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Quarterly Market Review: Q1 2017

April 20, 2017

 

Selling $4.5 Trillion Worth of Something? 

 

While the Federal Reserve Bank has been inching up interest rates, with two more raises expected by the end of the year, there’s another, less talked about factor that could also contribute to rising interest rates. The Federal Reserve bought up a whopping $4.5 trillion worth of bonds during the Great Recession that it will be looking to sell in the coming years.

Typically, when the Federal Reserve wants to stimulate the economy, it lowers the Federal Funds rate, the rate at which banks lend to each other overnight. However, the mortgage market collapse and related economic downturn in 2008 and 2009 created such turmoil and risks to the overall financial system that many were concerned that lowering short-term interest rates to essentially zero was not going to be enough to fend off further economic distress. As a result, the Fed instituted an experimental new monetary policy, called Quantitative Easing, where it bought up billions of dollars of bonds each month to keep bond prices high and interest rates low.

 

The Fed took these actions to stimulate new buying and refinancing activity so that mortgage holders could refinance at lower rates and free up cash flow with which to purchase goods or reduce debt. As the Fed bought bonds and mortgage debt each month to act as a constant buyer, this amount increased over time. At its peak, the Federal Reserve was buying $80 billion of bonds and mortgages per month to keep interest rates as low as possible. The blue line in the graph below shows the purchases in relation to the S&P 500.

All of those purchases now amount to a monumental $4.5 trillion dollar portfolio of bonds that the Federal Reserve would like to sell off, now that the economy is stronger. The logical question then becomes: “If the purchase of $4.5 trillion of mortgages and bonds helped keep interest rates low, does it not stand to reason that the SALE of $4.5 trillion of mortgages and bonds will cause interest rates to rise?” It’s a possibility. Going back to economics class, it is a typical supply and demand situation. If supply exceeds demand, the price of bonds will drop and interest rates will go up to the point that investors feel they are earning an adequate return for the given risks.

 

Why does it matter? Rising rates act as a dampener to the economy, and if the sell off is not handled appropriately, it could inhibit the growth of our economy. Of course, we don’t know what the demand will be. We do know that the Fed is not going to sell all $4.5 trillion in bonds at once; right now, their plan is to sell off $2 trillion by 2020.

 

While it’s something to be aware of, let me also put it in perspective. Though $4.5 trillion sounds like a lot – and it is – it’s not quite as overwhelming on a relative scale. The U.S. financial market consists of about $90 trillion of assets, so compared to the overall market, $4.5 trillion is a relatively small amount. While we don’t know what the demand will be, it will be something to watch. The market should be able to absorb it, especially in a stronger economic environment like we have now, making the sale of the bonds less of an event than the $4.5 trillion dollar figure may indicate.

 

We’ll have to wait and see, but the numbers alone are certainly eye-catching.

 

Economic Indicators at a Glance

 

Below you’ll find a snapshot of some top-line economic indicators, followed by the Quarterly Market Review. 

Data source: Trading Economics. 2017.

Market Summary
First Quarter 2017 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 1995–2017, all rights reserved. MSCI data © MSCI 2017, all rights reserved. Barclays data provided by Barclays Bank PLC. Citigroup bond indices © 2017 by Citigroup.

World Stock Market Performance

MSCI All Country World Index with selected headlines from Q1 2017

 

 

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 2017, 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

First Quarter 2017 Index Returns (%)

 

Looking at broad market indices, emerging markets outperformed both U.S. and non-U.S. developed markets during the quarter. Real estate investment trusts (REITs) lagged their equity market counterparts.

 

The value effect was negative in the U.S., non-U.S., and emerging markets. Small caps outperformed large caps in emerging markets and non-US developed markets but underperformed in the U.S.

 

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 1995–2017, 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.

 

U.S. Stocks 

First Quarter 2017 Index Returns

 

The broad U.S. equity market recorded positive absolute performance for the quarter. Value underperformed growth indices across all size ranges. Small caps underperformed large caps.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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: Marketwide (Russell 3000 Index), Large Cap (Russell 1000 Index), Large Cap Value (Russell 1000 Value Index), Large Cap Growth (Russell 1000 Growth Index), Small Cap (Russell 2000 Index), Small Cap Value (Russell 2000 Value Index), and Small Cap Growth (Russell 2000 Growth Index). World Market Cap represented by Russell 3000 Index, MSCI World ex USA IMI Index, and MSCI Emerging Markets IMI Index. Russell 3000 Index is used as the proxy for the US market. Frank Russell Company is the source and owner of the trademarks, service marks, and copyrights related to the Russell Indexes. MSCI data © MSCI 2017, all rights reserved.

 

Real Estate Investment Trusts (REITs)

First Quarter 2017 Index Returns

 

Real estate investment trusts (REITs) lagged their equity market counterparts.

 

 

 

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 © 2017.

Select Country Performance

First Quarter 2017 Index Returns

 

In U.S. dollar terms, Spain and Singapore recorded the highest country performance in developed markets, while Canada and Norway returned the lowest performance for the quarter. In emerging markets, India and Poland posted the highest country returns, while Greece and Russia returned 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 2017, all rights reserved. Russell data © Russell Investment Group 1995–2017, all rights reserved. UAE and Qatar have been reclassified as emerging markets by MSCI, effective May 2014. 

Fixed Income

First Quarter 2017 Index Returns

 

Interest rates were mixed across the U.S. fixed income market during the first quarter of 2017. The yield on the 5-year Treasury note was unchanged, ending at 1.93%. The yield on the 10-year Treasury note decreased 5 basis points (bps) to 2.40%. The 30-year Treasury bond yield decreased 4 bps to 3.02%.

 

The yield on the 1-year Treasury bill rose 18 bps to 1.03%, and the 2-year T-note yield increased 7 bps to 1.27%. The yield on the 3-month T-bill increased 25 bps to 0.76%, while the 6-month T-bill yield rose 29 bps to 0.91%.

 

Looking at total returns, short-term corporate bonds gained 0.69% and intermediate-term corporate bonds gained 1.16%.

 

Short-term municipal bonds generated a total return of 1.20%, while intermediate-term municipal bonds returned 1.91%. Revenue bonds performed in line with general obligation bonds.

 

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 © 2017 by Citigroup. The BofA Merrill Lynch Indices are used with permission; © 2017 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.

 

Gregory Saliba

President, Taurus Capital Management

saliba@tauruscap.com

(503) 756-2972

 

 

 

 

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

 

 

 

 

 

 

 

 

 

 

 

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