This year’s price action feels a bit like a bear market. The “Brexit” vote in the UK, the dismal first few days of the year, and increased volatility across the board. Yet, the second quarter of 2016 eked out small positive returns for many of the U.S. market indices, and most of them are showing positive gains over the first half of the year 6/30. On the first day of July, the Dow, S&P 500 and Nasdaq indices were all higher than they were before the Brexit vote. Panic sellers locked in losses and the ensuing two-week period 6/30-7/15 – saw many stock indices rise sharply. Short-term guesswork on market prices is a losing game.

q2 2016

I know, your international investments are down right now (and over the past few years), but eventually, you can expect them to come to the rescue when the American bull market finally turns. Markets price in bad news (sometimes over and over). Often they overreact. They aren’t perfect over short-time periods but they have shown themselves to be much more prescient than money managers, fearless forecasters, and the talking heads on CNBC or Bloomberg.

When will international markets turn?  As soon as my crystal ball has 20-20 foresight, you’ll be the first to know! In the meantime, we’ll face periodic surprises headline by headline, be it Bastille Day turmoil, a Turkish coup, or San Bernardino. The last century has seen all these and more and yet capitalism and human progress has moved on an upward path.

Interest rates have stayed low, helped by some of these headlines. Again confounding prognosticators who have been expecting significant rate rises for more than half a decade now.  The Bloomberg U.S. Corporate Bond Index is yielding 2.88%, while the Bloomberg U.S. Treasury Bond Index is yielding 1.11%%.  US Treasury yields are stuck near the bottom of historical rates; 3-month notes yielded 0.26% at the end of the quarter, while 12-month bonds were yielding just 0.43%.  Go out to ten years, and you can get a 1.47% annual coupon yield.  Low?  Compared with rates abroad, these yields are positively generous.  If you’re buying the German Bund 10-year government securities, you’re receiving a guaranteed -0.13% yield.  The 5-year yield is actually worse: -0.57%.  Japanese government bonds are also yielding -0.3% (2-year) to -0.23% (10-year).

There will be plenty of other opportunities for panic in a future where terrorism, a continuing mess in the Middle East, a refugee crisis in Europe and premature announcements of the demise of the European Union will deflect attention away from what is actually a decent economic story in the U.S.

How decent?  The American economy is on track to grow at a 2.0% rate this year. Not great, but appears sustainable and not likely to overheat different sectors and lead to a recession.  Manufacturing activity is expected to grow 2.6% for the year based on the numbers so far, and the unemployment rate has fallen to 4.7%, below the Federal Reserve target.  Inflation is also low: running around 1.4% this year.

The unemployment statistics are misleading in the sense that wages remain stubbornly low. But for many Americans, there’s work if you want it.  Historically low oil prices and high domestic production have lowered the cost of doing business and the cost of living across the American economic landscape.

Of course, questions remain.  The biggest one in many peoples’ minds is: will the European Union break up post-BREXIT? New talk in the air about a GREXIT, and some others….. dePartugal, the Czechout, the Big Finnish……with active political movements in at least a dozen Eurozone countries agitating for an exit, perhaps one day we’ll view the UK as the first domino?

What about asking this question: will BREXIT talk catalyze a fix to what was a flawed system that didn’t encourage or enforce accountability on all its members?

Thomas Friedman of Geopolitical Futures suggests that the EU is going to have to reform itself, and the vote in Britain could be the wake-up call it needs to make structural changes.  The Eurozone has been struggling economically since the common currency was adopted.  It is still dealing with the Greek sovereign debt crisis, a potential banking crisis in Italy, economic troubles in Finland, political issues in Poland, and a huge wealth disparity between its northern and southern members.  Is it possible that a flood of regulations coming out of Brussels is imposing an added burden on European economies?  Should different nations be allowed to manage their policies and economies with greater independence and focus?

Friedman thinks the UK will be just fine, because Europe needs it to be a strong trading partner.  Britain is Germany’s third-largest export market and France’s fifth largest.  Would it be wise for those countries to stop selling to Britain or impose tariffs on British exports?  And more broadly, with the political turmoil in the UK, is it possible that there will be a re-vote, particularly if the European Union decides to make reforms that result in a less-stifling regulatory regime?

The future ain’t what it used to be: Bad news sells. You’ll continue to see dire headlines, if not about Brexit or the Middle East, then about China’s debt situation and the Fed either deciding or not deciding to raise rates in the U.S. economy.  Oil prices are going to bounce around unpredictably – Exxon Mobile’s, CEO said confidently that the price of oil will be somewhere between $20-$120 per barrel!

Your investment success is determined by the mix that we have designed for you and your planning and investment time horizon.  Keeping the mix consistent with your goals is an important discipline that helps guide your strategy through the emotions that often accompany the roller coaster ride in financial markets.

Sources:

Morningstar

Aggregate corporate bond rates: https://indices.barcap.com/show?url=Benchmark_Indices/Aggregate/Bond_Indices

Aggregate corporate bond rates: http://www.bloomberg.com/markets/rates-bonds/corporate-bonds/

http://useconomy.about.com/od/criticalssues/a/US-Economic-Outlook.htm

http://www.marketwatch.com/story/first-quarter-us-gdp-raised-to-11-2016-06-28?siteid=bulletrss

DISCLOSURE: Investors cannot invest directly in an index. These unmanaged indexes do not reflect management fees and transaction costs that are associated with some investments. Past performance does not guarantee future performance. All investments are subject to risk, including possible loss of the money you invest. Diversification does not guarantee profit or protect against a loss. Nothing herein or elsewhere on this site constitutes investment, legal, or tax advice. Please see the Disclosure link at the bottom of the page: www.compoundvalue.com/disclosure/. 

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