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Alan McKnight, MBA, CFP®
April 20, 2016
We now seem to be experiencing the “calm after the storm” that started the first week of 2016. Investors experienced an unusually volatile start to the year, and as of March 31st, the U.S. stock market ended the quarter higher than it started the year. Following its worst start since 2009 and a fall of more than 10%, equity markets enjoyed an equally swift recovery of over 10%, bringing us back to even.
For the 1st quarter of 2016, the change in value of each of the major world market indices was as follows:
The world markets experienced a scare about China’s market and economy, a potential U.S. recession and deflation; it then recovered, all in less than three months. As a result, the Dow saw its biggest quarterly comeback since 1933.
We don’t want to obsess about the drama during the 1st quarter, but we need to examine what has change.
Oil seems to have found a bottom with prices recovering strongly, up more than 50% from its January low, while the dollar has weakened. Oil and the dollar tend to have an inverse relationship, with the dollar rising when oil falls and vice versa. Oil remains more than 60% down and the dollar more than 20% up from their levels of summer 2014. These factors relieved some of the fears investors had over bankruptcies in the U.S. energy sector.
Gold investors were rewarded in the 1st quarter. Though prices had fallen rather sharply in the past three years, gold did do well as a safe haven as investors rushed to purchase the precious metal. Gold prices soared 16.5% during the quarter, but many analysts feel that gold prices may now be overdone.
Last year was a strong year for the dollar, but Jeffrey Rosenberg, Blackrock’s Chief Investment Strategist of fixed income feels the dollar will not appreciate as much in 2016 as it did in 2015. I would guess, however, that it will remain strong against its foreign counterparts.
Corporate profits are important for investors to watch. Corporate profits have been disappointing, and many companies have guided investors to expect worse. A weakening dollar can strengthen overseas profits made by U.S. multinational corporations and a higher oil price can possibly avoid disaster for some energy companies’ bottom line. As of now, analysts are preparing for a potential downturn in corporate profits.
Corporate share buybacks were high this past quarter. At $95 billion in February, according to TrimTabs, the money U.S. companies spent on their own stock was the third highest in a month on record. Analysts are mixed as to whether corporations can continue to maintain this level of share buybacks moving forward and are projecting that most will scale back. Several companies have actually used cheap money from low interest rate loans to fund their buyback programs. The U.S. stock market is trading at an earnings multiple of approximately 18, which is not considered historically cheap, therefore investors need to keep a watchful eye on earnings.
Again this quarter, interest rates and Fed watching continued. Investors were carefully watching the federal funds rate in anticipation of a rate increase. In December of 2015, the Fed raised interest rates for the first time in 9 years and suggested that this was the beginning of anticipated rate increases. In December, Stanley Fisher, the Central Bank’s Vice Chairman, said that for 2016, four interest rate increases “were in the ballpark.”
That sentiment changed on Tuesday March 29th when Fed Chair Janet Yellen said in a speech that: “Various headwinds existed which made it difficult to justify aggressively increasing lending rates.” While global growth has become an issue, rising real interest rates have also weighed on both economic activity and financial market euphoria. Whether you agree with it or not, this seems to be the policy direction of the Fed. Even at the Fed, however, many aren’t in agreement. Prior to this, several Fed members expressed a more hawkish view, suggesting that interest rates may indeed rise faster.
In the wake of Yellen’s statements, markets celebrated. The prospect of continued low rates is usually seen as good for stocks, and that is playing out. Longer-term, though, Yellen’s stance raises deeper questions.
As for some overseas central banks, they are unclear in where rates can go, at least when it comes to exchange rates. Both the Bank of Japan and the European Central Bank cut rates further into negative territory this year and both saw their currencies strengthen. This is largely because markets perceive, perhaps correctly, that the banks can take rates no lower
Are there still several rate increases in our future?
This will depend on the Fed’s interpretation of primary indicators. At some point, improvements in employment and increases in inflation could encourage the Fed to aggressively raise rates. As of March, the markets seem to be suggesting that a “low for longer” path remains the most likely course for rates. The Federal Open Market Committee (FOMC) in March predicted two increases in the federal funds target rate from the current 0.25 to 0.5% range.
How does the federal funds rate affect other interest rates?
The federal funds rate is an important benchmark in financial markets. It is the interest rate that the borrowing banks pay to the lending banks to borrow funds. It is negotiated between the two banks and the weighted average of this rate across all such transactions is the federal funds effective rate.
While the federal funds rate is only directly applicable to banks that lend to one another, it has become a benchmark for consumer and business loan rates. Business executives and investors keep a close eye on the federal funds rate and the FOMC’s position on the economy to help them adapt their business plans accordingly.
The prime rate, for example, is established by banks and is offered to their best customers. It is used to determine interest rates for a variety of loans, including credit cards, car loans, small business loans, and home equity lines of credit.
Is it true some countries have negative interest rates?
Imagine a bank that pays negative interest. Depositors are actually charged to keep their money in an account. Crazy as it sounds, several of Europe’s central banks have cut key interest rates below zero and kept them there for more than a year. In theory, interest rates below zero should reduce borrowing costs for companies and households, driving demand for loans. In practice, there’s a risk that the policy might do more harm than good.
The European Central Bank cut rates again March 10, charging banks 0.4 percent to hold their cash overnight. At the same time, it offered a premium to banks that borrow in order to extend more loans. Sweden also has negative rates, Denmark is using them to protect its currency’s peg to the euro and last year Switzerland moved its deposit rate below zero for the first time since the 1970s.
When it comes to negative interest rates in the U.S., Kiplinger’s Finance says, “No Way.” They cite that many bond pros say subzero interest rates are unlikely because they wouldn't help the U.S. economy and could damage it. They feel that when it comes to the savings of the average American, subzero interest rates are a nonissue. If necessary, you could fight back by sticking your cash in a safety deposit box or finding an online bank that would pay you something. They point out that avid competition for the public’s money in the U.S., as opposed to near-comatose demand in Europe and Japan, provides some assurance that yields in the U.S. will stay in the black.
While oil traders may be disappointed with lower prices, this would seem to be good news for the U.S. economy. For years, politicians and consumers have griped about the high price of oil and how it hits consumers in their pocketbooks. Now that gas prices have fallen below $2 a gallon in much of the country, consumers will have more money to spend and stimulate the rest of the economy.
Although low energy prices are still better than high energy prices, a continued decline should worry investors about the possibility of smaller oil companies going bankrupt and negatively impacting those companies doing business with the oil companies.
The Presidential Elections
The U.S. presidential election will be held on Tuesday, November 8th, 2016, so we are only 7 months out! We are still finishing caucuses and primaries, but there is a high probability that Hillary Clinton will be the Democrat nominee as she is racking up the delegates. Of the 2382 delegates needed to win, Hillary Clinton has 1428 delegates plus 502 superdelegates. On the Republican side, it is looking more unlikely that any of the three remaining candidates (Trump, Cruz or Kasich) with make it to the “magical” 1237 delegates, so an open convention is becoming more and more likely. After the New York primaries, Donald Trump has 845 delegates to Cruz’s 559.
Of course there are no lack of views and opinions, and that's true not only when it comes to politics but also to the implications of politics over the markets. Will candidate X or Y be better or worse for the markets? The stock market does not like uncertainty, but I think things will start becoming clearer by the end of the summer months.
Many investors are still concerned about the market. Historically, prior to 2016, March shows up as the fourth best month for stocks after December, November and April. According to Bespoke Investors and Marketwatch, over the past 65 years, the S&P 500 has risen 42 times in March and fallen 24 times, with average return of 1.06%. The positive returns of March 2016 will increase that number.
While the mood is cautious, Bespoke Investment Group’s numbers show that April is not the cruelest month for investors. History shows that a positive March is typically followed up with a slight gain in April, however some believe that “this time it could be different.”
Where do investors go from here?
The markets will begin the 2nd quarter with companies reporting earnings. Oil prices, market volatility, interest rate decisions, and global growth worries will all factor in and possibly determine the future path of the market.
In the 1st quarter, U.S. stocks went from down 10.8% on February 11th to then gain 13.2% and finish the quarter up by over 1%. Although this roller coaster ride allowed investors that stayed to return to a place near where they entered, people still might feel queasy.
At the start of 2016, most analysts felt that bond yields had nowhere to go but up (meaning bond prices would fall) and the dollar would continue its ascent with gold prices dropping. They were wrong. Moving into the 2nd quarter a positive jobs report encouraged investor confidence, but CAUTION is still the principal notion for investors.
What can investors do?
Safety comes with a price. According to Bankrate.com’s March 30th charts, rates on one year CD’s were 0.28%. The average bank money market yield was 0.11%. Five year CD’s were averaging under 1%. Investors are not typically excited with interest rates less than 1%.
For many investors these rates will not help them achieve their desired goals. Most investors attempt to build a plan that includes risk awareness. Many times this can lead to safer but lower returns. Traditionally, bonds have been the de facto standard to hedge against market risk and did well in the January market downturn. However bond prices are at historical highs, and they may not offer the returns they did in the past. Investing is not about keeping pace with the market, but it’s about managing and hedging risk so your portfolio suits your individual needs regardless of market performance.
Have a Strategy. Investors need to be prepared. Market volatility may cause you to be concerned, but panic is not a plan. Market downturns do happen and so do recoveries. This is the ideal time to ensure that you fully understand your time horizons, goals and risk tolerances. Looking at your entire picture can be a helpful exercise in determining your strategy.
Focus on your own personal objectives. During tougher times it is always wise to create realistic time horizons and return expectations for your own personal situation and to adjust your investments accordingly. Understanding your personal commitments and categorizing your investments into near-term, short-term and longer-term can be helpful.
Make sure you are comfortable with your investments. Equity markets will continue to move up and down. Even if your time horizons are long, you could see some short term downward movements in your portfolios. Rather than focusing in on the turbulence you might want to make sure your investing plan is centered on your personal goals and timelines. Peaks and valleys have always been a part of financial markets and is highly likely that trend will continue. Morningstar research found that sadly, many investors have self-defeating behavior. They find that many investors are still buying funds and selling at precisely the wrong times. It is simply impossible to time the market, and it’s a fool’s errand to try!
Of course, as always, discuss any concerns with us. Our advice is not one-size-fits-all. We will always consider your feelings about risk and the markets and review your unique financial situation when making recommendations.
We offer consistent communication, a schedule of regular client meetings, and continuing education for every member of our team on the issues that affect our clients.
A good financial advisor can help make your financial journey easier. Our goal is to understand our clients’ needs and then try to create a plan to address those needs. We continually monitor client portfolios. While we cannot control financial markets, interest rates or geo-political events, we will always keep a watchful eye on them. No one can predict the future with complete accuracy, so we keep the lines of communication open with our clients. Our primary objective is to take the emotion out of investing. We can discuss your specific situation at your next meeting, or you can call to schedule an appointment. As always, we appreciate the opportunity to assist you in addressing your financial matters.
If it’s been more than a year since your last financial review, please give Jan Berkholtz a call at our office to schedule an appointment so we can make sure everything is in order. If you feel the need to discuss your situation before our next scheduled review, please call our office at (770) 951-9001 or e-mail me at firstname.lastname@example.org.
Alan McKnight, MBA, CFP® is Vice President of Kays Financial Advisory Corporation. He has 20 years of experience working with retirees and pre-retirees. He is also an Adjunct Faculty Member and Professor of Finance and is an Ed Slott Master Elite IRA Advisor. He can be reached at (770) 951-9001 or at email@example.com.
This report and Mr. McKnight’s comments are provided as a general market overview and should not be considered investment or tax advice or predictive of any future market performance. Any security mentioned in this report may not be suitable for all investors. No investment mentioned in this newsletter constitutes a recommendation to buy, sell or hold a particular investment. Such recommendations can only be made on an individual basis after an assessment of an individual investor’s risk tolerance and personal circumstances. Past performance of any investment mentioned is not a guarantee of future performance. Statements regarding the investment concerns and merits of any company and fair market value computations are strictly the opinion of Kays Financial Advisory Corporation. Employees of KFAC and KFAC clients may have positions and effect transactions in the securities of the issuers mentioned herein.
Sources: Fidelity.com, Wall Street Journal, Barron’s, Forbes.com, bankrate.com, Kiplinger’s, Bloomberg
APFA, Inc., Forefield and Broadridge Financial Solutions, RealClear Politics.