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Second Quarter 2016 Newsletter

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It’s Been Two Years and I’m Still Not Rich(er)!?

Perhaps you’ve noticed that your portfolio’s value hasn’t been doing anything special for several quarters.  And if you are paying attention to the Dow or S&P 500, you may be wondering why your portfolio hasn’t kept up.  To get some idea of what is happening, review Chart 1 below, which shows some cumulative asset class returns over the last two years.  (All charts courtesy of Yahoo! Finance.)

Chart 1

The blue line represents US Large Cap stocks, the red line shows US Small Cap stocks, and the green line shows all Global stocks not in the US (Global ex US).  In fact, from their high in 2014, Global stocks ex-US have been down over 25%, which of course means they have experienced a bear market (defined as at least a 20% pullback) over that time period.  

It helps to look at the bigger picture to fully understand what is happening.  See Chart 2 below.

Chart 2

Again, the blue line is US Large Cap stocks and the red is US Small Cap stocks.  The time period is from the low of the generational bear market (March 9, 2009) until last summer.  Note that US Small Cap stocks had an approximate increase of over 250% and US Large Cap stocks increased more than 175%.  Clearly, investors cannot expect a continuation of this kind of upward movement without some period of consolidation.  This can occur in two ways.  One is the way we have experienced it over the last couple years, as seen in Chart 1 above.   In this manner, the markets can work off overvaluation in a somewhat sideways pattern. 

Of course, there is a second, more painful way for a market to correct.  Chart 3 below shows the 2000-2002 bear market, when the S&P 500 Index fell over 45%.

Chart 3

Chart 4 below shows the infamous 2008-2009 bear market, when the S&P 500 fell 55%.  We certainly all remember that one, don’t we?

Chart 4

A properly diversified portfolio will not only own US Large Cap stocks.   We have often noted in this report that Large Cap stocks have one of the weaker long term performance records.  Value and Small equity asset classes both have better long term performance.  Adding foreign stocks, both in Developed and Emerging Market nations, also allows for additional diversification. 

Lastly, it is interesting to note that stock market valuations are currently much lower in most other countries compared to those in the US.  Valuations and earnings visibility/economic health are usually negatively correlated.  The worse off an economy and its companies’ earnings appear to be, the lower the valuation.  The only way to buy and own markets with low valuations is to own them during the times they deserve those low valuations. 

By owning a diversified portfolio of many different equity asset classes, and by rebalancing the portfolio when those asset classes vary too much from their desired amounts, we are giving your portfolio the greatest chance for maximum long term performance.  That is why it is unproductive to view your investment experience from a short term perspective. 

Chart 5 below shows that the longer you hold a diversified portfolio (this example uses a 60% equity/40% income model portfolio), the less chance of having disappointing total returns.  That is the true secret behind the success of disciplined, long term investors.

Chart 5

Does Brexit = Brecession = Brear Market?

By now, you are probably so sick of hearing and reading the word Brexit that you have sworn to never eat fish and chips again.  When Great Britain voted on Thursday June 23 to leave the European Union, global markets hemorrhaged the next day, and after having a weekend to review the situation, investors continued the massacre on the following Monday.  Stocks were dumped, the British Pound and Euro currencies had record one day losses, and both US Government bonds and gold gapped up in price.

This all took place despite these facts:

  • The formal “grand exit” will not occur for at least another two years. 
  • As the first ever EU exit and myriad issues to be resolved, the resulting time period will likely be much greater than two years.
  • Estimates show over 80% of the treaties currently enjoyed by EU members will be re-signed between the newly independent Great Britain and the EU.

We are not trying to say this was a non-event; it wasn’t.  But its real importance was not in the specific details of the breakup or the result thereof.  Rather, it was the potential for this same thing to happen among many other European countries who are currently members of the E.U.  Every country’s nationalist political party can now point to England when attempting to get enough votes to sever their relationship with the E.U.  There is good potential for the economies of many European countries to slow down and perhaps go back into a recession.  By the same token, both the British Pound and Euro have continued to sink, which should help their export growth at a time when they will really need it. 

Lastly, Brexit may ripple cross the Atlantic and come to roost here in America.  A majority of economists have determined that the anticipated raising of rates by the Federal Reserve later this month will not take place, and may dampen those prospects for the remainder of the year.  In addition, enjoying a very strong US Dollar is a double edged sword, which may hinder exports due to higher prices that accompany the stronger USD. 

But the final word on the subject has been dealt with by the markets themselves.  After  the Friday and Monday “lemmings off a cliff” reaction by all global markets, reason appeared to infiltrate the hysteria, and the next several days of market performance recouped the majority of that knee jerk selling experienced in the first two trading days after the news hit.  The bottom line – this will be a very long term event.  Given that time period, there will be many solutions to the initially perceived problems.  There will also be problems that occur that no one has even thought about.  Once again, this type of news oriented market reaction proves to be just another test to the resolve of a disciplined client.  We will continue to monitor world events and more importantly, we will look to manage those aspects of your portfolio that we can control.

Second Quarter 2016 Asset Class Returns

The second quarter was similar to the first, with positive but unspectacular returns from all domestic asset classes, and more spotty results from the International and Emerging Market regions.  The tepid returns belied the Brexit tumult that took place the last week of the quarter, which was discussed earlier in this report.  Real Estate securities continued their leadership position, both in this country and abroad.  The potential for its continued growth and relative yield advantage is proving a popular combination with investors.  Events which continue to push back the Federal Reserve’s plan to increase interest rates led to generous bond returns.

Walls of worry continue to exist. The anticipated slowdown in the European market, and potential attempts by other European counties to follow Brexit’s lead are big worries.  The US Presidential election is yet another political issue that has the ability to affect both domestic and global markets.  But there are also hopeful signs that economic growth is still available to well-run companies.  Interest rates still allow for dramatic debt consolidation for both individuals and corporations.   In addition, energy has bottomed and crude oil has almost doubled in price, insuring very favorable earnings comparisons for a sector that had been weighting down the entire market.

We will continue to manage your portfolio for a long term result, not allowing shorter term volatility to dissuade us from a disciplined approach to growing and conserving our clients’ capital.  In the meanwhile, enjoy the summer months, and buckle up for some political campaigning that is sure to make the 3rd quarter a most interesting one.


Frederick F. Kramer IV, JD
Chief Investment Officer