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Expert Perspective

News, research and market insights from our team of experts.

Investment e.Perspective

Current Issue | April 27, 2017

Second Quarter Review

By: Robert Schaefer, CFA, CFP®, Director, Investment Research & Oxford Investment Fellow


Six years into the global economic recovery, high debt levels and government intervention continue to exert their influence on financial markets. As the second quarter of 2015 came to a close:

  • Greece had defaulted on its debt and its banking system was largely shutdown.
  • The debt-fueled Chinese stock market was in a free fall and also largely shutdown.
  • Puerto Rico announced it lacked the resources to pay its debt and was seeking creditor relief.

Through it all, the stock market continued to climb the proverbial "wall of worry" – though just barely – eking out the slightest of gains for the quarter. This result still managed to best a weak bond market and several alternative investment categories – especially those emphasizing real assets and yield.

Sources: Morningstar Direct. US Large Cap (S&P 500), US Small Cap (Russell 2000), International Developed MSCI EAFE), Emerging Markets (MSCI EM), Cash (Citi Treasury 3 Month Bill), US Bonds (Barclays US Aggregate Bond), EM Bonds (JPM GBI EM Global Diversified), MLP’s(Alerian MLP), REITS (FTSE EPRA/NAREIT Developed), Hedge Funds(HFRX Global Hedge Fund), Natural Resource Equities (S&P N.A. Natural Resources), Commodities (Bloomberg Commodity)

Global Equities
With economic data showing signs of a modest rebound and first-quarter corporate earnings coming in better than feared, US equities continued to grind higher for much of the second quarter. Late in the quarter optimism gave way to fear as a European "Grexit" became a real possibility and a sudden reversal in Chinese stocks caught investors off guard. Similarly, international equities started the second quarter off strong (driven by continued quantitative easing in Europe and Japan) but experienced losses late in the period. Despite the recent weakness, international equities – developed and emerging – continue to outpace domestic stocks through the first half of 2015.

Fixed Income
Bonds weakened during the second quarter as the 10-year treasury yield climbed from 1.9% to 2.3%. The losses reversed gains during the first quarter, leaving the Barclays Aggregate Bond Index essentially flat through the first six months of 2015. Yields have also risen of late overseas, a sign that the deflationary scare from earlier this year is starting to abate. While fears of higher interest rates continue to run high among bond investors, we believe bond markets are likely to remain reasonably well supported as a result of slow global economic growth, continued monetary easing overseas and still-muted inflationary pressures.

Alternatives
Alternative investments generated mixed results for the quarter. Yield-oriented strategies were particularly weak, with MLPs and REITs both declining sharply. For some time we have been lightening up our exposure to these investments, recognizing the exceptional gains of recent years were unsustainable. Natural resource equities also continue to disappoint, with a combination of slowing demand (China) and excess supplies weighing on results. As usual, hedge fund investments varied widely based on the strategies and managers deployed.

Looking Forward
With Greece reaching a tentative deal with its creditors and the Chinese stock market showing signs of stabilizing, we expect investors' focus to shift squarely back to the Fed. At this point, interest rate "lift off" appears likely during the fourth quarter, perhaps as soon as September. Unlike some past periods of monetary tightening, the Fed will move patiently and cautiously. Periods of monetary tightening have often been unkind to investors, but there is no precedence for today's global monetary conditions. Our base case assumption calls for continued moderate economic growth. Below, we highlight our current portfolio positioning:

  • We are slightly underweight US equities. By most measures of value US equities are pricey. As equity valuations become extended they also become more risky, exposing investors to greater loss potential. We view the current equity underweight as a prudent "rebalancing" of risk, not an attempt to time the top. The bull market could stay in place for some time, though it is difficult to see large gains from these levels.
  • We continue to value fixed income investments for portfolio safety. With the Fed likely to move slowly, intermediate bond prices may prove surprisingly resilient. More importantly, fixed income is often the primary beneficiary of equity market stress.
  • We see long-term value in beaten up corners of the market, such as natural resource equities.While most equity classes have surged since the Financial Crisis and now look expensive, natural resource stocks have been battered by slowing Chinese demand and increasing commodity production. We see signs of supply and demand starting to rebalance, though the process could take time.
  • We continue to favor diversifying strategies such as hedge funds, unconstrained bonds and Asian fixed income. With traditional equity and fixed income strategies offering low return potential, diversification remains more important than ever.

The above articles represent the opinions of the authors as of 7.30.15 and are subject to change at any time due to market or economic conditions or other factors.