Market Analysis - Fall, October 2015
DIS and DAT - Market Analysis, October 2015
The ultimate authority must always rest with the individual's own reason and critical analysis.
This too shall pass
In this section a few news items which have moved markets will be discussed. As time passes, hopefully this section will serve as a reminder that the world keeps spinning as we try avoiding the “chicken little” thought pattern. In the third quarter of 2015, a focus was placed on the interest rate policy of the Federal Reserve. Will they raise or will they hold. Previous indications that they would most likely raise rates by now had caused longer term rates to rise. This in turn caused the dollar to increase relative to other currencies. Whether directly related or not; the Chinese stock market experienced a large fall and investors, speculators, and others sold international, and commodities anticipating much slower growth. So far this has held the Federal Reserve from increasing short term interest rates.
Now we turn to a review of the general investment fundamentals. According to the Bureau of Labor Statistics (www.bls.gov) the core (ex food and energy) inflation rate increased 1.8% and the headline increased 0.2% for 12 months ending August. The food index increased 1.6% while the energy index declined 15% for the last year. The five year average inflation rate is 1.72%. For purposes of analysis, using 2.0% inflation seems reasonable, given the Federal Reserve’s desire and related actions of reflation. While the Fed has not had much luck creating inflation, that is ultimately their end goal. From Value line selection and opinion (www.valueline.com) we find 90 day T-bill yields are 0.01%, which is slightly lower than the 0.03% a year ago. “A” rated industrial corporate bond yields are basically where they were a year ago at 4.26%. In our view, the required return on equity would be about 8.0% to be worth book value, using the 2% inflation. JP Morgan guide to the markets reports the SP500 index of stocks ended with a return on equity of 15.9%, and a price to book value of 2.4, meaning stocks are basically fairly valued. As of September 30th, SP500 has an earnings yield of 6.6% and the 10 year treasury yields 2.06%, which has widen a little as both stocks and yields have pulled back from their June 30th levels.
Thoughts and comments on asset classes
The 3rd quarter of 2015 produced volatility not seen in many years, as investors began to price in a China slowdown and the Federal Reserve eventually raising interest rates. Major US indexes, which had their first 10% correction and worst quarterly performance since 2011, now sit negative for the year. It was a typical “risk-off” quarter as International, Small Caps, and Commodities were hit the hardest, and credit spreads widen to their highest spread since the end of 2012.
The flight to safety was seen across all asset classes. In the US equity markets, Consumer Staples and Utilities vastly outperformed the index, while economically sensitive sectors like Energy and Materials were down sharply. Looking internationally, Emerging Markets, specifically China and Brazil, were hit the hardest. As for the Bond market, US Treasuries were the best performing sector, while High Yields, Leverage Loans, and Emerging Market Debt were the underperformers, continuing the “risk-off” trend.
Taking a broad view of the investment world, International still look to offer more value compared to US stocks. While price volatility could continue, the pull back in commodities might provide an intriguing entry point looking out several years. As for Bonds, between the flattening of the yield curve and low Real Yields after inflation, it is we lean toward keeping your duration short for now, with the possibility of seeing higher yields further down the road.
Going into the 4th Quarter, US Equities, gauged by the S&P, are on pace for their first negative year since 2008. Only time will tell if US equities can finish 2015 strong and keep the streak alive. We look forward to providing you with a DIS and DAT year-end review in January 2016. Until then, we appreciate your time and the opportunity to share with you our investment thoughts. We strive with our communications to add to our clients understanding of our investment management thoughts, which we hope will help improve longer term performance. You can submit questions to firstname.lastname@example.org.
We appreciate your time and will talk to you again soon,
Reggie McFadden, CFA
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All indexes are unmanaged and an individual cannot invest directly in an index. Index returns do not include fees or expenses. (JPM: Guide to the Markets)
The S&P 500 Index is widely regarded as the best single gauge of the U.S. equities market. This world-renowned index includes a representative sample of 500 leading companies in leading industries of the U.S. economy. Although the S&P 500 Index focuses on the large-cap segment of the market, with approximately 75% coverage of U.S. equities, it is also an ideal proxy for the total market. An investor cannot invest directly in an index (JPM: Guide to the Markets)
The Russell 2000 Growth Index® measures the performance of those Russell 2000 companies with higher price-to-book ratios and higher forecasted growth values. (JPM: Guide to the Markets)
The Russell 2000 Value Index® measures the performance of those Russell 2000 companies with lower price-to-book ratios and lower forecasted growth values. (JPM: Guide to the Markets)
The MSCI®EAFE (Europe, Australia, Far East) Net Index is recognized as the pre-eminent benchmark in the United States to measure international equity performance. It comprises 21 MSCI country indexes, representing the developed markets outside of North America. (JPM: Guide to the Markets)
The Barclays Capital U.S. Aggregate Index represents securities that are SEC-registered, taxable, and dollar denominated. The index covers U.S. investment grade fixed rate bond market, with index components for government and corporate securities, mortgage pass-through securities, and asset-backed securities. These major sectors are subdivided into more specific indexes that are calculated and reported on a regular basis. (JPM: Guide to the Markets)
The Dow Jones-UBS Commodity Index is composed of futures contracts on physical commodities and represents 22 separate commodities traded on U.S. exchanges, with the exception of aluminum, nickel, and zinc. (JPM: Guide to the Markets)
The spot price for gold bullion is determined by market forces in the 24-hour global over-the-counter (OTC) market for gold. The OTC market accounts for most global gold trading, and prices quoted reflect the information available to the market at any given time. (Ishares)
XOM is the common stock symbol of ExxonMobil Corporation that trades on the exchange