Early 2016 Market Update
The resumption of selling in global equity markets (including the U.S.) in 2016 has tripped up investors over the short term. This market action extends a lackluster calendar year 2015, which offered only a few positive pockets of return to support diversified portfolios.
Slowing global economic growth (below the long-term average of 3.5%) has been a source of anxiety for equities and related “riskier” strategies, like high yield bonds. Geopolitical concerns in North Korea, Iran and elsewhere are worrisome, as are Chinese officials’ attempts to “control” markets and their slowing economy as it rebalances. Finally, the U.S. Federal Reserve (Fed) has begun to raise interest rates, a policy that diverges from Europe and Japan, where accommodative monetary policy remains supportive.
Over the first seven trading days of 2016, a sharp selloff moved the Standard & Poor’s (S&P) 500 Index into negative territory by over 7%. U.S. bonds have moderated that shortfall in balanced funds, and added positive returns in bond funds.
To us, current market action reflects a return to a more normal environment. The former lack of volatility, especially in U.S. markets, was an anomaly caused by a hypersupportive monetary policy established by the Fed. During that period, the equity markets, especially in the U.S., had more than tripled from the 2009 lows.
Economic growth in the U.S. has held up relatively well. Earnings growth, admittedly helped by share buybacks and select technology outperformance, has held up except for commodity companies, and profit margins are high. The labor market also continues to improve, with the unemployment rate now down to 5%. The flip side, of course, is that wages have started to expand, and this development, while positive for workers, may slow corporate earnings growth.
As a result, while we believe the market could be more volatile, we do not expect a bear market, and believe that global equities in particular have a favorable risk reward after the selloff. This outlook depends on avoiding a U.S. recession.
While core U.S. bonds remain attractive from a diversification perspective, their total return potential, based on current valuations, appears limited compared to recent history. We do not expect a rapid rise in interest rates, and thus believe that price risks to core bonds are not high, but their return potential should remain low.
What have we done?
Equity Funds: We have recently highlighted, in prior issues of ENV, a number of Pension Boards’ managers charged with picking securities with the best prospects. We are overweight developed markets (including the U.S.), and underweight emerging markets, although we recently added two managers to take advantage of selected opportunities. We also hold 8.5% in hedged strategies built up since 2013, designed to protect principal and lessen volatility during these periods.
The Global Sustainability Index Fund is up and running as of November 1; this additional equity option focuses on index like returns with additional environmental, social, and governance (ESG) screens.
Balanced Funds: Our Target Annuitization Date (TAD) Funds adjust the mix between stocks, bonds, and stable value assets to become less risky the closer you are to retirement. In the Balanced Fund, we can alter the mix between stocks and bonds based on forward-looking market projections, and will take advantage of disproportionate selloffs when prudent.
Bond Funds: We have added select diversifying strategies, and continue to have a 10% allocation to bank loans, for example, which we believe can offer 5-6% returns per year over the next few years. In broad market selloffs, it is too easy to get consumed by the immediacy of negative headlines and sentiment. A thoughtful approach to opportunities, rather than succumbing to short-term concerns, still remains the optimal approach.