On behalf of the Altium Investment Committee;
Spring has sprung and the baseball season is at hand, prompting us to lead this letter off with one more Yogi Berra quote: “When you come to a fork in the road, take it”. Yogi’s wisdom reminds us that It’s time to give you a report on what we see “out there”. We hope that your winter was as mild as ours and that this update finds you well.
In our December update, we described what we thought was an uneasy stability in the financial markets, which seemed to be pricing in slower growth in China, some stability in the price of oil (which had declined over the course of the previous 12 months to the mid 30’s) and a gradual tightening path for the FED (indicated by a 25 basis point increase of the Fed Funds Rate in Dec). While we did suggest that investors should be prepared for pronounced market swings in the new year, we could not have predicted the whipsaw that has occurred thus far year to date.
The S&P 500 got off to its worst start ever, declining around 11% in the first 2.5 weeks of the year. In addition, International markets including Japan, UK, France and China entered into bear market territory during this time period. So what caused the sell-off? The main catalysts driving the weakness across the globe remained centered around China and commodities. Specifically, lackluster Chinese GDP growth expectations, a lower world growth outlook from the IMF and Crude Oil that declined to its lowest level in over 12 years. China’s decision to let its currency depreciate at a much faster rate than the markets had expected also had the effect of tightening monetary conditions globally. Investors around the world had lost faith in the central banks’ ability to continue to support asset prices, growth and inflation as they had been doing over and over again since the financial crisis of 2008.
The U.S. equity markets have rebounded from their mid-February lows and are now mostly positive for the year. The International markets have also recovered nicely, yet still remain down year to date. Catalysts for this snap back can be attributed to: Some stability in oil prices and the Chinese Yuan, expectations of a slower-moving FED, and more clarity on the accommodative monetary policies of the BOJ and the ECB. While we are experiencing a calmer tone in the markets, we can’t help but think that it will be difficult to meet current 2016 domestic economic growth and inflation targets. The 7-year economic expansion that we have experienced since 2009 has been a bit underwhelming and could be even more so. PIMCO, already credited with naming the now time-tested model of slow secular growth the “New Normal”, has called the current expansion the “BBB expansion”- “Bumpy, Below-par and Brittle”. The Wall Street Journal Economic Forecast Survey estimates 2016 GDP growth in the U.S. to be 2.4%, flat with 2015. Growth rates in Europe and Japan are lower and no one seems to know how much the Chinese economy has slowed down.
A corollary of slow GDP growth around the world is persistently low interest rates, which appear likely to remain well below normal for the foreseeable future. This scenario is supported currently by the central banks which have discovered the limits of monetary policy divergence (which became apparent in the form of excessive U.S. dollar strength). We believe that a lack of aggregate demand caused by high debt levels and an excess of saving over investment provides an on-going headwind for growth. Complicating matters are the additional headwinds coming from political uncertainties both domestically and abroad.
But lest we despair too much, in our opinion, the risk of a U.S. recession in the next 6 to 12 months is still relatively low – certainly lower than the equity and credit markets had come to price in during the first 6 weeks of 2016. Employment in the U.S. (measured by the growth in nonfarm payrolls) remains steady. While wage growth (measured by the growth in real average weekly earnings) is still sluggish and inflation (measured by the PCE price index) has moved closer to the FED’s target of 2%. We should remember that expansions tend not to die of old age, but when serious imbalances develop and significant monetary tightening takes place. Right now, in our opinion, there does not appear to be any particular signs of a pending recession; no over-consumption, no over-investment, no over-heating and no monetary overkill. Just more “BBB” GDP growth.
The chart above shows the divergence between wage growth (in blue) and US employment growth (in orange)
Our thoughts on investment strategy are the same as they were when we wrote in December. We remain committed to broad diversification and appropriate asset allocation based on your individual circumstances. While European and Japanese stocks lagged their U.S. counterparts in the first quarter, emerging market stocks outperformed the S&P 500 index during the period. Investment grade bonds continued to play an important role in client portfolios, outperforming stocks and dampening down the impact of volatility in the equity markets.
The chart above shows the 2016 relative performance of the major world stock market indexes as of 3/31/2016
The chart above shows the total return of the SPY (S&P500) and LQD (Corporate Bond Index) year to date
As we look ahead to the rest of the year, we are keeping our eye on the 3 C’s – China, Commodities and the Central Banks. Beneath the surface of slow overall global growth lies a multi-speed, multi-faceted global economy. At present, the Chinese seem on a path to a gradual Yuan depreciation, rather than a disruptive devaluation; the outlook for the price of oil appears constructive given higher demand sparked by lower prices and ongoing supply rebalancing; and central banks seem able and willing to find the right tools to support asset prices and keep the economic expansion on track. However, navigating an environment of low growth and near-zero interest rates is unprecedented and we anticipate market volatility to continue.
Gregory Slater, CFA, CFP®
Chief Investment Officer
Altium Wealth Management LLC (“Altium”) is an SEC registered investment adviser with its principal place of business in the State of New York. Registration does not imply a certain level of skill or training.
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