The Cornerstone Investment Commentary: 2nd Quarter, 2016
It was a largely positive, if boring, quarter … at least until late June. Stock markets, employment and consumer confidence were all up; inflation and interest rates remained low. Fears of a Chinese slowdown that caused sharp declines and pessimism early in the year were clearly overblown. Then came the British, crashing the party, and pushing results into the red.
But before that … the second quarter was a continuation of the first. Further job growth propelled consumer and business spending despite the drag on exports and corporate profits from a stronger dollar and stagnant European economies. Of note is emerging evidence that consumer behavior in the Great Recession’s aftermath still isn’t as great as what follows most recessions; the increased saving and more aggressive debt pay-downs – laudable at the individual level – mean a bit less fuel for overall economic growth. And the differences between U.S., British and European choices since 2008-09 already make for some very good economics case studies.
In this environment, U.S. stocks (a little over 75% of your non-bond holdings) and, in particular, value stocks (just over 60% of your equities) led markets back near their all-time high levels of a year ago by June’s final week. Government securities (increased earlier this year) and high-grade, short-term corporate bonds which comprise over 90% of your fixed income holdings continued to show the best results since last summer. Overall, nearly halfway through 2016, things seemed on their way to a solid – if not spectacular – year’s investment results.
Then came Great Britain’s vote to leave the European Union’s common market. To the obvious question, “What happens next?”, the most honest answer must be “No one really knows.” Those offering predictions are clearly speculating (based on whatever their general worldview happens to be), stirring up the impetus to ‘do something’. At such times, it’s usually both prudent and valuable to remember that there have been many, many seemingly-such ‘just do something’ past moments where doing just that was later revealed as the most costly move of all. This is because the most reliable prediction of all is that given the chance to overact, most will indeed do just that.
But we needn’t cast our ‘thinking caps’ aside and ignore unfolding events. Analysts at LitmanGregory commented that initial market reactions seem to reflect: 1) Concern about slower future global economic growth; 2) Fear that Britain’s ‘exit’ will lead to further ‘-exits’ and, possibly, the EU’s complete unraveling; and 3) Heightened uncertainty in general, which markets never like. Such things definitely bring the next recession closer, at least for now.
Assuming these are in-the-ballpark and given our knowledge of human behavior, an appropriate strategy would include: 1) Holding less stocks than you otherwise would (true in your portfolio the past 2-3 years); 2) ‘Leaning’ equity holdings more toward U.S. and value stocks (already true, even before further such moves this year); and 3) Holding higher-quality bonds and more Government securities than usual (again, true even before recently making this even more so). Altogether, these moves make your portfolio 10-15% less volatile than if not taken at all.
As we continue to monitor the ripple effects and unintended consequences, remember that these are likely to be more significant politically than economically. However, we won’t hesitate to shift to a more defensive position should unfolding events warrant. And we will keep our eyes peeled for attractive opportunities to buy equities should excessive market over-reactions present them. As we watch together, please feel free to be in touch with any questions or comments you may have.
We send both our thanks for the continuing opportunity to work with you and best wishes for a pleasant and enjoyable summer wherever you may be.