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Third Quarter 2016 - Pinnacle Investment Management, Inc.

Third Quarter 2016

October 4, 2016 / Quarterly Newsletters

In the aftermath of the June “Brexit” vote, global equity markets briefly declined before advancing for the quarter. Most major stock market indexes are now ahead for 2016 with emerging markets and US small companies leading the way. Volatility appears to be increasing as we grow closer to the US presidential election and the possibility of a Federal Reserve interest rate hike.

This year the financial markets have withstood a myriad of concerns, including declining oil prices, a slowing Chinese economy, the possibility of rising interest rates, and the British vote to exit the Eurozone. In spite of this “wall of worry” equity markets have advanced, which is often considered characteristic of a bull market.

The interest rate on ten-year US Treasury bonds declined from 2.27% at the beginning of the year to 1.49% in June and has since risen slightly to 1.6%. Rising interest rates provided a head-wind for bond returns and the US Aggregate Bond Index advanced only 0.4% for the quarter.

Returns for key indexes were:


1st Half



3rd Quarter



9 Months


Dow Jones Industrials index 4.3% 2.8% 7.2%
S&P 500 index 3.8% 3.9% 7.8%
NASDAQ 3.3% 9.7% 6.1%
S&P 400 mid-cap index 7.0% 3.7% 11.0%
Russell 2000 small-cap index 1.4% 8.7% 10.2%
Total International, excluding US 0.1% 6.8% 6.9%
Dow Jones Global Stock index 0.1% 5.0% 5.1%
Barclays US Aggregate Bond index 5.3% 0.4% 5.7%


Economic and Market Outlook The US election is prominently in the news and although financial markets do not like uncertainty, so far they have remained comparatively stable. As election day grows near, and polls indicate it will be a close election, we may see an increase in volatility, however that may be short lived.

There does not seem to be any clear relationship between a presidential election and future stock returns. Historically when the market was up in the three month preceding the election, the odds greatly favored the incumbent party.  Yet with only one month to go before the election, the stock market has been flat for the past two months so the financial markets are not providing an indication on the outcome of this election.

Profits of US corporations have declined over the last five quarters due to declining oil prices and a strengthening US dollar, resulting in lower profit’s (in dollars) earned abroad. Although those two trends have stabilized or reversed, it appears that earnings of US corporations will be lower again for the third quarter.  It will be difficult for stocks to advance without a more positive outlook for corporate profits.

Although the Federal Reserve is likely to raise interest rates by December, that should not be a source of concern. Interest rates have been held at historically and artificially low levels and slightly higher rates will not have a significant impact on economic growth.  Higher rates should be viewed as the Fed’s belief that the economy is on the right track and can withstand higher rates.

The US economy continues to inch ahead. Employment and consumer spending are up, home and auto sales remain strong and economic growth is estimated to be 2% in the second quarter.

Foreign stocks of Europe, Japan and emerging markets are all more attractively priced than US stocks, but as the Brexit vote indicated, there is significant uncertainty and discontent in Europe. Italy, (which does not have its own currency like England) will have an important referendum in December which could conceivably result in steps to exit the European Union (EU).    Other European countries are also evaluating what their relationship should be with the EU.  As a result of the 2008 financial crisis, rising income disparities, and the refugee crisis, the cohesion of the EU and its benefits are being questioned.  It would only take one member of the Eurozone common currency (EZ), such as Italy, to secede from the EU to cause it to begin to unravel with significant financial and geopolitical consequences.  It would be prudent to remain cautious in investing overseas considering the potential for disruption.

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 and savers are losing purchasing power every day.

Politics and Investing  It is important to differentiate politics from investing.  While the US election may raise emotions, the next President will need approval from Congress for new legislation.  Innovations by individuals and corporations create value for investors, not politicians.  The President will have little impact on the ability of individuals and companies to innovate and produce new pharmaceuticals, the next iPhone, or more efficient means of producing energy, etc.   Don’t let politics distract you from the important elements of investing.

Government Spending    Both US presidential candidates have promised to increase government spending at a time when the US budget deficit and level of debt is already projected to grow to alarmingly high levels.  This is due to an aging population, rising healthcare costs and Social Security benefits.  Continued or increased government deficit spending will increase US interest payments and result in either significant tax increases or a reduction in spending on other government programs. While it may take some time for the “chickens to come home to roost”, the US is already heading in the wrong fiscal direction.  If Congress fails to exercise fiscal restraint and a new administration throws “fuel on the fire” by increasing spending, it would not be good for economic growth, the stock market or future generations of Americans.  Some campaign promises are best left unfulfilled.

Economic Statistics    Whenever we hear economic statistics it is natural to consider GDP a highly accurate measure. In reality, GDP is a complex concept, not a specific item that can easily be measured.  The methodology has been derived from multiple subjective decisions made by the government and economists over a long period of time.  Initially GDP began as a measure of private industrial production such as cotton and steel to measure readiness for war. Military and government expenditures were excluded since they were not considered “productive”.  The government then desired to include these expenditures in order to show economic growth even in war.  Later expenditures for services were added to reflect the growing importance of that sector of the economy.   Then adjustments were made to reflect improving characteristics of items like computers, TV’s and autos.  Inflation is now also taken into consideration to determine the “real” gains.  Since there are many ways to calculate inflation, that adds another subjective element.  For international comparison, exchange rates must be used, but since exchange rates fluctuate, there needs to be a determination of what exchange rate to use. The result of the current rules can be quite interesting and are inherently political.  If you pay someone wages to mow your lawn or clean your house that increases GDP unless you pay them under the table or you or your spouse does it.   Not long ago the Greeks pressed criminal charges against a highly respected economist responsible for accurately reporting statistics (i.e. for not cooking the books) and the UK economy gained 5% once prostitution and illegal drug sales were included.  In 2013 the US GDP increased by 3% when it added  art, music, film royalties, books, theater and R&D spending, the first country to include these.  Wages paid to school teachers and bankers are included in the GDP, but determining their productivity is nearly impossible. Reportedly there may be only a dozen experts in the world who truly understand GDP.  It is prudent to be cautious about treating GDP numbers as a precise measurement.

About the author

John Eckel: CFP®, CFA is President of Pinnacle Investment Management Inc. of Simsbury. He has been included in BusinessWeek.com’s list of the Most Experienced Independent Financial Advisors, has been named four times to Worth Magazine’s list of Top Financial Advisors, included twice in Medical Economics list of Top Financial Advisors for Doctors and named twice in JK Lasers list of Top Professional Advisors for Baby Boomers.

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