Quarterly Review April 2016

Improvements Here, Still Not So Great Overseas

The year started out very much like last year—but for different reasons. This year experienced a January selloff—then a recovery to nearly all-time market highs. It took some time for markets to make it into the black. In fact, it wasn't until March 17th that the Dow Jones Industrials Average crawled its way into the plus column.

Before we delve into details, let's take a look at how various indices fared for the past quarter.


​1st Qtr
​Dow Jones Industrials (the Dow)           
​+ 1.5%
​S& P 500 Stock Index   (S&P 500)       
+ 0.8%
NASDAQ Composite
- 2.7%
​Russell 2000 Index (small companies)
- 1.9%
​Dow Jones World (non-US)
​- 1.0%
​10-Year Treasury Bonds
+ 4.9%
​Commodities:  Dow Jones-UBS Index
+ 4.1%
​The U.S. Dollar (WSJ Index)
- 4.0%

All index values come from the Wall Street Journal.Stock indices do not include dividend return

The relatively benign performance figures above mask the wild ride that the first quarter provided. Things have settled down recently, but the year began with a continuation of the downward trend of December. As measured by the Dow, equities swooned to a 9% decline for the year in January, then recovered a bit before dropping back to a 10% decline for the year in mid-February. After that point buyers re-entered the market and methodically pushed the large-company indices into the black by the end of the quarter—a positive trend that has continued into April. The NASDAQ index (dominated by large technology companies) didn't fare quite as well. International equities remained in the red—reflecting overall weakness in many foreign economies and markets. While high-quality bonds like the 10-year Treasury Bond Index had a banner quarter, it was at the expense of a mass exodus out of low-quality bonds. High yield bonds are in a recovery mode but were severely hit by selling early this past quarter. Bonds were assisted by the Federal Reserve Bank (the Fed) decision to backpedal from their earlier ambition of pragmatically raising interest rates. Due to economic weakness here and especially abroad, the Fed opted to leave rates alone at their last meeting. They also expressed the intent to scale back their plan of raising interest rates--by only 0.5% during 2016 rather than the 1.0% as previously announced. Overall, this was taken as positive--even though the implication is that economic conditions are too weak at this time for even a quarter-point hike in interest rates. This weakened the US dollar markedly as the air was let out of the balloon. Oil prices bottomed out near $25 per barrel before staging a solid recovery, dragging along the commodity index which gained a welcome 4%.

Where We Are Now

Quarterly earnings reports are beginning to be released and they will be critical to maintaining the current level of the stock market. The rally in the markets has raised overall valuation to a high level. The S&P 500's Price-To-Earnings (P/E) ratio is high compared to historical levels and—based on the past 12 month's earnings—is 15% higher than this same measure was a year ago, which was high then! High market valuation reflects the anticipation for a healthy increase in corporate earnings. Let's hope investors are not simply turning a blind eye to the technical characteristics of the stock market. There has been positive economic news to fuel market optimists. By all measures the employment picture has improved. Though some gauges are more reliable than others to measure employment, all have shown improvement. Employers have added a healthy number of new jobs and this has motivated frustrated jobseekers to return to the hunt. Consumers continue to provide support for the economy. There is hope that a declining dollar will allow exports to recover, as our goods and services will cost less to foreign consumers. Healthy increases in US corporate revenue and profits would be quite helpful in sustaining the market's advances.

Economic growth in the last quarter of 2015 as measured by Gross Domestic Product (GDP) was finalized at the modest rate of 1.4%. Predictions for the rate of growth for the first quarter of this year (just completed) vary but the consensus estimates are below the 4th quarter of 2015. 

There is an odd phenomena occurring in foreign banks and bonds that could impact global risk. The issue is one of "real" interest rates. Real rates are the rates being offered, minus the rate of inflation. Overseas central banks have been taking strong measures to stimulate their sluggish economies. Just as our Fed does, they have significantly reduced interest rates--so significantly that the interest rate offered is actually below the rate of inflation. Taken to the extreme, some countries have actually lowered rates below zero—basically charging customers to hold their cash. Many consumers have increased borrowing to take advantage of the low rates and the level of household debt abroad—especially in the Euro Zone--has begun to worry economists. Rates in the US are also very low. In fact, if one compares the 10-year Treasury yield to the rate of core inflation (not including energy and food) the result is a negative "real" yield. While the Fed wants inflation to increase to their goal of +2.0% per year, this would be accompanied by a proportionate increase in interest rates. On the other hand, if our economy stagnates the Fed would be reluctant to stimulate the economy by backtracking on their current course of moderate interest rate increases. This is the fine line being navigated by the Fed.​

Looking Ahead

This quarter will mark the home stretch leading up to the Presidential election. It has been an uncomfortable election cycle and voters' discomfort may increase as the election nears and the slate of candidates narrows further. Let's hope for the best for our country. The election has the potential to create market volatility.

Some oil market observers feel that oil prices may give up some of their recent gains. Oil producers recently failed to agree on limiting production levels and Iran is beginning to ramp up their production now that previous trade restrictions have been loosened. 

Low inflation and low interest rates normally favor financial investments like stocks and bonds. Normal may not be the right word to use, however, as interest rates and inflation are both quite low by historical standards. In the near term it would not be a surprise to see stocks decline a bit to consolidate recent gains and allow market valuation to return to a level that would be closer to historical ranges. Factors driving the market will be earnings announcements, the price of oil, the direction of overseas markets, and the rate of growth of our economy as measured by GDP. As always, we will continue to follow the markets closely and will take appropriate actions within client accounts to manage risk and return in accordance with each client's respective Investment Policy Statement. 

As always, we will continue to follow the markets closely and will take appropriate actions within client accounts to manage risk and return in accordance with each client's respective Investment Policy Statement. 

Please feel free to call with any questions or comments.Craig S. Limoges CFA, CFP, EA George Middleton CFA, CPA-PFS.

The Department of Labor recently established that advisors to owners of retirement plan accounts must adhere to the fiduciary standard of placing the client's interest first. We have maintained this high standard for all our clients since the company was established in 1993. Glad the rest of the industry is finally joining us.

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