Benchmark Returns through 3/31/2016
T-Bill 3-mo (Cash): 0.07%
Barclay’s Aggregate Bond Index: 3.03%
Barclay’s Municipal Bond Index: 1.67%
S&P 500: 1.35%
Russell 2000: (1.52 %)
MSCI EAFE (International Stocks): (3.01 %)
MSCI Emerging Market Stocks: 5.71%
Credit Suisse Hedge Fund Index: (2.48 %)
Data provided by Orion
Financial Market Performance
The first quarter of 2016 was marked with a large decline and quick recovery in prices to finish the quarter with mixed results. Benchmark interest rates in the United States fell across the board as market participants doubted the ability of the Federal Reserve to achieve 4 interest rate hikes in 2016. This led the Aggregate bond index to a much more attractive quarter. High yield bond indices also rose, but at a lower rate than investment grade bonds as the spreads have not fully recovered. Crude oil ended the quarter at approximately $38 up $1 per barrel from the end of the year. During the quarter, prices fell as far as the high 20s. We continue to expect oil prices to eventually recover from these levels, but this will only occur as the continued low prices drive lower investment in drilling new wells. This appears to be occurring as investment, drilling and now productions have fallen.
Growth Is slow but steady
Chinese stimulus measures have increased as Beijing attempts to manage a growth slowdown across their economy. The direct effects of the stimulus are working to increase measures of the manufacturing and services sectors of the economy. The stimulus is driven primarily by increased lending to already inefficient and struggling industries. This will be positive for the short term as risks are pushed out further into the future, however these continued imbalances are only growing and the risks of a future crisis in China has risen.
Survey data showed a rebound in US manufacturing in March as the index rose from displaying contraction to expansion. A particularly bright spot in the manufacturing survey data was a significant jump in new order growth. The data suggests that the recent manufacturing sector contraction was based on a shorter term inventory build-up that has likely normalized. As oil prices stabilize and the economy continues to grow, further manufacturing growth will continue. The US service sectors showed continued strength as the effects of the manufacturing slowdown in the US on the broader economy appears to have been limited. Labor markets continue to broadly improve and while certain industries struggle, the US economy appears to continue growing at an annualized rate for 2016 of approximately 2%.[i]
Manufacturing in the United States will likely not experience a jump in growth, but rather a slower steady growth trajectory. Energy prices have appeared to have bottomed. Although it is very possible for crude oil to post a new low, oil production in the US has responded correctly to the oversupply and drilling has been cut down significantly. While inventories are still large, this will get diminished as lower production rates reduce the oil surpluses in the later part of 2016 and 2017 take effect.
The growing ineffectiveness of Central Banking
Global monetary policy has found itself in a corner. The continued positive effects of extraordinarily easy monetary policy are experiencing diminishing marginal returns, while the downside risks to removing these policies are growing. This is creating a scenario which the highly educated Ph.D. staff currently running the Federal Reserve are no longer familiar with. Macroeconomic models and theories are running to catch up with the current circumstances and discoveries. Traditional relationships between macroeconomic variables, particularly in the realm of money and prices, are behaving differently than the long held views of macroeconomics would suggest.
The argument is not that monetary policy is ineffective. The perspective we hold is that the central banks around the globe have limits. They have seemingly reached and exhausted those limits. Making the case that monetary policy is losing its effectiveness has recently become much easier. The most basic function of rewarding risk taking during lending has been inverted. Central bankers across a number of many major economies have pushed the envelope beyond reason in the attempt to fix structural economic issues that have never traditionally been the focus of central banks.
Now the age of central banking has become more intervention-focused and paradoxical than ever. Central banks are now forcing losses on banks, while requiring them to prove that they can operate healthily. Banks are being forced to hold so called ‘high quality liquid assets’ such as European government debt in the pursuit of making banks safer. Paradoxically, the quantitative easing and negative interest rate policies have caused the prices of those bonds to move up to a price so high that mathematically those European government bonds hold significant risk, especially as they are yielding negative rates. How can forcing banks to hold a German Bund for 2 years guaranteeing them a loss of 0.51% be healthy for the financial system as many central banks simultaneously cite the need for less risk taking?[i] The answers offered seem to deviate so far from the realm of common sense that an investor’s full faith cannot be placed in them. The only sense seems to be found in the seemingly persistent truism that for every risk a regulator tries to legislate away, another inevitably evolves and emerges. The newly evolving and emerging risks may be born from the central bankers themselves.
Emerging markets face pressure from a normalizing US interest rate, and the long term prospects remain compelling, however the current environment is still negative for many of these economies. As these economies stabilize, the current valuations will likely offer opportunities in the future, however this is not likely to occur quickly. US stocks have recently struggled along with international equities. Although valuations remain somewhat high, they are cheap compared to most fixed income investments. Corporate profits may continue to be pressured as they are still near historically high levels, however revenue growth is expected to continue growing which will be supportive for earnings. International developed equities continue to look attractive relative to other equities. The headwinds of a higher dollar continue to have a negative effect on exporters and this has driven stock prices lower of those companies most effected. European stocks are more attractive from a valuation viewpoint and offer potentially higher upside as Europe has further ground to regain in its own recovery. The continued fall in interest rates has continued to surprise those investors expecting higher interest rates. Bonds have rallied over the past six months as investors return find appeal in the safety of high quality bonds. While we still expect interest rates to eventually rise to a more normal level, we do not expect this to occur immediately.
These are the opinions of James Regitz and not necessarily those of Cambridge, are for informational purposes only, and should not be construed or acted upon as individualized investment advice. Diversification and asset allocation strategies do not assure profit or protect against loss. Indices mentioned are unmanaged and cannot be invested into directly. Past performance is not a guarantee of future results.
Investment Advisor Representative, Cambridge Investment Research Advisors, Inc., a Registered Investment Advisor. Registered Representative, Securities offered through Cambridge Investment Research, Inc., a Broker/Dealer, Member FINRA/SIPC. Newport Advisory, LLC and Cambridge are not affiliated.