing China growth, energy price movements, and rising interest rates. The S&P 500 declined by 10% over the first six weeks. However, as solid annual company profit numbers were announced, those fears subsided, and the large cap U.S. stock index ended up 1% higher for the entire quarter. The rest of the markets produced mixed results. Small cap stocks declined by 1%, developed international stocks fell by 3%, while emerging market stocks rose by 6%. Bond funds also performed well, increasing by 3%.

 

In our 2016 outlook, we expressed concern that volatility might be higher than the past few years. While that concern was realized, we were surprised by both the tremendous level of volatility over the first six weeks, and by the immediacy of the reduction in volatility since mid-February.

 

U.S. Economy

Below is a table showing key economic and market indicators (as of March 31)*:

*Sources: Bureau of Economic Analysis, Bureau of Labor Statistics, JP Morgan, Federal Reserve Board

 

The economic news is good in general. The 5% unemployment figure is the level that many economists (including the Fed) consider to be full employment, and while economic growth has been far from spectacular, it’s been steady over the past six years. Inflation remains at a historically low level. And while interest rates are likely to increase some in the future, they are still relatively low. A concern that we raised three months ago – that the value of the dollar relative to other currencies had risen, thereby hurting exports – has waned a bit. The dollar has fallen about 6% since the beginning of the year.

 

U.S. Stock Market Outlook

While the extreme market movements in the first six weeks of the year have leveled off, we still believe they could return. Our belief is that while the focus of long-term investors should be on profitability and earnings growth, daily volatility might be driven by other factors, such as the Chinese economy, oil prices, exchange rates, and interest rate levels. As difficult as it may be, we suggest you ignore these daily movements as they only affect you if you sell your positions.

As a long-term investor, we think there’s good reason (based on history, and based on fundamentals of the markets) to believe in positive growth in stock prices over the next few years.  

 

Bond Market

Longer-term interest rates actually declined over the past three months, as the market became more convinced the Fed was not going to follow through on its long-term plan to raise interest rates by one percent each year (evidenced by the fact that Fed did not increase rates in the 1st quarter).  We still believe that rates will eventually increase, albeit at a relatively slow rate.  

International Stocks

The recent recovery in emerging markets was good for investors – however, it doesn’t make up for the losses incurred over the past two years.  We believe we will have good performance in international markets in general, and emerging markets specifically.  However, investments in those markets should not outweigh domestic markets because of the heightened level of potential volatility.

 

Summary

The first quarter was a volatile period, but overall a positive return producing three-months.  While we see signs of continued volatility, we believe in a broadly diversified portfolio for investors with a long-term investment horizon.

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