Third Quarter Market Review

Global equities generated a mid-single digit return in the third quarter, with developed international equities outperforming domestic stocks, and small capitalization stocks outperforming larger capitalization equities.  One of the best performers this quarter was emerging market stocks, as concerns of a hard landing in Chinese real GDP growth and strong US dollar headwinds proved to be overblown.chart1

During the quarter, US interest rates remained in a fairly tight range, as the 10-year Treasury ended the quarter at a yield of 1.60%. As stated last quarter, central banks globally have embraced the idea of easy monetary policy, so much so that one-third of all sovereign debt generates yields below zero and almost three-fourth’s of all government debt yields under one percent.

On the macroeconomic front, the Federal Reserve once again refrained from raising interest rates during their two day meeting in September, leaving markets eyeing the November and December meetings as possible dates for an interest rate hike.  The Fed has acknowledged that although global growth remains lackluster at best, the US economy continues to move in a sort of Goldilocks fashion–not too hot and not too cold. This quarter saw reports of mixed regional manufacturing data, slowing auto sales, paltry retail sales figures, and an abrupt slowdown in new home sales.  On the flip side, continued tightness in the US labor market is a positive for inflation expectations, consumer confidence is at its highest reading since before the Great Recession, and consumer expenditures are trending higher going into the holiday season.  All eyes will continue to be focused on the Federal Reserve as we move into the fourth quarter.

Interest Rates: Volatility Redux

You have probably heard the old adage, “Sell In May And Go Away”, whereby investors are wise to side-step the summer’s market volatility, only to become more engaged in the market as the seasons change.  As catchy as it sounds, we never advise investors to subscribe to this bit of folksy market-timing.  In fact, this would have been a fruitless exercise given the lack of volatility in the equity markets over the summer.

Let’s use some numbers to bring this volatility point to life.  From mid-July until early September, the S&P 500 went 42 trading days without a market move greater than or less than 1%.  To put this docile quarter into historical context, Convergex, a global brokerage company, state that since 1971, there has been an annual average of 62 trading days a year where the index moves above or below 1%[i].  Year to date, we have had just 43 of these days.

cartoon-10-2016So what’s behind the lack of volatility?  Investor complacency seven years into a bull market?  Summer’s general malaise?  Maybe, but doubtful in our opinion.  We think there’s no coincidence that the low level of interest rates, and the Federal Reserve’s inaction on raising rates, is a big part of the reason.  Markets love certainty.  However, the questions of who will be the next President and when the Fed will raise interest rates leads us to believe volatility will likely move higher and towards more historic levels over the coming year.

It seems as though good news with the economy can be viewed as bad news for the stock market, as though the United State’s low interest rates (punch bowl) will be taken away from the party as soon as interest rates rise.  If you’ve ever wondered why good macroeconomic news can make the stock market go down, this is largely the culprit.  Confusing we know.

Politicians change.  Interest rates, volatility and markets change.  But as we can see from the timeless 35 year old cartoon from The New Yorker above, the more things change, the more they seem to stay the same.  Experience observing and investing through market cycles leads us to believe that market volatility is not to be feared but rather provides opportunities.  At Madison, we purposely structure globally diversified portfolios to help withstand higher or lower interest rates, changing volatility, and the outcomes of Presidential elections.

[i] Colas, Nicholas (August, 28th, 2015). Convergex, Tell ‘Em That It’s Human Nature

Important Note: This material is for informational purposes only and is not intended to serve as a substitute for personalized investment advice or as a recommendation or solicitation of any particular security, strategy or investment product. Actual economic or market events may turn out differently than as presented above.