Economic Review & Outlook

Transcription

1 Economic Review & Outlook FIRST QUARTER 2016 Expectations Often Differ from Reality Getting Comfortable with Volatility Markets like people don t always behave predictably, and there s no singular trend or story line right now that can reliably anticipate what s going to happen in the market. You may read a very convincing article stating that outcomes will be good. The very next article you read may be just as convincing that outcomes will be bad. There is rarely, if ever, a clear answer. That s what makes up a market many different viewpoints and great 30 arguments for all types of outcomes. In this first Economic Review and Outlook of 2016, we want to address some of the key economic and market events influencing investor behavior and expectations in our current environment and explain the impact on our portfolio strategy. Review of Key Economic News BPS Market Implied Central Expectations Federal European Reserve Central (and subsequent move upward). None of these were new themes in the economic world. CENTRAL BANK DIVERGENCE Markets began 2016 with the belief that the U.S. is in a better place economically than the rest of the world. England Canada Reserve Australia Reserve New Zealand Swiss National Norges Riksbank Japan Mar-16 Jun-16 Sep-16 Dec-16 Source: DoubleLine, Morgan Stanley Basis point (BPS) refers to a common unit of measure for interest rates and other percentages in finance. One basis point is equal to 1/100th of 1%, or 0.01% (0.0001). The first quarter was dominated by news of the central banks economic intervention and manipulation through interest rate policy, as well as oil s continued price decline The chart above illustrates the unconventional monetary policy demonstrated by central banks around the world. While rates in the U.S. were expected to modestly increase throughout 2016, rates outside the U.S. are predicted to slide even more into negative territory.

2 However, slowing global growth led to concerns about a U.S. recession, and the Fed responded by lowering the expected number of rate hikes in 2016 from four to two. This action reminded the markets that what happens outside our borders matters to policy here. The Fed continues to push rate normalization further out an action that is not without consequences and possible future additional disruption to the markets. NEGATIVE INTEREST RATES Last year, the world became familiar with the concept of negative interest rates, and we have seen this trend continue this year. When banks charge negative interest, depositors must pay to keep their money with the bank, instead of earning money on deposits. Central banks that take the step of moving interest rates into negative territory are concerned about stagnant growth and are hoping to stimulate economic growth via consumer spending. We certainly do not view negative interest rates as a positive policy move for a variety of reasons. It does not encourage appropriate risk taking in the economy; it doesn t promote economic healing and productive redeployment of capital; and it skews consumers and investors actions and asset prices. When banks charge depositors to save their money, they risk depositors taking their money out of the banking system, which disrupts liquidity. If banks try to recoup their loss by charging a higher interest rate on loans, financial conditions would tighten the opposite effect of what central banks are looking for. OIL PRICES RECOVER SLIGHTLY BUT CONTINUE TO STAY LOW Both supply and demand have been contributing factors to oil s price decline. Advances in U.S. oil production created excess supply in the market. As a result, oil producers have engaged in fighting a price war to keep market share, leading oil prices to reach a low of $26/ barrel this year from more than $100/barrel just two years ago. We feel prices this low are not sustainable, and it appears that the market would agree based on the 60% recent rebound to $41. While the drop in the price of oil may have negatively affected stock markets in the short run, we see the lower cost as an overall positive for the global economy and a stimulant to global growth. Also, with oil s historically low correlation with stocks, we believe that we should not necessarily associate low oil prices with future, long-term stock market performance. SLOWING GLOBAL GROWTH Global growth continues to hobble along at a low rate despite massive efforts on the part of policy makers to revive the sluggishness. In fact, according to the World Economic Outlook by the International Monetary Fund (IMF), global growth is currently projected at 3.2% for 2016 and 3.5% in Contrast that with their forecasts from 2012 for 4.6% global growth in 2016 and 4.7% in Two big culprits weighing on growth are overindebtedness and aging demographics. Since 2007, global debt has grown by $57 trillion ($25 trillion of which is government debt), raising the ratio of debtto-gdp by 17 percentage points. Analysts expect this level of debt to continue to rise in many countries, given their current economic fundamentals. 3 Aging demographics also have an impact on global productivity, as workers age and leave the workforce in the developed world. Statistics show that aging demographics have a negative affect on GDP growth. Worldwide, the population of those over 65 is growing at three times the overall population growth rate. In this environment, investors seem to be taking cues from central banks as the primary drivers in their investment decision-making. Policymakers have seemingly been appointed to forestall any deceleration in economic growth. Our concern is they re incented to sacrifice the long term on the altar of short-term success. PG 2

3 First Quarter Asset Class Returns Compared with recent years, it was an unusual quarter for asset class returns, with emerging market stocks and gold leading the pack. Concerns over U.S. rates being raised amid slowing global growth could be seen in January and February as gold delivered strong returns, while growth assets like stocks were negative. When the Fed communicated they would move more slowly in hiking rates, stocks breathed a sigh of relief and rallied strongly in March. Year-to-date, gold came out on top at 16.5%. market stocks, with a 5.8% return, outpaced U.S. stocks by a wide margin as the U.S. dollar weakened. U.S. stocks were negative for most of the quarter, but have rebounded since. Our Perspective The world is uncertain and unpredictable. Consider the chart below that illustrates the many expected increases in interest rates (dotted lines) that have never happened. The actual effective Fed funds rates (red line) have remained flat and low a stark visualization of how unreliable predictions can be The Wolf is Coming? Rates markets have been pricing in Fed liftoff since 2009 Effective Fed Funds Rate Fed Funds Futures Pricing January February March YTD % 10.6% 13.3% 16.5% Int'l Developed U.S. Stocks % 6.0% 6.8% 5.8% U.S. Stocks Int'l Developed -5.0% 0.7% 6.6% 3.0% Commodities U.S. Stocks Commodities U.S. Stocks -5.0% -0.1% 5.6% 1.3% Commodities -6.5% -0.2% 0.9% -0.7% Int'l Developed Commodities Int'l Developed -7.2% -1.0% 0.0% -2.9% Indices used: Commodities Credit Suisse Commodity Index, Barclays Aggregate U.S. Bond Index, S&P GSCI Index, U.S. Stocks S&P 500 Index, Int l Developed MSCI EAFE Index, Markets MSCI Markets Index. Indices do not reflect the deduction of advisory fees, transaction charges, and other expenses. Past performance does not indicate future returns. Source: FRB, Bloomberg Finance LP The Fed Funds Rate is the interest rate at which a depository institution lends funds maintained at the Federal Reserve to another depository institution overnight. Market prices reflect people s opinions of value, not value itself. It s important to have holdings in an asset because of your core convictions about what drives its value, not because of how the market is performing. The suddenness of the price move in gold this quarter is a good reminder to not wait until pressures start to build in asset prices to take positions. Six weeks into the year, there was a 27% return spread of gold over U.S. stocks. Investors with long time horizons should be willing to hold more volatile growth-based assets and accept downturns every year it s normal and should be PG 3

4 expected. The chart below shows an average annual double-digit decline in U.S. stocks (numbers in red). Regardless, we can see that the majority of years end up with positive returns. Based on valuations and growth outlook, we continue to view emerging market stocks and international stocks in general, as more attractive than U.S. stocks across most economic scenarios. It s easy to deduce a cause-andeffect relationship between emerging market stocks and U.S. stocks. In reality, emerging market stock returns are not determined by U.S. stock returns. markets economic growth, in conjunction with valuation, is what ultimately drives emerging market stock returns. Therefore, a downturn in U.S. stocks does not necessarily precipitate a downturn in emerging market stocks. This is good news for investors looking for global opportunities. Source: Standard & Poor s, FactSet, J.P. Morgan Asset Management; U.S. Stock Market = S&P 500. Returns are based on price index only and do not include dividends. Max Drawdown refers to the largest market drops from peak to trough during the year and is represented by a red dot and red (negative) return. Returns shown are calendar year returns from 1980 to 2015, except for 2016, which is year to date as of 3/31/16. Past performance does not indicate future results. The markets reflect investor fears in the short term, and these days, there are many things that induce fear. Debt problems, terrorism, commodity selloffs, and China s instability are just a few. But over time, markets compensate investors for taking a risk, which is why volatility can be rewarding for those who have the wherewithal to endure it in the near term because they re focused on the long term. Our Investment Strategy The economic backdrop has not changed significantly over the last quarter. Growth and inflation probabilities have shifted very minimally, continuing to suggest that below-average growth and below-average inflation are the highest probability scenarios in the U.S. and the rest of the world for the next few years. We continue to see opportunities to meet intermediate and long-term return goals, but there are challenges. Volatility spikes will likely be higher than we ve historically seen. As long as stock and bond valuations remain above average and central banks are fully engaged in their policy experiments, we will likely continue to advocate that long-term investors hold positions in gold and commodities because of their hedging properties. In Closing The first quarter of 2016 continued to underscore that the world is uncertain and unpredictable. Events will continue to happen that cause volatility in the market, and no one can predict with any degree of certainty its short-term direction. However, with proper fundamentals and principles in place to guide our investment decisionmaking process, we can be prepared to handle the inevitable ups and downs of the markets. Remember that markets often behave illogically and counterintuitively in the short run, but fundamentals will ultimately deliver over the long term, as they have historically. PG 4

5 Disclosures The information contained herein is general and educational in nature and not specific investment advice. Any investment strategies presented may not be appropriate for every investor and investors should review the terms, conditions and risks involved with specific products or services with their financial professional. Unless stated otherwise, any estimates, projections (including performance and risk), or predictions (including in tabular form) given in this presentation are intended to be forward-looking statements. Although Ronald Blue & Co. believes that the expectations in such forward-looking statements are reasonable, it can give no assurance that any forward-looking statements will prove to be correct. Such estimates are subject to actual known and unknown risks, uncertainties, and other factors that could cause actual results to differ materially from those projected. These forward-looking statements speak only as of the date of this presentation. As with any investment strategy, there is potential for profit as well as the possibility of loss. Ronald Blue & Co. does not guarantee any minimum level of investment performance or the success of any portfolio or investment strategy. Past performance does not guarantee future results. Diversification does not guarantee investment returns and does not eliminate loss. 1 World Economic Outlook, April 2016 Update, International Monetary Fund 2 World Economic Outlook, Spring 2012, International Monetary Fund 3 McKinsey Global Institute, Debt and (Not Much) Deleveraging, February 2015 Please contact your financial advisor, call us at or visit our website at for more information PG 5