November 2016 Special Election Market Commentary

It’s The Final Countdown

via GIPHY

I am not talking about the popular 80’s rock anthem by Europe.

By the time many of you read this we will have a new President.  The markets will react accordingly based off of these results.  My crystal ball is quite cloudy these days so I can’t tell you who will win.  I can tell you that as a nation we have survived 56 of these and I anticipate we will survive number 57.

I always caution against watching stocks on a daily basis, because it’s too easy to get caught up in the daily volatility that inevitably will occur. If we go back to last summer’s late August swoon, it might have been tempting to bail when shares were near their bottom and financial reports bordered on hysteria.

Or, fast forward a few months to the start of 2016. Remember how stocks were hit by one worry after another? “The S&P 500 and Nasdaq posted their worst start to a year since 2001, while it was the worst for the Dow since 2008,” according to an early January headline by Reuters.

Anytime stock comparisons run up against 2001 or 2008, it’s natural to start asking questions. But it can also generate needless worry.

Monitoring daily moves in stocks may not always bring about volatility. Instead, it may be as exciting as watching the paint dry.

The S&P 500 Index closed at an all-time high 2,190 on August 15 (St. Louis Federal Reserve). We then preceded to close within 3% of the all-time high for the next 54-straight business days ending October 31 (St. Louis Federal Reserve). That’s the longest streak since 1928, according to LPL Research.

The sheer boredom in this broad-based index of 500 larger companies contrasts sharply with the circus that has unfolded. You know, the 2016 presidential election.

Charges and counter charges have been levied by the candidates. Reality TV couldn’t have done a better job scripting the antics in this campaign. Sadly, however, this isn’t reality TV. It’s an election that will decide who will be the nation’s commander-in-chief for the next four years.

Unless the collective wisdom of investors believes the election will have a material impact on the economy, the lack of market reaction really shouldn’t come as a surprise.

There are some who would say that a come-from-behind win by Donald Trump might spook the market because a win by his opponent, Hillary Clinton, is supposedly priced into shares.

That may or may not be the case. A Trump win might produce a “Brexit-like reaction.” You may recall the sharp two-day selloff in shares following the U.K.’s referendum to leave the European Union in June. A ‘yes’ on Brexit wasn’t supposed to happen. That ‘yes’ vote suddenly injected a large dose of uncertainty into the market.

But the bottom didn’t fallout of the UK or the EU economy. There weren’t any post-referendum economic tremors to reach our shores either. Within about one month, the major indices in the U.S. were posting new highs.

I can’t say the market will surge to new highs after the election. No one can predict where shares might go in a two or three-week period and do it consistently. But let’s step back a moment and take things into perspective.

Short-term market gyrations are the playground of traders. Long-term investors with long-term plans shouldn’t be distracted by daily movements.

Eventually, longer-term money will eventually set its sights on the boring fundamentals that have tugged at shares for many years – the economy, profits and expectations of profit growth, and Federal Reserve policy.

Table 1: Key Index Returns

MTD % YTD % 3-year* %
Dow Jones Industrial Average -0.9 +4.1 +5.3
NASDAQ Composite -2.3 +3.6 +9.8
S&P 500 Index -1.9 +4.0 +6.6
Russell 2000 Index -4.8 +3.7 +2.4
MSCI World ex-USA** -2.0 -1.5 -4.0
MSCI Emerging Markets** +0.2 +14.0 -4.4

Source: Wall Street Journal, MSCI.com

MTD returns: Sep 30, 2016—Oct 31, 2016

YTD returns: Dec 31, 2015—Oct 31, 2016

*Annualized

**in US dollars

Digging for gold in emerging markets

Take a look back at Table 1. While the Dow and S&P 500 Index have managed a modest-at-best advance during the first ten months of the year, emerging markets have put on quite a show. It’s not enough of make up for the three-year deficit, but nonetheless, developing nations have been a big winner this year.

While performance varies widely from country to country, Russia is up over 30%, and Argentina and Brazil are posting gains of 50% (Wall Street Journal). Brazil comes as a big surprise given a recession and the political chaos that has gripped the nation.

What gives?

Emerging market economies that are reliant on the sale of raw materials have benefitted from an uptick in commodity prices. The underperformance in recent years may also be attracting cash from investors who have been discouraged by lackluster growth in the developed world.

BlackRock may sum it up best. In a recent blog post, the asset manager noted, “Asia has displayed the strongest growth of any emerging region, as well as favorable trends in inflation and current accounts measures (Source: IMF, Bloomberg).

“With lower external debt than other regions, Asian economies have been less vulnerable to a strengthening U.S. dollar, which remains one of the main risks to (the) outlook for emerging markets. Controlled inflationary pressures also support (the) expectation of further (cuts in interest rates) by Asian central banks.”

It comes after years when many investors side-stepped a large swath of the global economy.

Typically, I recommend a well-diversified portfolio that not only places you in the major sectors of the U.S. economy, but I also want to make sure we don’t bypass the global economy, including smaller, developing nations.

It is a potential way to increase diversification, reduce long-term risk, and participate in gains that emerging markets are likely to see over a long period.

Before anyone wants to run headfirst into emerging markets, a note of caution is in order.

I also feel strongly that too much exposure creates too much risk. Investing in these economies is not for the faint of heart. Political risk, currency risk, and economic risk can all exaggerate swings in shares.

Longer-term, however, prospects are generally deemed to favorable, and I believe a modest stake in these economies is a worthwhile investment choice, especially as valuations have been attractive.

You paid how much for that?!

Tune into well-known economists and Federal Reserve officials and you’ll hear that one reason interest rates have been slow to rise has been a rate of inflation that’s too low. Yes, you heard it right, prices aren’t rising fast enough.

While some of you are thinking about the cheap price of gasoline, others can’t help but point to everything from college and health insurance costs, the latest rise in your cable bill, or even the cost of popcorn at the movies.

Key measures of pricing, such as the Consumer Price Index (CPI) and the lesser known PCE Price Index (the one the Fed prefers. The PCE price index is defined as personal consumption expenditures (PCE) prices excluding food and energy prices. The core PCE price index measures the prices paid by consumers for goods and services without the volatility caused by movements in food and energy prices to reveal underlying inflation trends.), have held below the Fed’s inflation target of 2% for over three years (BLS, BEA).

I readily acknowledge that everyone’s monthly basket of goods and services is unique. A person who puts 6,000 miles on her Prius each year won’t benefit nearly as much from lower gasoline prices as the person who racks up 25,000 on her SUV. Still, the major price gauges really do a good job of monitoring the overall price level.

And here lies the disconnect. From an investment perspective, markets (including the stock and bond markets), the Fed, and economists are going to key in on the major indexes such as the CPI and the PCE.

That said, the CPI is beginning to detect rising inflation in parts of the economy. In particular, the price paid for services is advancing at a moderate clip, up 3.0% from a year ago (BLS)

Notably, medical care has started to rise at a much faster pace, up nearly 5% over the past year, and the cost of shelter (primarily rent as actual home prices aren’t included in the CPI), have accelerated to almost 3.5%.

Despite important pockets of the economy which are experiencing pricing pressures, it is unlikely that we will see much reaction from the Federal Reserve. The Fed’s focus remains on overall economic growth.

You see, the Fed wants to keep interest rates low in order to squeeze extra job growth out of the economy. Unfortunately for savers, any interest rate hikes are likely to be gradual unless overall inflation rises sharply.

Epilogue

I know that for some of you, this year’s election has been particularly difficult. You are rightly concerned about the direction of the nation, and you fear the leadership that will take the helm next year won’t be in the country’s best interest.

I won’t comment on the many pressing issues of the day, nor will I suggest how to vote.

I will leave you with something I wrote just a couple of months ago, and something I wholeheartedly subscribe.

In his 2015 letter to shareholders, Warrant Buffett said, “For 240 years it’s been a terrible mistake to bet against America, and now is no time to start. America’s golden goose of commerce and innovation will continue to lay more and larger eggs (Bloomberg – Warren Buffett’s 2015 Shareholder letter, Annotated).”

A growing economy fueled by innovation and entrepreneurship has been the biggest driver of stocks over the many decades. As Buffett emphasized, betting against America isn’t a winning hand. And he didn’t qualify his remarks based on the outcome of the upcoming election.

I hope you’ve found this review to be educational and helpful. As I always emphasize, it is my job to assist you. I always emphasize that as your financial advisor, it is my job to partner with you. If you have any questions about what I’ve conveyed in this month’s message or want to discuss anything else, I’m simply a phone call away.

 

If you are interested in a second opinion on your investment plan or are in need of a financial plan to get your financial life on track give me a call in the office at 336-310-4233.

 

Securities offered through LPL Financial. Member FINRA/SIPC. Investment advice offered through Independent Advisor Alliance, a registered investment advisor. Independent Advisor Alliance and Thorium Wealth Management are separate entities from LPL Financial

The economic forecasts set forth in the presentation may not develop as predicted and there can be no guarantee that strategies promoted will be successful.

Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. To determine which investments or strategies may be appropriate for you, please contact your financial advisor. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.

Investing involves risk, including loss of principal.

Unmanaged index returns do not reflect fees, expenses, or sales charges. Index performance is not indicative of the performance of any investment. The Standard & Poor’s 500 Index is a capitalization weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. The Russell 2000 Index is an unmanaged index generally representative of the 2,000 smallest companies in the Russell 3000 index, which represents approximately 10% of the total market capitalization of the Russell 3000 Index. The MSCI World ex USA Index captures large and mid cap representation across 22 of 23 Developed Markets (DM) countries*–excluding the United States. With 1,005 constituents, the index covers approximately 85% of the free float-adjusted market capitalization in each country. The MSCI EM (Emerging Markets) Index is a free float-adjusted market capitalization weighted index that is designed to measure the equity market performance of the emerging market countries of the Americas, Europe, the Middle East, Africa and Asia. The MSCI EM Index consists of the following emerging market country indices: Brazil, Chile, Colombia, Mexico, Peru, Czech Republic, Egypt, Greece, Hungary, Poland, Qatar, Russia, South Africa.Turkey, United Arab Emirates, China, India, Indonesia, Korea, Malaysia, Philippines, Taiwan, and Thailand.

The NASDAQ Composite Index measures all NASDAQ domestic and non-U.S. based common stocks listed on The NASDAQ Stock Market. The market value, the last sale price multiplied by total shares outstanding, is calculated throughout the trading day, and is related to the total value of the Index. The Dow Jones Industrial Average is comprised of 30 stocks that are major factors in their industries and widely held by individuals and institutional investors. International investing involves special risks such as currency fluctuation and political instability and may not be suitable for all investors. These risks are often heightened for investments in emerging markets. There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk. Because of their narrow focus, sector investing will be subject to greater volatility than investing more broadly across many sectors and companies.