Quarterly Commentary – September 2016

U.S. Equity markets exhibited unusually low volatility during July and August as we saw prices creep up in a slow but fairly steady pace. Early part of September things reversed somewhat, then things stabilized and started turning back around. The following are performance numbers from various popular indexes for the quarter. Index numbers are not individually comparable to a properly diversified portfolio. Each portfolio may include an allocation to securities similar to these indexes in varying amounts based on your personal risk tolerance and should only be compared in that context. The S&P 500 reflected a gain of 7.8% for the first nine months of 2016. The Dow Jones Industrial Average was up 7.2%. International equities as represented by the MSCI World Ex U.S. Index were up 3.1%. Fixed Income as represented by the Barclays Aggregate Bond Index closed up 5.8% for the year.

It is notable that market leadership this year has not followed the traditional late-cycle trends. The advance has been led unexpectedly by defensive sectors. Earlier this year, defensive sectors such as telecommunication and utilities were the best performing sectors. The current low interest environment has created some aberrations with valuations in some of these areas as investors are seeking yield levels that cannot be obtained in the more traditional way through fixed income investments. This is the type of environment when seemingly safer investments become quite the opposite as people pile into them, only to later see a rush to the exits at a most unexpected time. The return disparity between various sectors has been quite wide.

U.S. economic growth in the second quarter was well below what economists expected, but concerns about the recovery stalling were eased by data reflecting strong consumer spending. Consumer spending which represents more than two-thirds of U.S. economic activity increased 4.3% in the second quarter. This was the fastest pace since the fourth quarter of 2014. The U.S. economy is in decent shape relative to the rest of the world.

A lot of focus has been placed on watching the Fed and every nuance in language coming from them has been scrutinized. With unemployment below 5% and inflation moving a bit higher over the past year, there is some optimism that U.S. economic growth is headed toward full employment and a Fed inflation target of 2%. For the time being, the Fed decided to hold off raising rates at the September meeting, however there is an increased likelihood that it will happen relatively soon, possibly as soon as October, possibly December. To the extent that inflation stays in check, future increases should happen at a slow, measured pace.

In case you had not noticed, we are in a presidential election year. One that should prove dramatically different than those that preceded it. Very much is being said in the media about potential outcomes and the impact on the equity markets. Markets typically do not like uncertainty but love positive surprises. Accommodative monetary policies have probably done all that they can do to prop our economy. Fiscal policies will be required for the U.S. economy to return to trend growth. Growth oriented policies will be important to help transition the economy back to this higher level of growth. Not everyone will agree on what those policies should be.

This certainly has been a long recovery, lasting over seven years. Expansions don’t typically die of old age, they die of excess. The excess is often in the form of inflation, capital spending, capacity utilization, debt, etc. The positive aspect of this anemic recovery is that it has kept various types of excess in check.

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