July 12, 2016

Monthly Market Summary – June 2016

Financial markets were dealt two major surprises during June. The first surprise came on the third day of the month in the form of a particularly poor U.S. employment report.  The report showed that only 38,000 net new jobs were created in May, which was much worse than the 158,000 that were expected.  This was the smallest monthly number of new jobs reported since September 2010.  The unemployment rate fell to 4.7% from 5.0% but the decline was due to workers leaving the workforce.  The labor participation rate declined to 62.6%.  Market participants do not like surprises so equity markets, the dollar, and Treasury bond yields initially declined in reaction to the poor jobs report.  Markets soon reversed course as investors concluded that the likelihood of an interest rate hike by the Federal Reserve Open Market Committee (Fed) was greatly diminished after the report.

Market Indices – June 2016

 

June Chart

The second major surprise came later in the month, on the 24th to be exact, when the result of the vote in the United Kingdom (UK) on the question of leaving the European Union (EU), referred to as Brexit, was announced.  The UK voted 51.9% to 48.1% in favor of leaving.  The outcome shocked market participants around the world since just the day before polls were indicating voters favored remaining in the EU.   The reaction was a sharp sell-off in global equities and the British pound along with a steep rise in prices for safe haven assets like gold and global government bonds, and for currencies like the dollar and yen.  For example, for the two-day period following the vote, the S&P 500 index fell over 5% and the Stoxx Europe 600 fell over 10%.  Yields on U.S. and Japanese 10-year government bonds fell to record levels (and prices rose), and gold rose to near a two-year high.  The global equity sell-off was short-lived, just the Friday and Monday after the vote.  Then markets swiftly reversed and many assets recovered much of the declines of the prior two days as central banks said they were prepared to take any necessary actions to ensure financial market liquidity and stimulate economic activity.  Safe haven assets including government bonds and gold, stayed at the higher levels however, as Brexit uncertainty ebbed but was not completely calmed.

Also of note during June was the continued march lower for government bond yields around the world. Even before the Brexit vote, 10-year German and 30-year Swiss government bonds traded in negative territory for the first time.  Events such as the poor U.S. jobs report and the UK leaving the EU only serve to increase the uncertainty about global economic growth and increase the expectations for extended continuation of lower interest rates.

Despite the ups, downs, and swift changes in the direction of prices, the S&P 500 and the Russell MidCap® indices ended June with small positive returns. The index of smaller company stocks, the Russell 2000®, had a return of  -0.1%.  At month-end the S&P 500 was only 1.5% away from the all-time closing high of 2,131 set in May 2015.  Value stocks outperformed growth stocks across the market capitalization (cap) spectrum since defensive stocks and energy stocks were the better performers.  The financial sector had the lowest return in the S&P 500 as the likelihood of higher interest rates faded after the poor jobs report and the Brexit vote.  The industrial sector had the lowest return in the mid-cap index and healthcare was the weakest sector in the small-cap index.

The return for the MSCI EAFE index of developed international country equities lagged both U.S. equity indices and the MSCI Emerging Markets (EM) index.   While global equity indices declined sharply after the Brexit vote, the UK, European, and Japan stock markets declined the most and did not recover as much before month-end as the U.S. and EM markets.  The EAFE index return for June was -3.4% on a U.S. dollar basis.  The EM index with a return of 4.0% not only outperformed EAFE but also major U.S. equity indices.  Brazil with a return of almost 20% along with other Latin American countries were the performance leaders.  Improving commodity prices and the lower U.S. dollar have been benefiting various EM equity markets.  The change in the political situation in Brazil continues to be seen as a positive for that country.

The Barclays U.S. Aggregate Bond index had a return of 1.8% in June. The 10-year U.S. Treasury bond yield fell to a record low after the Brexit vote on safe haven trading but moved a bit higher after the initial reaction subsided.  The 10-year Treasury bond yield was 1.48% at the end of the June down from 1.84% at the end of May.  In the declining yield environment, bonds with the longest time to maturity had the highest returns.  All sectors of the U.S. bond market including municipal bonds, mortgage-backed, and high yield corporate bonds posted positive returns for the month due to strong demand.

The Bloomberg Commodity index was the top performing index we track in the chart above with a return of 4.1%. The precious metals sub-index was the driver of the strong return gaining over 10% as both gold and silver advanced on flight to safety trading surrounding the Brexit vote and the increasing amount of bonds trading with negative interest rates.  Gold gained 9% and closed the month at $1,327 per ounce.  Silver gained 14%.  The industrial metals sub-index advanced as the supply/demand picture improved for several commodities.  The price of oil advanced during the month to $51 per barrel as data showed U.S. stockpiles are declining.  The oil prices fell after the Brexit vote on worries about slower global demand but later retraced much of that decline to end the month at $48.35.  Natural gas however, spiked higher in June on elevated demand due to the hot weather in the western U.S.

Vogel Consulting, LLC (Vogel) Tactical Recommendations

The uncertainty surrounding the impact of Brexit will continue to influence financial markets for some time since the process of negotiating the various exit agreements will take at least two years and periods of volatility are likely as events unfold. However, market participants will soon be turning their attention to the upcoming corporate earnings season.  In the U.S., forecasts are for S&P 500 earnings to decline again in the second quarter.  The outlook for earnings in the second half of this year is more positive.  The outlook is improving particularly for industrial, export-oriented, and multinational companies since the drag from a high U.S. dollar and falling oil prices is diminishing as the dollar has declined and oil prices have been trending higher.  While there are pockets of improvement, global economic growth, though positive, remains slow and uneven.  Bond yields are expected to stay low as a result of central bank policy and in the U.S. from increasing demand for our more attractive yields relative to negative yields in many regions.  Asset valuations are generally still near or above historical averages.  In this period of uneven growth, volatile markets, unprecedented central bank policies, and high valuations we continue to recommend remaining invested with both growth and limited volatility strategies along with having adequate cash reserves to avoid raising cash in a period of market weakness.

There was no change to our tactical asset allocation recommendation. We continue to recommend an equal weight position in each equity market sector (U.S. large-cap, mid-cap, and small-cap stocks as well as developed and emerging market equities).  We favor hedge fund strategies over fixed income for the lower expected volatility portion of portfolios since yields are near historically low levels.  Our fixed income recommendation is to underweight this sector and to maintain a focus on short to intermediate term bonds.  Non-Treasury bonds are favored for the yield advantage they provide compared to Treasury bonds.  As our expectation is for a moderate rate of inflation to continue, we recommend an equal weight to real assets.  Finally, since we expect that financial markets will experience periods of wide swings up and down in reaction to changes in expectations to Federal Reserve interest rate policy, oil prices, economic data reports, and Brexit news, we continue to recommend using periods of market strength to raise any cash needed to support spending needs over the coming 12-24 months.

 The statistical information contained in this commentary has been compiled from publicly available sources and is presented to you for your review and for discussion purposes only. The information contained in this commentary represents the opinion of the author(s) as of its date and is subject to change at any time due to market or economic conditions. These comments do not constitute a recommendation to purchase, sell or hold any security, and should not be construed as investment advice or to predict future performance.  Past performance does not guarantee future results.

 The statistical information contained in this commentary was derived from sources that Vogel Consulting, LLC believes are reliable, and such information has not been independently verified by Vogel. Russell Investment Group is the source and owner of the trademarks, service marks and copyrights related to the Russell Indexes. Russell® is a trademark of the Russell Investment Group.  An index is not managed and is unavailable for direct investment.