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First Quarter 2016 - Pinnacle Investment Management, Inc.

First Quarter 2016

April 7, 2016 / Quarterly Newsletters

The stock market went on a roller coaster ride, ending the quarter not far from where it began.  The S&P 500 declined 7.5% in the first few weeks of the year over fears of declining oil prices, a slowing Chinese economy and concern that the Federal Reserve would raise interest rates.  Although both February and March were bumpy, the bumps had an upward bias, especially March.  As a result the S&P 500 gained 1.4% for the quarter.    Although emerging markets in Asia and Latin America performed poorly the last four years, they did very well this quarter.  Canada and Australia also out-performed the US while most of Europe, Japan and India lost ground.  As in 2015, the US markets out-performed a composite of all foreign markets.  Overall the Dow Jones Global stock index closed down 0.2%.    Gold and precious metals began a rebound after four years of a down and sideways market.  Gold had the largest quarterly gain in thirty years.

US economic growth slowed from an already low level. Seasonally adjusted growth is estimated to be less that 2% in the first quarter, down from the lackluster 2.4% growth last year and in 2014.   Although most economists forecast that interest rates were heading higher, the slowing economy contributed to a decline in the yield of the ten year US Treasury bond from 2.27% to 1.78% Falling long term interest rates boosted the prices of bonds, and resulted in a strong return for the Barclays US Aggregate Bond Index of 3.0%.

In a surprise move, the Bank of Japan (The “BOJ” is similar to the US Federal Reserve) announced that it would implement “negative interest rates” by charging commercial banks for leaving excess reserves on deposit with the BOJ. They now join the European Central Bank (ECB), Sweden, Switzerland and Denmark in zero or negative interest rate policy.  The intention of zero or negative interest rates is to spur inflation and economic growth but has never been tested on such a large scale and risks causing speculation and “asset bubbles”.

Economists were also surprised that after two years of strengthening, the US dollar weakened slightly, providing a small boost to disappointing returns of many foreign markets. The weakening dollar was especially surprising after the Federal Reserve raised rates, which theoretically should have made the US dollar more attractive.

Returns for key indexes (including dividends) were:

 
1st Quarter

2016

Dow Jones Industrials index 2.2%
S&P 500 index 1.4%
NASDAQ 2.8%
S&P 400 mid-cap index 3.3%
Russell 2000 small-cap index 1.9%
Total International, excluding US 0.1%
Dow Jones Global Stock index 0.2%
Barclays US Aggregate Bond index 3.0%

 

Economic and market Outlook

Employment continues to improve. The US has been creating and filling new jobs for each of the last 66 months and wages are now rising faster than inflation.   Yet more people are now seeking work, causing the pool of job applicants to increase and the US unemployment rate to inch up to 5.0%.  A growing workforce will not only increase economic growth but also help government budgets by reducing unemployment benefits and increasing income taxes collected.  Although wages are increasing, they are not increasing so rapidly to prompt the Federal Reserve to raise interest rates.  This could be termed the “Goldilocks” effect with wage growth neither too hot nor too cold.  In contrast to the US, Eurozone unemployment remains above 10%.

Auto sales remain above historic average.   Consumers and most companies are benefiting from lower energy prices, which have risen somewhat recently but remain significantly below the levels of one year ago.  Home builders are back at work yet still unable to keep up with the long term demand for housing created by our growing population.

Although economic growth has been disappointing since the 2008 – 9 financial crises, a growing workforce, along with low interest rates and energy prices, should provide a catalyst for improved growth. It appears the US dollar is no longer appreciating against foreign currencies, providing a more favorable environment for US companies exporting goods.

One important reason for the stock markets lackluster performance recently is that corporate earnings have been weak. Some analysts now predict that corporate profits will begin to improve which could prove very beneficial to the stock market.

Foreign stocks of Europe, Japan and emerging markets are all more attractively priced than US stocks, but each carries its own set of risks, as does the US. Investors are concerned that the low and negative interest rates in Europe and Japan leave their governments with little ammunition in case of a recession.  Emerging markets are still struggling with the decline in the value of commodities they export and the rise of the US dollar has made it more difficult for companies who borrowed in US dollars to repay their loans.

A small but growing number of US investors are wondering if the sudden increase in the price of gold along with the increase in wages is a harbinger of future inflationary pressure that will cause the Federal Reserve to increase interest rates faster than anticipated.

Another concern for the US stock market is the contentious presidential election. Candidates are espousing wildly different and frequently ill conceived policies.  This creates uncertainties in financial markets that do not like uncertainty.

With core inflation running at 2.3% there is little financial incentive for long term investors to invest in CD’s or money market funds which are paying negligible interest.

Will College Pay Off? College tuition and fees are only 1.8% of the overall consumer price index (CPI) but can cripple budgets of families who have college bound students since they are increasing at an alarming rate.  Economics Professor Bryan Caplan studied whether or not attending college makes financial sense.  He concluded that it does, but more for students who (a) attend a reasonably priced school, (b) choose a high earning major and (c) graduate on time.  But along with the growing costs of higher education is the growing use of student loans, encouraged by the federal government.   Some forecasters are now sounding a warning that the country may face an education loan bubble down the road as more and more individuals face potential default on their student loan obligations.

Women continue to beat men at investing      Numerous studies over the last twenty years show that on average women investors achieve higher returns than men. Not because women pick better investments than men, but rather because they make fewer trades.  Each trade is a drag on performance, not only because of trading costs involved but also because the investments sold often do better than the ones purchased.  Men tend to make more trades, apparently because they are more confident (often over confident) in their ability to pick the right investments and at the right time.  Often the best decision is no decision.

 

 

This letter is for general informational purposes only and not specific advice for any one individual or situation. Future results may differ from past performance. Different investments and/or investment strategies involve varying degrees of risk, and there can be no assurance that any specific investment or investment strategy, including the suggestions in this letter will be either suitable or profitable for an individual. Our firm and/or individuals within the firm may have an ownership in one or more of the investments discussed.


About the author

Pinnacle Investment Management: Pinnacle Investment Management, Inc. is a comprehensive investment management and financial planning firm committed to the financial future of our clients.


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