October 07, 2016

Monthly Market Summary – September 2016

Accommodative global monetary policies and concerns about any potential changes to those policies continue to be a primary driver of global asset prices. For example, early in the month bond yields rose and equity prices declined on worries that central bank stimulus may be nearing a limit after the European Central Bank signaled no additional stimulus will be coming soon and comments by certain Federal Reserve (Fed) governors hinted that the U.S. economy may have improved enough for the Fed to raise its policy interest rate.  However, after the Fed declined to raise its policy rate at its September 21 meeting and trimmed its estimated number of rate hikes for 2017 to two, equity and bond markets around the world rallied.  The same day, the Bank of Japan announced a new policy to target a 0% yield on its 10-year government bond.

Market Indices – September 2016

Sept Chart

Economic news reported during September continued to be mixed, which adds to the uncertainty about central bank monetary policies. In the statement released after the latest Fed meeting, the committee indicated that it is waiting for further evidence about economic conditions before it will make a change in its federal funds rate.  In the U.S., labor market conditions continue to be positive including increases in job openings, lower new unemployment claims, reduced duration of unemployment, and higher wages compared to the prior year. However, the industrial side of the economy continues to be weak with industrial production down again.  The housing market cooled with housing starts, existing home sales, and new home sales all declining compared to the prior month.  The most recent eurozone purchasing managers’ composite index declined mostly because activity in Germany fell to a three-year low.  On the positive side, economic activity in China is showing signs of picking up.  China recorded the first increase in imports since 2014 and the manufacturing index showed expansion for the third month in a row.

For the third consecutive month, small company stocks were the performance leaders in the U.S. equity market. The Russell 2000® index of small capitalization (cap) stocks had a return of 1.1% compared to returns of 0.0% and 0.2% for the S&P 500 and the Russell MidCap® respectively.  Growth stocks outperformed value stocks among large and small-cap stocks.  In contrast, value stocks outperformed growth stocks in the mid-cap category.  In a continuation of the trend in August, investors rotated out of defensive sectors resulting in weaker returns for utilities and consumer staples stocks. Investors  instead favored stocks with higher earnings growth resulting in information technology stocks being among the top performers for the month. Many information technology companies have provided positive guidance about the upcoming earnings reporting season.  Energy stocks were also top performers benefiting from higher oil prices.  The financials sector was another weak sector for the month with the sector posting negative returns in each market cap category.  The financial sector declined on worries about a potential hike in the Fed funds rate, weaker housing data, concerns about European bank capital levels, and the Wells Fargo sales practices controversy.  Consumer discretionary and industrials stocks were also weak on reports of lower retail sales, homes sales, and new orders.

Both developed international market and emerging market stock indices outperformed U.S. stock indices in September. The MSCI Emerging Markets (EM) index had a return of 1.3% and the MSCI EAFE index of developed international country equities had a return of 1.2%.  Among developed markets, European equity indices were weaker than the Far East and Pacific regions in part due to large declines in European bank stocks on capital adequacy concerns.  Returns for U.S. investors in Japanese stocks are benefiting from positive currency moves with the yen rising.  EM stock prices were propelled higher during the month on improving fundamentals in countries such as Brazil, rising commodity prices, and positive currency moves.  China, Russia, Taiwan, Korea, and Brazil were among the best performing EM country indices and all had positive returns for the month.  The Latin American index was one of the weakest performing with a negative return primarily due to the decline in the Mexican index.  Mexican equities continue to be hurt by capital flowing out of the country to other countries seen as offering lower valuations and better growth potential, such as Brazil.

For the second month in a row, the Bloomberg Barclays U.S. Aggregate Bond index had a return of -0.1%. In early September, Treasury bond yields rose.  The benchmark 10-year Treasury bond reached a yield just over 1.7% on expectations that the Fed would raise its Fed funds rate sooner rather than later.  In the second half of the month yields moved lower again after the Fed left the rate unchanged at its September meeting and indicated that the path of future rate increases will be gradual.  Despite the various ups and downs experienced during the month, the yield on the 10-year Treasury bond ended the month about where it began the month at 1.6%.  High yield bonds were the top performing sector.  However, the Bloomberg Barclays U.S. Corporate High Yield bond index gained less than 1%.  High yield bond prices were boosted primarily by higher oil prices that improved the credit conditions of energy companies which make up a sizeable portion of the high yield index.  Municipal bonds declined due to in part to market dislocation caused by the upcoming money market fund regulation changes.  Billions of dollars have been pulled from tax-exempt money market funds which will be subject to floating daily net asset values.

The Bloomberg Commodity index returned to positive territory after a negative return in August. The index had a return for September of 3.1%.  Of the sub-indices we track, only livestock had a negative return for the month.  Livestock prices are being pressured by oversupply.  The petroleum sub-index, which gained 7%, had the highest return for the month.  The price of oil moved higher on reports of inventory drawdowns and on the surprise agreement by the Organization of Petroleum Exporting Countries (OPEC) to limit production.  West Texas Intermediate crude ended the month at $48.24 up from $44.70 at the prior month-end.  The industrial metals sub-index also had a strong gain of over 5% for September, reversing the decline in August.

Vogel Consulting, LLC (Vogel) Tactical Recommendations

No changes were made to our tactical asset allocation recommendations. 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 continue to recommend an equal weight to hedge fund strategies.  We favor hedge fund strategies over fixed income for the lower expected volatility portion of portfolios since bond 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.  Since 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 political 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.