SageVest Wealth Management recently released our quarterly commentary. Highlights are as follows:
– The third quarter was docile, allowing markets to advance and support modest, yet encouraging, year-to-date results.
– US elections and a December meeting of the Federal Reserve could make the fourth quarter more volatile as the markets await and absorb results.
– Absent a resurgence in corporate earnings, investors might need to gain comfort with more speculative momentum investing.
The third quarter was quiet, but upbeat. Global stocks moved modestly higher, hopefully positioning 2016 to land in positive territory by year-end, after a difficult start to the year.
The investment markets quickly disregarded potential impacts of the Brexit vote. The Federal Reserve (Fed) again elected to hold US interest rates steady. Similarly, the European Central Bank (ECB) opted for no new monetary easing. All-in-all, it was a fairly hum-drum quarter.
As SageVest Wealth Management looks forward, there are several points that suggest the fourth quarter could be anything but boring. Our US elections certainly come to mind, as well as the December Fed meeting, and corporate earnings results. With the markets now in modest positive territory, the impacts of these events in the fourth quarter remain critical in determining 2016 investment results.
The Ups And Downs Of Election Results
If we had to pick the most frequently asked client question as of this moment, it’s without a doubt, “How do you think the markets will react depending upon the outcome of the Presidential election?”
This is undoubtedly an unprecedented election, and one that could spark stronger than normal market reactions. However, concerns about trade treaties if Trump wins, or higher taxes and regulation if Clinton wins, can be tempered by recalling our democratic process, whereby votes from the House and Senate can moderate the ability of either candidate to effectuate abrupt change. Furthermore, we think it’s worth noting that the stock markets have experienced highs and lows under both Democratic and Republican administrations, indicating that politics isn’t the single determining variable of market performance.
Ultimately, our opinion is that the state of the economy, global growth levels, and actions by the Fed and other central banks around the world are far more impactful to the markets than any election outcome. Market performance has historically been based upon market fundamentals. Yes, there are short-term variances due to political and other events, but the fundamentals always emerge as the dictating force.
We’ll conclude on this topic by reminding readers of the short-term reaction to the Brexit vote. This was a substantial change in global political and trade structures. Yet what are the stock market impacts thus far? We’ve only seen a two-day pullback, followed by sharp stock market rebounds, despite a precipitously falling Pound.
The Fed – A Fourth Quarter Hike Or Punt?
Perhaps the largest fundamental that could shift the markets in the fourth quarter is the outcome of the Fed’s December meeting, as we wait to see if interest rates will rise or remain the same.
Minutes from the last Fed meeting revealed that three Fed Chairs dissented on the vote to hold rates steady. This is an unusual turn of events, and one that certainly raises the probability of a rate increase in December, particularly if economic conditions remain steady or improve.
Although inflation remains low, headline data points certainly suggest that it’s time to move back toward a more ‘normal’ rate environment. US employment is arguably at ‘full employment’ level. Income and wages are trending higher, giving consumers more discretionary income. Recent new records on household net worth also suggest strong consumer confidence.
Two variables seem to keep the Fed on hold; low inflation, and global financial conditions. We question how much longer these factors can sway the Fed from rate increases, particularly as energy prices steadily recover, and things appear to be calming on the international front.
A rate hike could create a ripple effect through the markets. However, we believe that any potential rate increase will be modest and that the pace of potential future rate hikes will likely remain gradual. Furthermore, international central banks continue to be very accommodative, creating demand for US Treasuries that helps to keep our US rates low. In fact, Treasury and mortgage rates are lower now than when the Fed last increased rates! This serves as a reminder to take any rate increase with a grain of salt, as potential market effects could again be short-lived.
With Eyes On Earnings, Perhaps A Time To Take Heed
One note of disappointment in the third quarter was a recurring trend of declining earnings. Corporate earnings have now declined for five consecutive quarters. As we previously stated, market performance will sometimes deviate from fundamentals. This is one of those times, as the stock market continues to be supported by ultra-low rates, corporate buybacks, and other factors. However, history shows that corporate earnings must eventually resume positive growth to sustain stock market growth.
In the absence of earnings growth, we continue to monitor corporate revenues, consumer spending and other variables that support performance. We also caution investors that the longer the markets continue on an upward trend without a coinciding upward move in earnings, the more the markets become dependent upon momentum buying.
Market momentum can support markets for extended periods of time. Just look at the late 1990s as a prime example. It’s a market condition that can certainly allow investors to reap significant stock market profits, and to that end, investors are wise to participate in stock market exposure during a momentum phase. However, it’s also a time to take heed of investment risk, as momentum markets can end sharply and swiftly when the music stops. We caution investors to carefully evaluate their risk tolerance and comfort levels.
Looking Ahead
Looking ahead, 2016 investment results could be dictated by short-term reactions to the US elections and to the Fed’s December meeting. Either event could move the markets higher or lower, perhaps significantly, and over a short time period. Ultimately, we encourage investors to remain focused on fundamentals, some of which remain strong, while others, such as corporate earnings, remain disappointing. We could be at a pivotal moment in a mature market cycle, now at 86 months of a bull market. We believe that this is a time to carefully evaluate both your desire to participate on the upside, and your need to protect on the downside. We recommend maintaining exposure across a diverse set of investments that react differently under varying political, economic, and market conditions.
As always, we encourage you to contact us with any questions.