Quarterly Market Update

The end of the second quarter provides a good opportunity to review what happened the first half of the year and to share some insight into our plan for the rest of the year.

Let's start with a general review of the markets to date. Before looking at individual asset categories, there is one overall market note. The Greek debt situation is coming to a head with negotiations coming down to the wire. Will Greece exit the Euro zone or will they reach a deal? The uncertainty surrounding this question triggered a selloff in late June into July both domestically and internationally. In addition, the Chinese stock market woes did not help as the Shanghai composite shed 32 percent from its June 12th high. That said, here are some additional highlights for the first half:

    -The broader U.S. market moved sideways the first half of the year with a fair amount of volatility. The U.S. total stock market indexes posted less than 2 percent gains in the first half.

    -The Greek selloff in June and July affected international stocks more than U.S. stocks. But even with the larger giveback, international stocks still drove performance in the first half of the year.

    -As expected, fixed income was a drag on returns. Interest rates rose in the second quarter in anticipation of a Federal Reserve rate hike that likely will come in the fall. The rising rates caused the year-to-date returns for U.S. aggregate bond indexes to end in negative territory at the end of the second quarter.

    -In terms of S&P 500 sectors, health care finished the second quarter with the strongest returns, up almost 10 percent for the year. Energy was the worst performing sector in the second quarter with nearly a 6 percent decline.

Looking forward, here is what to expect:

    -We will keep our current allocation to international stocks and may increase our exposure when the Greek situation has more clarity. A Greek exit from the Euro zone will roil the markets, but after the drama passes, the European markets should recover and move upward as the European economy continues to strengthen.

    -Domestic stocks remain more expensive than international stocks. We believe that the best opportunities this year will continue to be in small- and mid-cap stocks as well as in three sectors.

    -The financial sector of the S&P 500 has lagged the broader index over the past 5 years. As a result, it is relatively undervalued. As the economy continues to strengthen, so will loan activity which will enable banks to put near-zero-interest cash to work. Furthermore, higher interest rates will increase banks’ interest margins. Both developments would boost earnings.

    -Technology stocks have outpaced the broader index over the past 5 years. Although valuations are a little expensive, they are still reasonable based on expected growth. We believe technology stocks have momentum and that CFOs will allow hardware and software upgrades when they believe the economic recovery is on sound footing.

    -The health care sector has consistently outperformed the broader S&P 500 index the past five years, besting the broader index by 60% over that period. However, like technology, the sector generally has reasonable valuations when future growth is considered. We expect returns in the health care sector will be higher than the broader index, albeit more modest than the 20% annualized returns we have seen in the past. We expect that higher utilization and continued innovation should be able to overcome the headwinds created by implementing provisions of the Affordable Care Act and managing downward price pressure created by Medicare.

    -Fixed income will continue to be a drag on returns, but we need to hold an underweighted position to provide some buffer if there are large negative events in the stock market.

Please contact us if you have questions or would like to review your account’s performance.

Quarterly Market Update

We are a little more than a quarter of the way through 2015. Now is a good time for a general review of what has transpired in the markets so far this year:

    -Last year international equities were negative. This year, they are                beating U.S. equities by about double.

    -In the U.S. equity market, growth stocks are noticeably outperforming        value stocks.

    -Healthcare and biotech have been the best performing sector,                    exceeding both international and the overall U.S. markets.

    -Energy has bounced back somewhat after last year’s dramatic                    pullback, up around 10 percent year-to-date.

    -The worst-performing domestic sector has been utilities, down nearly        4 percent.

    -Bonds have given a positive return in the 1 to 2 percent range.

In thinking about where we are and where we are going, there are some key factors we will monitor closely throughout this year. Three of the more prominent factors are oil prices, unemployment, and interest rates.

The energy sector cratered last year as oil prices fell over 40 percent. Oversimplified, the growth in U.S. shale production along with production from other non-OPEC countries created a large supply while demand slowed. According to Exxon CEO, Rex Tillerson, we could see lower energy prices for the next three or four years. Lower energy prices should help consumers and those businesses not in the energy sector. Hopefully, it will help stimulate manufacturers in Europe and emerging markets. Of course, we will need to see if three to four years of lower oil are priced into energy stocks. However, there is an opportunity on a longer-term basis.

Probably the most important factor to watch is unemployment. The economy will not recover fully if unemployment persists. Eventually, the market will reflect the true conditions of the economy since it is difficult to generate profits when consumers lack jobs. Much progress has been made since the Great Recession ended. Unemployment claims have continued to drop in March, hitting a 15-year low. However, the seemingly good 5.5 percent unemployment rate may hide the true jobs picture in America. That is the opinion of economists David Blanchflower and Andrew Levin. The two men published a paper on March 19, 2015 in which they propose that the true unemployment rate, factoring in the underemployed and those who have given up looking, is likely between 7.4 to 9.4 percent. High and persistent unemployment will hamper economic growth and market returns.

Finally, all eyes will be on the Federal Reserve Board (the Fed), anticipating when the Fed will raise interest rates for the first time. At the April meeting, the Fed left the door open to a June rate hike if the data warrants. However, disappointing first quarter gross domestic product (GDP) of 0.2 percent (annualized) and inflation that remained well-below target point to a fall rate increase instead. When rate normalization does begin, it will probably be slow and measured. Fixed income will likely suffer negative returns. However, the damage can be kept in check if rates rise slowly. 

We should mention that the European Central Bank (ECB) has begun quantitative easing (QE), buying bonds by the billions. The QE will keep interest rates low. The 10-year German bund had an interest rate of under 0.1 percent a few weeks back (as compared to 2.2 for the U.S. 10-year Treasury). These low rates will keep downward pressure on U.S. Treasury rates and upward pressure on European equity markets. 

These, and other factors not discussed, lead us to the following outlook:

    -International equities in developed countries continue to look                      attractive with lower valuations, aggressive central bank action, and            lower energy prices. We are concerned about Greece and the effect a        Greek exit could have on European markets. 

    -While emerging market equities have very attractive valuations, we            have concerns that rising interest rates in the U.S. could roil EM equity        and bond markets. We are dealing with this uncertainty by holding              funds that allow the manager to take emerging market exposure.

    -Technology and healthcare long-term may underperform for a little,          but they still have a solid long-term story.

    -We are remaining underweight bonds because they are at all-time              highs with an imminent (although maybe not too soon) rate hike on the      horizon.