quarterly-update-august-2016

 

  • Slower and lower GDP growth persists
  • Growth in consumer wages, jobs, and housing market are solid
  • Investors should favor stocks rather than bonds

The U.S. economy remains in the same slow and low growth trajectory as before the United Kingdom voted to leave the European Union. Given the uncertainty Brexit created, we believe the relative attractiveness of the U.S. economy has improved. However, the U.S. dollar has further appreciated against the pound and euro, which means U.S. companies selling into those economies will likely sell fewer goods and services, and the value of those goods and services will be lower. So while the overall U.S. economy is largely unaffected by Brexit (U.S.-Europe trade is much less than UK-Europe trade, as a % of GDP), the decision will have some negative impact on U.S. companies’ earnings growth. How much depends on how expensive the dollar becomes and how long that lasts. There are good reasons to believe that while Brexit negotiations are in progress (one to two years) investors will likely prefer dollars over euros and pounds.

Despite Brexit, our outlook for U.S. earnings over the next 12-18 months is modestly upward, growing perhaps 4%, which would translate into similar price appreciation for equity investors. Add in the dividend yield and stocks may generate total returns of 4-5%. This view is supported by the recent all-time high of the S&P 500, which is a bellwether of current and future earnings of U.S. companies. We remain comfortable with significant underweight allocation to European equities until the implications of Brexit are clearer.

This slow and low growth trajectory in the U.S., accompanied by even slower and lower growth in Europe, has drawn fixed income investors to U.S. government bonds. The all-time low yields in government bonds are not necessarily a positive. However, while slow and low growth persists, we believe the good news is that U.S. economic expansion may continue for a few more years. Leaving aside any potential for self-inflicted wounds by policymakers and looking solely at economic activity, there is reason to believe the next recession is not yet within sight. Slow, but continued, expansion means equity investments are likely to perform better than fixed income.

We have also seen significant positive returns (over the past three years) from our high dividend paying equities, as income-oriented investors seek better yields than those offered by investment grade bonds. We like dividend-paying equities, and with the right return expectations ahead, we believe they are likely to outperform fixed income returns. That said, we think neither stocks nor bonds in the U.S. will generate returns equaling their historical averages over the next one to two years.

Important Disclosures

The information presented does not involve the rendering of personalized investment, financial, legal, or tax advice. This presentation is not an offer to buy or sell, or a solicitation of any offer to buy or sell, any of the securities mentioned herein.

Certain statements contained herein may constitute projections, forecasts, and other forward-looking statements, which do not reflect actual results and are based primarily upon a hypothetical set of assumptions applied to certain historical financial information. Certain information has been provided by third-party sources and, although believed to be reliable, it has not been independently verified, and its accuracy or completeness cannot be guaranteed.

Any opinions, projections, forecasts, and forward-looking statements presented herein are valid as on the date of this document and are subject to change.

There are inherent risks with equity investing. These risks include, but are not limited to, stock market, manager, or investment style. Stock markets tend to move in cycles, with periods of rising prices and periods of falling prices. Investing in international markets carries risks such as currency fluctuation, regulatory risks, economic and political instability. Emerging markets involve heightened risks related to the same factors as well as increased volatility, lower trading volume, and less liquidity.  Emerging markets can have greater custodial and operational risks, and less developed legal and accounting systems than developed markets.

Concentrating assets in the real estate sector or REITs may disproportionately subject a portfolio to the risks of that industry, including the loss of value because of adverse developments affecting the real estate industry and real property values. Investments in REITs may be subject to increased price volatility and liquidity risk; concentration risk is high.

There are inherent risks with fixed income investing. These risks may include interest rate, call, credit, market, inflation, government policy, liquidity, or junk bond. When interest rates rise, bond prices fall. The yields and market values of municipal securities may be more affected by changes in tax rates and policies than similar income-bearing taxable securities. Certain investors’ incomes may be subject to the Federal Alternative Minimum Tax (AMT) and taxable gains are also possible. Investments in below-investment-grade debt securities and unrated securities of similar credit quality, commonly known as “junk bonds” or “high-yield securities,” may be subject to increased interest, credit, and liquidity risks.

Investments in emerging markets bonds may be substantially more volatile, and substantially less liquid, than the bonds of governments, government agencies, and government-owned corporations located in more developed foreign markets.  Emerging markets bonds can have greater custodial and operational risks, and less developed legal and accounting systems than developed markets.

As with any investment strategy, there is no guarantee that investment objectives will be met, and investors may lose money.

Returns include the reinvestment of interest and dividends.

Investing involves risk, including the loss of principal. Diversification may not protect against market loss or risk.

Past performance is no guarantee of future performance.

Index Definitions

The Standard and Poor’s 500 Index (S&P 500) is a market capitalization-weighted index of 500 common stocks chosen for market size, liquidity, and industry group representation to represent U.S. equity performance.

The U.S. Treasury 10 year note is a debt obligation issued by the United States government that matures in 10 years. A 10 year Treasury note pays interest at a fixed rate once every six months and pays the face value to the holder at maturity.

The MSCI World Index captures large and mid-cap representation across 23 Developed Markets countries.

The Barclays U.S. Corporate High-Yield Index covers the U.S. dollar denominated, non-investment grade, fixed rate, taxable corporate bond market and includes securities with ratings by Moody’s, Fitch and S&P of Ba1/BB+/BB+ or below.

The Barclays Emerging Markets USD Aggregate Bond Index is a flagship hard currency Emerging Markets debt benchmark that includes fixed and floating-rate U.S. dollar denominated debt issued from sovereign, quasi-sovereign, and corporate EM issuers.

The Bloomberg CFETS RMB Index is an index replica of the trade weighted CFETS RMB Index, which tracks the yuan against 13 currencies.

The U.S. Dollar Index is an index (or measure) of the value of the United States dollar relative to a basket of foreign currencies.

Indices are unmanaged, and one cannot invest directly in an index. Index returns do not reflect a deduction for fees or expenses.