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Third Quarter 2015 - Pinnacle Investment Management, Inc.

Third Quarter 2015

October 8, 2015 / Quarterly Newsletters

The stock market encountered its worst quarter in four years as investors grew concerned with the slowing rate of economic growth in China and the prospect of rising interest rates in the US. This quarter was similar to the third quarter of 2011 when the market declined even more than this year and eliminated all prior investment gains that year, impacting foreign markets more than the US. There is certainly no way of knowing what lies ahead, but after the market decline in the third quarter of 2011, it rebounded very well in the fourth quarter.

Almost every other major global market suffered as much or more than the US. Although the US economy is growing slowly, it is growing, and the prospect of rising interest rates continues to make the US a relative safe haven for foreign investors.

Investors’ reactions to the possibility of increasing US interest rates have been erratic. In August, the prospect of rising interest rates contributed to the market decline. Yet in September, the Fed announced that it would leave rates unchanged and that also contributed to a market decline.

Returns for key indexes (including dividends) were:

 
 

1st Qtr

2015

 

2nd Qtr

2015  

 

3rd Qtr

2015

 

9 Months

2015

   
Dow Jones Industrials 0.3% 0.3% 7.0% 7.0%
S&P 500 0.9% 0.3% 6.6% 5.6%
NASDAQ 3.5% 1.7% 7.4% 2.5%
S&P 400 mid-cap 4.9% 1.4% 8.9% 8.6%
Russell 2000 small-cap 4.0% 0.1% 12.2% 7.8%
Total International, excluding US 4.5% 1.0% 11.9% 7.1%
Dow Jones Global Stock 2.1% 0.1% 10.1% 8.3%
Barclays Aggregate Bond   Index 1.5% 1.8% 1.3% 1.0%

 

The yield on ten-year US Treasury bonds declined from 2.35% to 2.06%. The lower rates helped the US Aggregate bond index gain more than 1%. However, corporate and municipal bonds with lower credit ratings declined in value as investors became more concerned with credit risk.

Economic and Market Outlook Global markets have declined by more than 10% since their high in July. A decline of 10% or more is often termed a “correction” and on average occurs once every 12-18 months.  The past few years have been relatively calm and the last time a “correction” occurred was in the summer of 2011 when the S&P 500 declined about 18%. It typically takes about 4 months for the market to recover, but this varies and is impossible to accurately predict.

The “correction” does not seem to be directly linked to the economy. The US economy continues to improve with employment growing, the number of discouraged job seekers declining, and wages increasing.

The current economic environment of a growing economy, low oil prices and low interest rates remains favorable for stocks and Professor Jeremy Siegel of the University of Pennsylvania believes the fair value of the Dow to be more than 15% above its current level.

It appears likely that the Federal Reserve will begin raising interest rates by December. This will be the first increase in nine years, and the increases are expected to be both small and infrequent – perhaps 0.25% in December followed by increases every few months for a year or two. Rising interest rates should not end market advances. During the period between 1955 and 2006, when the Fed increased rates the stock market advanced 7.4% on average in the following twelve months (somewhat below the long term average).

In contrast to the anticipated monetary tightening in the US, the European Central Bank and the Bank of Japan are expected to continue their monetary easing in an effort to improve those economies and financial markets.

Although US interest rates are low they remain significantly higher than many other countries. This interest rate differential is keeping the US dollar strong relative to other currencies. This is benefiting US consumers, but presents an obstacle to US exporters. Low interest rates in Europe and Japan will likely keep their currencies weak in relationship to the US dollar and if the Fed increases rates as expected in 2015 that would further strengthen the dollar. Mutual funds that hedge the currency risk offer some protection against weakening foreign currencies.

 China is the world’s second largest economy and its’ demand for raw materials such as oil and iron has spurred economic growth elsewhere, especially in the emerging markets. Yet recently investors have become concerned that a slowdown in China will lead to a slowdown elsewhere. Although we live in a highly connected world, US exports to China amount to less than 1% of US GDP. Further, the economies of the US, Europe and Japan have been continuing to grow. While low oil prices will impact the earnings of firms in the petroleum industry, low oil prices will be good for other aspects of the global economy. The economic problems in China may cause minor disruption in the US, but will not likely have a significant or long term affect on the economy.

The impact of a US Government Shutdown   John Boehner’s resignation reduced the likelihood of a US Government shutdown this month, however it increased the probability of one later this year if the new Speaker of the House becomes combative on spending and deficits. While a government shutdown sounds scary, it is not. All essential services will continue, but non-essential services will halt and non-essential federal workers will be furloughed. On the positive side, government spending will decline and the budget deficit will be reduced. Historically, government shutdowns seemed to have little or no impact on economic growth. The last government shutdown was in October of 2013 and the GDP gained 3.8% during that quarter. If Washington does shut down, don’t let the antics in Congress impact your financial planning and investing – lean back, enjoy the theatrics and appreciate that they are spending less of your money.

Reverse Mortgages offer those who are 62 years or older the opportunity to more readily utilize equity in their home to improve their retirement. Payments are optional and the homeowner retains title to and can remain in the house as long as they are paying the taxes and insurance. The reverse mortgage can be thought of as a “payment optional” mortgage combined with a line of credit. It can be 100% mortgage or 100% line of credit or a combination of the two up to the maximum allowed, which is determined by the homeowners age and other factors established by the FHA. If used prudently a reverse mortgage could improve retirement by allowing homeowners to delay taking Social Security resulting in higher benefits. It could also be used as a standby line of credit for emergencies or to avoid taking money out of investments during bear markets. For this to work you should ideally have at least 40% equity in your home, or be willing to put up additional funds.


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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