On behalf of the Altium Investment Committee;
As we take a look back at the first half of 2017, we are excited about what we have thus far accomplished as a firm this year, including the successful addition of new partners and team members that share our enthusiasm towards the business and servicing all of you, our clients. While we remain busier than ever at Altium, the financial markets are rather quiet at the moment. The equity and fixed income markets continue to be resilient. Despite political and economic uncertainties both domestically and abroad the domestic equity markets have reached all-time highs and the international equity markets continue to rally. Meanwhile, domestic fixed income assets have remained stable in the face of another Fed rate hike. Market volatility is at multi-year lows and investors continue to be rewarded for staying committed to their specific portfolio allocations. We continue to echo this sentiment as we look out to the second half of the year.
KEY HEADLINES DURING Q2 2017
U.S. STOCKS MADE NEW HIGHS AND INTERNATIONAL STOCKS CONTINUE TO OUTPERFORM
Large Cap U.S. stocks rose 2.5% in the quarter (up ~8.5% YTD) while international developed market stocks rose 4.7% (up ~12% YTD) and emerging market stocks rose 5.1% (up ~17% YTD) *.
International and Emerging market stocks have outperformed domestic stocks over the past 12 months. Contributing factors include weakness in the U.S. dollar, muted GDP growth forecasts in the U.S. and a broad recovery from depressed values relative to the domestic market indexes.
MARKET VOLATILITY IS LOW
The average daily swing in the S&P 500 during the quarter was approximately 0.3%, the lowest it has been in more than 50 years (based upon the daily price movement of the S&P 500 index). While we anticipate volatility to remain low during the summer months, we will continue to watch for rising volatility which can be a characteristic of a late stage economy.
Politics in the U.S. are undeniably chaotic, however, the market appears to have discounted the risk of excessive fiscal stimulus or disruptive protectionist policies being implemented.
GLOBAL CENTRAL BANK POLICY SHIFTS WHILE U.S. FED POLICY REMAINS
The U.S. Fed raised short term interest rates 0.25% for the second time this year and reiterated a gradual pace of expected rate increases (despite core inflation readings below the Fed’s Core PCE target of 2%).
Global central banks led by the ECB (European Central Bank) signaled a subtle change in policy towards less accommodation following their most recent meeting in June. The end of ECB quantitative easing policy could lead to higher Eurozone yields which we believe should pull the U.S. Treasury yields higher. In fact, the U.S. 10yr yield jumped from 2.14% to 2.39% following the June ECB meeting (as of 7/7/17).
WHAT WE ARE WATCHING NOW
STATUS OF THE ECONOMY AND ITS IMPACT TO THE MARKETS
Our domestic economy continues its recovery from the 2008 recession. As with all full cycles, the economy will experience periods of expansion, contraction and ultimately another recession. While predicting cycle changes may be difficult, the Treasury Yield curve can be a reliable indicator of the current economic stage. Specifically, we are keeping an eye on the flattening of the yield curve and potential for an “inversion” of the yield curve (i.e. long term interest rates turn lower than short term rates). An inverted yield curve would normally indicate that the economy is in its later stages of the business cycle, nearing a recession. For additional commentary regarding the market’s reaction to the last two recessions please click here to view our Q1 2017 commentary.
FLATTENING TREASURY YIELD CURVE
As measured by the spread between the rate on 2yr. Treasuries and the rate on 10yr. Treasuries, the yield curve shifted down (“flattened”) by 20 basis points during Q2 (vs. a 10 basis point flattening in Q1). The Fed has raised interest rates twice in the last 6 months and is expected to raise them again, potentially two more times, over the balance of 2017.
The U.S. Treasury yield chart below illustrates this “flattening” effect that occurred during the second quarter (current yield curve in green vs. Q1 yield curve in purple). The red arrows show the decline of long term bond yields and the green arrow shows the increase in short term yields during this period of time. In other words, the difference between rates on longer term bonds and shorter term bonds is narrowing. The yield curve would become inverted when some longer term rates are below short term rates.
Source: Bloomberg; U.S. Treasury Yield Curve as of 06/30/17 (green) and 03/31/17 (purple)
The next chart below provides some perspective on how we can use the yield curve as an indicator of a pending recession. The blue shaded line in this chart represents the Treasury yield curve, with everything above zero (or the yellow line) signaling a positive spread between short and long term interest rates. What is clear from this chart is that just prior to each of the last two recessions in 2001 and 2008 (highlighted in red), the yield curve “inverted’ or turned negative for a short period of time. The current spread remains at a positive ~0.96%, well above “inverted’ levels. While the curve continues to “flatten”, current levels suggest that we remain out of recession territory. Additionally, despite the length of this most recent post-recession recovery, we believe that we could easily remain years, not months, away from the next recession. The purple line in the graph tracks the performance of the S&P 500 index over this period of time, which we highlight as an example of how the equity markets have reacted over these particular economic cycles. Specifically, a trend of equity market selling leading up to and during economic recessions followed by a significant post-recession recovery.
Source: Bloomberg; U.S. Treasury Yield Curve Spread between 2yr and 10yr Treasury rates
Oftentimes during our communications, we speak to the commitment we have to our investment philosophy. This is important to us as it keeps us steady during periods of uncertainty, including both positive and negative market cycles. You should find comfort in knowing that our deep understanding of your individual risk tolerances and investment time horizons have resulted in asset allocation decisions for each of you that we firmly stand behind.
With that said, should you believe that changes have occurred in your financial and personal lives since our last review, we would be happy to hear from you and discuss your current investment allocations. We hope that you enjoy the rest of your summer and we look forward to speaking with you again soon.
Gregory Slater, CFA, CFP®
Chief Investment Officer
* LC US stocks = S&P 500 Total Return Index; Emerging Markets Stock Index = MSCI Emerging Markets Net Total Return Index; International Markets Stock Index = MSCI EAFE Total Return Index
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