Volatility in 140 Characters (or Less)
Welcome to 2017 and the new era of Presidential communication where fully articulated thoughts are difficult to express in 140 characters or less.
This quarter’s discussion is not meant to be political in nature but explain the nature of political influence in the markets. Perhaps the most important thing to know and remember is that markets (meaning the millions of investors investing trillions of dollars) really like stability and/or predictability. There is always increased uncertainty leading up to an election, as the outcome is unknown. Once the outcome is known, regardless of what the outcome is, the markets often respond favorably to the relative certainty, or the reduction of uncertainty. The U.S. stock market tends to be politically indifferent.
As such, it is not surprising that the stock market has risen since the election. There are clearly disappointed people across the country, but markets tend to respond to future prospects for the economy, employment growth and corporate profits in an distinctly unemotional way. President Trump’s proposals for deregulation, tax cuts and new trade policies will undoubtedly influence the domestic and international business landscape. However, the markets are also now impacted by sudden, unexpected, and vague pronouncements, praises and condemnations that are broadcast via Twitter at random hours throughout the day. On any given day, an individual company may find itself under the Presidential gaze and either be denounced or praised for product costs, hiring plans or other business issues. The probability of increased market volatility rises the more frequent and targeted the tweet. So far, companies that have been negatively targeted, such as Boeing, Lockheed Martin, Macy's and Apple, have seen the negative effects to be relatively short-lived, but the unknown risk remains.
Beyond Presidential influences, the risk of increased volatility may also be attributable to the current state of the market which, by many measures, is quite expensive amid a gradually strengthening economic backdrop. The climbing stock market and the rise in interest rates both speak to future expectations of economic growth and may potentially result in inflationary pressures.
While historical data cannot tell us about the future, it does give us information about trends and where we are in relation to the past. The graph below shows the Shiller Price/Earnings (P/E) Ratio, which was developed by Robert Shiller, a Nobel Laureate in Economics from Yale University. This ratio measures the relative "expensiveness" of the stock market going back to the late 1800s. The current stock market valuation is roughly in line with the value prior to the housing crash in 2008 and is higher than any other time outside of the Great Depression and the Technology bubble of the late 1990s. This could resolve itself in one of two ways: prices decline and/or corporate profits rise until we are closer to historic averages.
Why do I find this historical data so interesting? It provides interesting context for the new era of Presidential communications. When markets and economic conditions differ from historic averages, and you layer in unexpected surprises from a highly vocal public figure (President, Federal Reserve Official, Foreign Leader, etc.), it can lead to higher than normal market volatility. As for the kind, speed and degree of change… If only I had a little birdie on my shoulder telling me what will happen next… tweet tweet.
While volatility cannot be eliminated, one benefit of being a disciplined, long-term investor with a diversified portfolio is that unexpected change is already anticipated within your investment holdings.
Below you’ll find a snapshot of some top-line economic indicators, followed by the Quarterly Market Review.
Data source: Trading Economics. 2017.
Fourth Quarter 2016 Index Returns
Past performance is not a guarantee of future results. Indices are not available for direct investment. Index performance does not reflect the expenses associated with the management of an actual portfolio. Market segment (index representation) as follows: US Stock Market (Russell 3000 Index), International Developed Stocks (MSCI World ex USA Index [net div.]), Emerging Markets (MSCI Emerging Markets Index [net div.]), Global Real Estate (S&P Global REIT Index), US Bond Market (Barclays US Aggregate Bond Index), and Global Bond ex US Market (Citigroup WGBI ex USA 1−30 Years [Hedged to USD]). The S&P data are provided by Standard & Poor's Index Services Group. Russell data © Russell Investment Group 1995–2016, all rights reserved. MSCI data © MSCI 2016, all rights reserved. Barclays data provided by Barclays Bank PLC. Citigroup bond indices © 2016 by Citigroup.
World Stock Market Performance
MSCI All Country World Index with selected headlines from Q4 2016
These headlines are not offered to explain market returns. Instead, they serve as a reminder that investors should view daily events from a long-term perspective and avoid making investment decisions based solely on the news.
Graph Source: MSCI ACWI Index. MSCI data © MSCI 2016, all rights reserved.
It is not possible to invest directly in an index. Performance does not reflect the expenses associated with management of an actual portfolio. Past performance is not a guarantee of future results.
World Asset Classes
Fourth Quarter 2016 Index Returns (%)
Looking at broad market indices, the US outperformed both non-US developed and emerging markets during the quarter. US and non-US real estate investment trusts (REITs) recorded negative returns and lagged the US and non-US equity markets.
The value effect was positive in the US, non-US, and emerging markets. Small caps outperformed large caps in the US and developed markets outside the US but underperformed in emerging markets.
Past performance is not a guarantee of future results. Indices are not available for direct investment. Index performance does not reflect the expenses associated with the management of an actual portfolio. The S&P data is provided by Standard & Poor's Index Services Group. Russell data © Russell Investment Group 1995–2016, all rights reserved. MSCI data © MSCI 2016, all rights reserved. Dow Jones data (formerly Dow Jones Wilshire) provided by Dow Jones Indexes. Barclays data provided by Barclays Bank PLC.
Real Estate Investment Trusts (REITs)
Fourth Quarter 2016 Index Returns
US and non-US REITs had negative performance for the quarter, lagging the broad equity market in both regions.
Past performance is not a guarantee of future results. Indices are not available for direct investment. Index performance does not reflect the expenses associated with the management of an actual portfolio. Number of REIT stocks and total value based on the two indices. All index returns are net of withholding tax on dividends. Total value of REIT stocks represented by Dow Jones US Select REIT Index and the S&P Global ex US REIT Index. Dow Jones US Select REIT Index used as proxy for the US market, and S&P Global ex US REIT Index used as proxy for the World ex US market. Dow Jones US Select REIT Index data provided by Dow Jones ©. S&P Global ex US REIT Index data provided by Standard and Poor's Index Services Group © 2016.
Select Country Performance
Fourth Quarter 2016 Index Returns
Italy and the US recorded the highest country performance in developed markets, while Belgium and New Zealand posted the lowest returns for the quarter. In emerging markets, Russia and Greece posted the highest country returns, while Turkey and Egypt recorded the lowest performance.
Past perfomance is not a guarantee of future results. Indices are not available for direct investment. Index performance does not reflect the expenses associated with the management of an actual portfolio. Country performance based on respective indices in the MSCI World ex US IMI Index (for developed markets), Russell 3000 Index (for US), and MSCI Emerging Markets IMI Index. All returns in USD and net of withholding tax on dividends. MSCI data © MSCI 2016, all rights reserved. Russell data © Russell Investment Group 1995–2016, all rights reserved. UAE and Qatar have been reclassified as emerging markets by MSCI, effective May 2014.
Fourth Quarter 2016 Index Returns
Interest rates rose in the fourth quarter. The yield on the 5-year Treasury note was up 79 basis points (bps) to 1.93%. The 10-year T-note yield climbed 85 bps to 2.45%. The 30-year Treasury bond yield added 74 bps to close at 3.06%.
In 2016, the short end of the yield curve saw the greatest rate increases. The 1-year T-bill gained 20 bps to 0.85%, while the 2-year T-note finished at 1.20% after an increase of 14 bps for the year.
In terms of total returns, short-term corporate bonds declined 0.18% during the quarter but gained 2.36% for the year. Intermediate corporates fell 1.84% during the quarter but rose 4.04% in 2016. Short-term municipal bonds declined 1.07% for the quarter but increased 0.07% for the year. Intermediate-term municipal bonds fell 3.74% for the quarter and 0.45% for the year. Revenue bonds outperformed general obligation bonds for the year.
Past performance is not a guarantee of future results. Indices are not available for direct investment. Index performance does not reflect the expenses associated with the management of an actual portfolio. a. Bloomberg Barclays US Corporate Bond Index. b. Bloomberg Barclays Municipal Bond Index. Yield curve data from Federal Reserve. State and local bonds are from the Bond Buyer Index, general obligation, 20 years to maturity, mixed quality. AAA-AA Corporates represent the Bank of America Merrill Lynch US Corporates, AA-AAA rated. A-BBB Corporates represent the Bank of America Merrill Lynch US Corporates, BBB-A rated. Bloomberg Barclays data provided by Bloomberg. US long-term bonds, bills, inflation, and fixed income factor data © Stocks, Bonds, Bills, and Inflation (SBBI) Yearbook™, Ibbotson Associates, Chicago (annually updated work by Roger G. Ibbotson and Rex A. Sinquefield). Citigroup bond indices © 2016 by Citigroup. The BofA Merrill Lynch Indices are used with permission; © 2016 Merrill Lynch, Pierce, Fenner & Smith Incorporated; all rights reserved. Merrill Lynch, Pierce, Fenner & Smith Incorporated is a wholly owned subsidiary of Bank of America Corporation.
This report was prepared by Gregory Saliba.
President, Taurus Capital Management
20 years in Corporate Finance, Debt Capital Markets and Investment Management
2010 Oregon Ethics in Business Award Recipient
Public Speaker on Risk, Behavioral Finance and Ethics
Finance Faculty Member (12 years)
Willamette University, Atkinson Graduate School of Management
Portland State University, School of Business Administration
Extensive Community Involvement