Monthly Outlook: October 2016
During our in‐house strategy meeting today, we bantered about markets, monetary policy, political possibilities, economics and more. There are just so many cross currents and potential outcomes that a high conviction outlook is difficult. Bob summed it up best, “So it’s cloudy with a chance of meatballs!” (after the children’s book/movie). That sounds about right.
In September, U.S. stocks were flat once again. The S&P500 started the month at 2,171 and ended at 2,168. It’s just stuck and seems to be waiting for something. Remember, the S&P500 was flat for the first six months of the year, too, starting the year at 2,044 and it was still 2,038 on June 26th. Then, in an incomprehensible rebound rally in response to Brexit, it floated 6% higher in 10 days to 2,065 on July 14th, where it’s been stuck ever since. So really, the whole year’s gain was made in 10 trading days. The risk and concern is that the same kind of political news that moved it higher, could easily bring it down in 10 trading days. The year is not over and we’re balancing the need to be invested for growth with the concern for downside and need for protection. We’re finding some opportunities in a few asset classes, but we have growing concern for stocks, overall. We’ll review allocation and opportunities later.
While the outlook is cloudy, we are watching many developments. The U.S. Federal Reserve passed on raising interest rates at its recent September 21st meeting but did hint that a rate hike by year end is increasingly likely. Their next meeting is in mid‐ December so we’ll wait for that. Of course the U.S. Presidential election is coming in 36 days and that could move markets. But with polls surprisingly close and the electorate so strongly opinionated but split, the post‐election period will surely be more volatile for the markets, not less volatile. But which direction will markets break? Over in the U.K., Brexit continues to evolve and in Germany, their largest banks are proving to be unstable. The list of potential market movers is as long as ever. So yeah, it’s meatballs.
Allocation Opportunities
Most of the portfolios we manage are globally diversified “balanced” portfolios that include fixed income, U.S. and international stocks, commodities and cash. Of course these are the very broadest categories and there are a lot of sub‐categories to analyze and consider. Let’s look at fixed income first. We can choose between short term to long term maturities, investment grade to “junk” grade, and U.S. and international issues. They all behave differently depending on changes in interest rates, risk tolerance, and currency movement. Bonds have been a solid contributor to performance this year, which surprises some investors given how low interest rates are. We recently shortened the average maturity and are concentrated in investment grade holdings. These are conservative moves in light of the Fed’s announcement that an interest rate hike is now likely by year end.
Another allocation opportunity to point out is related to the U.S. dollar. You may not realize, but the U.S. dollar has actually been falling against an index basket of other global currencies for most of 2016. This is an important change after nearly five years of a rising dollar. The opportunities come from “real assets” like commodities, gold and silver, and international bonds. And we have them all in our portfolios. A falling dollar could also help international stocks relative to U.S. stocks though we haven’t seen this yet. As a reminder, we consider every investment relative to cash – cash defined as U.S. dollars. Now we even have to consider the real value of dollars!
Two Hands on the Wheel
On the one hand, stocks remain over‐valued, interest rates are likely to rise, and the U.S. dollar is declining. But on the other hand, global central banks and their stimulus plans have successfully created a perceived floor to prices and downside risk. We have our eyes wide open, two hands on the wheel, and are ready to carefully drive client portfolios forward. It’s probably safe to predict a few curves in the road ahead.