3rd Quarter 2016 Market Recap

Alan McKnight, MBA, CFP®
October 13, 2016
Following the Brexit vote in June, the 3rd quarter of 2016 was fairly uneventful. The major stock market indices started off the quarter with a small rally and stayed quiet until the first week of September. This included a period of somewhat lower volatility with the S&P 500 going 42 trading days without moving more than 1%. Volatility then reared its ugly head on September 9th with the Dow dropping 2.1% along with the S&P 500 and NASDAQ dropping by 2.5%. Investors had started focusing on what the Fed may or may not do with respect to interest rates at their September meeting. Of course the Fed, again, decided not to raise rates which made the markets happy, giving us a late summer rally.
For the 3rd quarter of 2016, the change in value of each of the major world market indices was as follows:
  • Dow                           2.11%
  • S&P 500                   3.31%
  • NASDAQ                  9.69%
  • Russell 2000             8.66%
  • Global Dow               6.38%
While the quarter ended on an up note, investors were reminded once again to watch out for sudden market volatility. Deutsche Bank was one of the major drivers of the quarter’s final week. Shares of the bank plummeted on Thursday, September 29th pulling markets into a selloff before giving them a massive boost on Friday, September 30th. The German Bank had been reeling since the U.S. Justice Department proposed a $14 billion fine in early September over residential mortgage-backed securities. Reports on September 30th indicated that the bank had settled with the Department of Justice for a fraction of the original fine. A J.P. Morgan report indicated the penalty could be as low as $5.4 billion.
Oil prices, foreign currency valuations, corporate earnings and the upcoming presidential election are all still major concerns for investors. All of those issues made big headlines, but for investors, interest rate concerns seemed to still be the main event. The most news-generating and interesting situation for the upcoming quarter is who will be sworn in as President of the United Sates next January. Investors also need to pay careful attention as to which party will control the House and Senate in 2017. Although the year only has three months left, this last quarter could bring some more volatility to the equity markets.
Interest Rates
During the September session, the Fed chose to keep the Fed-funds target rate at a range of 0.25 to 0.5%, but it strongly implied that an increase is on the horizon. During this session, several members of the policy committee voted for an immediate increase leading analysts to suggest that a December increase is highly possible.
The key news from the Federal Open Market Committee (FOMC) meeting was another ratcheting down of their target rate projections (basically their guestimates) for the end of 2017 and 2018 by 50 basis points to 1.1% and 1.9%, respectively. This continued a pattern of Fed officials lowering their outlook for future interest rates and indicates that investors need to consider that we are probably still in a period of lower rates.
The Bank of Japan left their key short-term interest rate unchanged at -10 basis points. They also said they would target their 10-year Government bond rate at 0% in order to hit its elusive 2% inflation target, rather than allowing this yield to drop to a negative rate.
There have been no rate increases this year, and there is no reason for investors to get overly worried. A rate hike is usually aimed at preventing an economy from overheating, and currently that doesn’t seem to be a concern. Economic growth is still sluggish, and inflation remains low. Housing activity has been somewhat disappointing; retail sales are declining, and manufacturing activity is slowing. This leaves only one major purpose for a rate hike, the desire to get one done.
Fed Chair Janet Yellen suggested that ultra-low interest rates can lead to asset bubbles. Raising rates allows the Fed the power to cut them should we enter a recession. David Rosenberg, Chief Economist and Strategist at Gluskin Sheff says it’s important to separate those fears from reality. When it comes to an interest rate hike he suggests the Fed, “hurry up and get it over with.”
When the Fed raised interest rates last year in December, their forecasts suggested that 2016 would bring four more rate increases. That created a lot of anxiety for investors. Currently, the Fed is suggesting the possibility of two more rate increase next year. This could be good news for stocks at least in the short term. Stayed tuned!
Oil and Energy Prices
The trend for higher oil and gas prices has held up of late, and a report from the Dallas Fed in the week of September 30th showed that the energy sector’s activity rose in the 3rd quarter. In the quarter’s final week’s report, the Dallas Fed Energy Survey showed that oil and gas executives have responded positively to higher activities in the energy space.
Crude oil ended September with a monthly gain of nearly 8%. That gain helped push crude to a one-month high after the Organization of Petroleum Exporting Countries (OPEC) came to a production freeze agreement. OPEC agreed to limit oil production to 32.5 million barrels a day following a three-day energy meeting in Algeria. Members had shown reluctance to agree to any deal and cede market share.
As we head into the 4th quarter of the year, OPEC has provided the market with uncertainty. Until the final week of the quarter, the cartel had been consistent in their inaction when it came to any policy that
would support the price of oil. OPEC nations have increased daily production wherever possible. Words from their recent session signal a change in that policy. Now it will be a game of wait and see until November 30th to find out if the membership carries through on their promise to cap production. We remain watchful as there are many factors that could send the price of oil higher or lower in the coming months.
The Presidential Election
It would be an understatement to say that this year’s presidential election features one of the most interesting and controversial political landscapes of all time. The first debate between Hilary Clinton and Donald Trump was compared to the famous Ali vs. Foreman “Rumble in the Jungle” fight as the two candidates squared off at Hofstra University in Long Island, New York.
According to the Wall Street Journal, a record 87 million viewers watched both candidates take personal shots at each other. The second debate had a 20% less viewership but contained many more personal shots than the first. Unfortunately for investors, not a lot of their economic policies were discussed in great detail. Maybe we’ll get more substance during their third and final debate on October 19th.
Many folks have been asking which political party is better for investors. Oppenheimer Funds, in a summary piece, suggested that, “It’s probably best not to let your reaction to who wins shape your investment decisions.” While both parties try to offer reasons for optimism and despair, the numbers form the New York Times (10/26/12) below might provide some insights. As history shows, neither party can lay a claim to providing better market performance.
FDR                            1932-1936                            30.1%
Clinton                        1992-1996                            16.9%
Clinton                        1996-2000                            16.1%
Wilson                         1912-1916                            12.0%
JFK/LBJ                      1960-1964                            10.7%
Truman                       1948-1952                            9.4%
Obama                        2008-2012                            8.8%
FDR/Truman               1944-1948                            6.5%
LBJ                              1964-1968                            2.2%
FDR                             1940-1944                             2.1%  
Carter                          1976-1980                            -1.1%  
Wilson                          1916-1920                           -5.0%
FDR                             1936-1940                           -6.6%
Coolidge                       1924-1928                           24.8% 
Reagan                         1984-1988                          15.5% 
Eisenhower                   1952-1956                           15.5% 
GHW Bush                    1988-1992                           10.7% 
T. Roosevelt                  1904-1908                             7.0% 
Reagan                         1980-1984                             6.9% 
Harding/Coolidge          1920-1924                             5.2% 
Eisenhower                   1956-1960                             4.9% 
McKinley/Roosevelt       1900-1904                             3.8% 
Taft                                1908-1912                             2.4% 
Nixon/Ford                    1972-1976                              0.2% 
Nixon                             1968-1972                              0.1% 
GW Bush                       2004-2008                            -1.8% 
GW Bush                       2000-2004                            -2.2% 
Hoover                          1928-1932                           -29.6%
Though historical performance is not an indication of future performance, over 100 years of Democrats and Republicans have shown us that stocks generally do well no matter.
We highly recommend that investors not let their emotions take over due to the polarizing nature of this election. No matter what, we would expect some volatility as we get closer to the election and possibly even after the election. However, we need to take a long-term perspective and continue to see how things play out after the election. We will certainly offer longer term strategies as policies become clearer.
Staying Invested
Traditionally, October has had a bad reputation among investors. That's because some of the biggest market corrections in history took place during this month. In 1929, there were three record slides in October that are remembered as: Black Thursday of October 24 (when stocks retreated 11%), Black Monday of October 28 (when the Dow lost 13%) and Black Tuesday of October 29 (when markets closed 12% lower). In 1987, the Dow dropped over 22% in one single day on October 19, then noted as the new Black Monday. In fact, October is historically the second month of the year with more market crashes after September.
However, the “October Effect” theory that stocks tend to decline during the month of October is false. In fact, since 1928, the median stock market return in October is 1%, the average gain is 0.4% and stocks tend to finish the month higher 60% of the time.
A long range study from 1928 to 2014 found that October is also the month of the year with the biggest share of 1% day moves (up or down) in the S&P. In fact, 28% of the trading days in October see over 1% moves (up or down) in the overall index.
No one can accurately predict the future, and we feel as though investors always need to consider the risks of investing when making decisions and should always be prepared. A well-defined investment plan tailored to your goals and financial situation that considers the probability of normal market ups and downs can help investors weather volatile periods.
According to a recent report prepared by global management consultants, McKinsey and Company, the forces that have driven exceptional investment returns over the past 30 years are weakening. Given the waves of turbulence that have swept through financial markets in recent years, including the 2000 dot-com bubble and the 2008 financial crisis, it may sound odd to describe the past three decades as a golden age for investors. The reality is that total returns on equities and bonds in the United States and Western Europe from 1985 to 2014 were significantly higher than the long-term average. These returns were driven by an extraordinary confluence of favorable economic and business fundamentals. Inflation and interest rates declined sharply from peaks in the late 1970s and 1980s. Global economic growth was strong, fueled by positive demographics, productivity gains, and rapid growth in China. During this period, corporate-profit growth was even stronger.
This does not mean that stocks or bonds are inferior investment vehicles but that investors should lower their equity return expectation. Additionally, bonds may have a tougher time in a long-term rising interest rate environment.
Closing Thoughts
Volatility is not going away completely and will return from time to time. We carefully monitor the equity markets and interest rates so we can communicate with clients. Market volatility is a part of investing, and instead of being worried by volatility, try to be prepared.
Today’s low fixed rate returns will not help most investors reach their financial goals, so they probably will need to include equities in their portfolios. According to Bankrate.com, through September of 2016, the national rate for 1-Year CD’s remained around 0.57% (that is far less than 1%). Equity investors should be prepared to take a long-term approach when looking at returns. Your time horizon, goals, and tolerance for risk are key factors we consider in helping to ensure that you have an investment strategy that is created for you.
We always encourage you to ask yourself these three questions:
1. Have my time horizons or needs changed?
2. What are my investment cash flow needs for the next few years?
3. Am I comfortable if my investment returns fluctuate?
Instead of focusing on the markets and what other investors are doing, focus on your specific situation. Your answers to these questions will govern how we recommend investment vehicles for you to consider. We can help you determine which investments to avoid and how long to hold each of your investment categories before making major adjustments. We continually review economic, tax and investment issues and draw on that knowledge to offer direction and strategies to our clients.
We offer all clients:
  • consistent and strong communication,
  • a schedule of regular client meetings, and
  • continuing education for our team on the issues that affect our clients.
As experienced financial advisors, part of our job is to help make your life simpler and easier. Our goal is to understand our clients’ needs and then try to create a plan to address those needs. We continually monitor our clients’ portfolios. While we cannot control financial markets or interest rates, we 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 emotions out of investing for our clients. We can discuss your specific situation at your next review 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 has 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 amcknight@scottkays.com.
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 amcknight@scottkays.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: Barron’s, The Wall Street Journal, dallasnews.com, thestreet.com, 247wallst.com, seekingalpha.com, mckinsey.com, bankrate.com, APFA, Forefield, Morningstar.com.