2016 Second Quarter Report: The Shadow of Brexit

It certainly feels like we are in a bear market with starting the year off so terribly, now the surprising “Brexit” vote in the UK, and increased volatility across the board. Therefore, it may come as a surprise that the second quarter of 2016 and year-to-date market indices generally show positive total returns. 
When you look at the global markets, you realize that the U.S. has been a haven of stability in a very messy world. The S&P 500 was up 2.46% over the second quarter and 3.84% on the year. 
Surprisingly to some, emerging markets stocks of less developed countries, as represented by the MSCI EM index, has held up quite well, returning 4% in the month of June and 6.41% YTD. 
The broad-based MSCI EAFE index of developed foreign economies – about half of which is in Euro-area markets – lost -3.36% in June and -4.42% YTD. 
Meanwhile, interest rates have trended lower, once again confounding many prognosticators who have been expecting significant rate rises for more than half a decade now. The phrase ‘lower for longer’ is now being commonly used to describe a likely continuing period of low rates. 
The recent slide in rates has been positive for bond returns in 2016 with the Barclay’s U.S. Aggregate Bond Index returning 5.31%. Yet, as prices increased, yields have lowered damping the expected returns for bond assets going forward. U.S. Treasury yields are stuck near the bottom of historical rates. Going out to ten years, you can get a 1.47% yield and a whopping 2.3% for thirty years. Compared with rates abroad, these yields are positively generous. If you are buying the German Bund 10-year government securities, you are receiving a -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).
Looking over the other investment categories, the decline in interest rates was very positive for real estate, which has been a haven in our low-yielding world. Commodities, as measured by the S&P GSCI index, gained 12.67% in the second quarter, giving the index a 9.86% gain for the year so far. The biggest mover, unsurprisingly, is Brent Crude Oil, which has risen more than 15% in price over the quarter.
On the first day of July, the S&P 500 index was higher than before the Brexit vote took investors by surprise, which suggests that, yet again, the people who let panic make their decisions lost money while those who kept their heads did better. 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, which is hardly dramatic, but it is 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%, which is actually below the Federal Reserve target. Inflation is also low: running around 1.4% this year. The unemployment statistics are almost certainly misleading in the sense that many people are underemployed, and a sizable number of working-age men are no longer participating in the labor force, but for many Americans, there is 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. 
Despite all this good news, the market is struggling to keep its head above water this year and is not threatening the record highs set in May of last year.  
Questions remain. The biggest one in many peoples’ minds is: will the European Union break up now that its second-largest economy has voted to exit. There is already renewed talk of a Grexit, along with clever names like the dePartugal, the Czechout, the Big Finnish and even discussion about Texas leaving the U.S. With active political movements in at least a dozen Eurozone countries agitating for an exit, it is possible that someday we will view the UK as the first domino.

A recent report by Thomas Friedman of Geopolitical Futures suggests that the EU, at the very least, 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, in general, a huge wealth disparity between its northern and southern members. 
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? 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.
You will 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. Another unforeseen crisis du jour may appear as well. 
The remarkable thing to notice is that with all the wild headlines we have experienced so far, plus the worst start to the year in U.S. market history, the markets are up slightly here in the U.S., and the economy is still growing. 
You should expect continued volatility and will need to stay disciplined.

To Your Prosperity,

Kevin Kroskey, CFP®, MBA

This article adapted with permission from BobVeres.com.
Sources :
Wilshire index data.  http://www.wilshire.com/Indexes/calculator/
Russell index data: http://indexcalculator.russell.com/
S&P index data: http://www.standardandpoors.com/indices/sp-500/en/us/?indexId=spusa-500-usduf--p-us-l--
Nasdaq index data: http://quicktake.morningstar.com/Index/IndexCharts.aspx?Symbol=COMP
International indices: http://www.mscibarra.com/products/indices/international_equity_indices/performance.html
Commodities index data: http://us.spindices.com/index-family/commodities/sp-gsci
Treasury market rates: http://www.bloomberg.com/markets/rates-bonds/government-bonds/us/
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/

Future Posts at www.TrueWealthDesign.com

Any future blog posts will be done at www.TrueWealthDesign.com . Thank you, Kevin Kroskey, CFP, MBA