John Fischer, CFA®, CFP® | Chief Investment Officer
John Fischer, CFA®, CFP®
The second quarter began with a focus on the Fed and how many interest rate hikes we would see in 2016. At the time, the Fed was still forecasting two additional rate increases this year. But a very disappointing employment number in early June quickly cast significant doubt on the Fed’s forecast. Shortly thereafter, the United Kingdom (UK) voted to leave the European Union (EU) in an event termed the Brexit. The outcome of this vote caught many investors by surprise and as a result stirred global markets. Suddenly, a quarter that began with all eyes on the Fed shifted to investors wondering what the impact of the Brexit would be to their portfolios.
Despite the market volatility that followed the Brexit vote, many asset classes finished the second quarter with solid results. The S&P 500 index finished the quarter up 2.46%, less than 2% below its all-time high set last year. Stock market returns had a volatile end to the quarter as the S&P 500 dipped more than 5% in the two days following the Brexit vote before making a solid recovery to close the quarter. U.S. small and mid-cap stocks also posted gains in the second quarter, each finishing up more than 3%. The MSCI EAFE index, which tracks international mid and large cap stocks, ended the quarter down only 1% after falling by 10% in the two-day selloff following the Brexit vote. Emerging market stocks finished up 0.66% for the quarter.
Energy, telecom, and utilities led all sectors in the second quarter, each posting a return above 6% for the quarter. The combination of increased demand and supply shortages helped bolster the energy sector while investors continued to aggressively purchase stocks with stable, attractive dividends in the telecom and utility sectors. The financial sector has been the worst performing sector year-to-date down over 4% as bank profit margins continue to be squeezed by the persistent low interest rate environment.
The Brexit news and its accompanying uncertainty provided a boost to bonds as investors piled into high quality bonds as a safe haven to riskier asset classes. 10 year treasury yields finished the quarter near historical lows at 1.49%, down from 1.83% to start the quarter. The Barclay’s U.S. Aggregate Bond Index, which is comprised of higher quality investment grade bonds, finished up 2.21% for the quarter. High yield bonds, which carry greater risk than investment grade bonds, also finished up 3.6% despite pressure from the Brexit event.
Some investors may be tempted to speculate that U.S. interest rates cannot go much lower. Bond yields in Switzerland, Germany, and Japan (just to name a few) would suggest that to be a false assumption as interest rates in these countries are either near 0% or negative. Bonds with negative yields will return less money to the investor at maturity than what the investor originally invested. As of June 30th, an astounding 77% of global sovereign debt yielded less than 1% with almost half of that debt carrying a negative yield. Central banks across the globe continue to use all the levers at their disposal to keep interest rates low (or negative) in hopes of igniting their respective economies and avoiding recessions. These accommodative policies have also served as catalysts of support for the equity markets, at least to this point. Ultimately, these low rates continue to make U.S. interest rates attractive to global investors, which puts continued pressure on U.S. bond yields.
The quarter that began with a question of how soon the Fed would move to raise interest rates again finished with renewed uncertainty that has the market expecting the Fed to keep rates unchanged into 2017. While equity markets have recovered nicely following the Brexit turmoil, there is still considerable uncertainty among investors as illustrated by the continued outperformance of so-called safe haven assets such as treasury bonds, commodities, and Japanese yen. As the third quarter begins, investors will turn their attention to second quarter earnings season. Despite improved consumer strength on the heels of stronger wages and declining energy prices, the market will be seeking to break a string of four consecutive quarters of declining corporate profits. Meanwhile, investors will continue to pay close attention to the uncertainty surrounding Brexit and how it may impact future growth and corporate earnings in the EU, the UK, and their trading partners across the globe.
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