After enduring a relatively flat 2015, investors are experiencing a bumpy ride in 2016. Headline risk (the possibility that a news story will adversely affect a stock's price), caused a great deal of market volatility at the start of that year, continued into the 2nd quarter ending June 30th. In a persistently slow economic environment, investors are inclined to over focus on negative news.
CHART 1 (below) illustrates the volatility of markets through June 30th. During the 2ndquarter major headlines moved the spotlight off collapsing oil prices, a surging dollar, and slowing China, and squarely onto the “calamity” of the British exit from the European Union. Let’s get behind the headlines to the heart of the current situation.
Britain’s decision to exit the EU on June 23rd led to $3 trillion of global stock losses in two trading days and caused investors to flee to “safe haven” type assets. Perceived safer assets include commodities and assets with higher income yields like REITS, dividend-paying stocks, and fixed income securities. After a volatile post-Brexit-vote week, the broader markets rebounded significantly by June 30th.
CHART 2 (below) shows what “worked” and what “did not work” in the second quarter. Included in the top performers were commodities and debt, while foreign equities ranked with the weakest performers. Commodities like energy, precious metals, and agricultural goods produced positive returns for both the quarter and year-to-date, a turn-around from previous years; however, given the varying returns within the group, diversification remains important. Bonds unexpectedly delivered good relative returns in a tough environment, where investors sought a safe haven from economic and geo-political concerns.
Lack of clarity on the future trend of corporate earnings creates an uncertain mood in the markets, which can also drive volatility. Earnings peaked most recently in 2014 and then took a tumble when hit with the headwinds of sharply declining oil prices and a fast rising dollar. As CHART 3 (below) shows, year over year earnings have been down for the last 5 quarters. Given this year’s partial reversal in the price of oil and the U.S. dollar, we expect positive earnings comparison trends to begin as early as the 3rd quarter of this year and, most likely, no later than the 4th quarter. This change in trend should help underpin the markets going forward by dampening volatility and uncertainty.
Investors have been faced with a high volatility, low interest rate environment this year. Sitting on the sidelines is not an option with interest rates near zero. Efforts to try to time the volatility prove futile. As we have stated before, our belief is that our clients will benefit from staying invested for the long term in a portfolio that is diversified both across asset classes and within asset classes, and by emphasizing higher quality. CHART 4 (below) illustrates well that, despite intra-year corrections averaging -14.2% since 1980, 75% of the time a given year ended in positive territory (27 out of 36 years shown). History is on the side of those who don’t overreact to market volatility and are mindful that markets do not move in a straight line.