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FORGEXIT

July 12, 2016
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FORGEXIT

For-gex-it: eternally blocking from one’s memory bank the grossly sensationalized summer media circus that was “Brexit” – Britain’s 2016 referendum on exiting the European Union (EU). Did it seem like “Brexit” went on forever? It did to me. The Brits voted to exit the EU last month, “politically” that is, but they had never adopted the Euro dollar anyway, always maintaining the British pound. Most experts believe a domino effect where other significant member countries opt out of the EU is unlikely, as Britain never really wanted to be in the Union in the first place. The vote was certainly a wake-up call for the EU, but a mass exodus at this point it probably is not. So, with the vote and aftermath hopefully behind us, I’m ready to “forgexit” and move on to the world’s next great sensationalized calamity … see Italy’s debt crisis, fall 2016 (Italexit).

What about stocks? While the stock market’s reaction to Brexit was nerve-wracking, dropping over 5% in two days, the S&P is once again pushing all-time highs. After several meaningful 2016 drawdowns and a seemingly endless number of negative headlines (Brexit, oil instability, corporate earnings woes, a very negative presidential campaign season, China’s slowdown, Federal Reserve interest rate policy uncertainty, etc.), the stock market has somehow stayed afloat with the S&P 500 closing Q2 up 4.06% year-to-date.

2016 Index and Asset Class Total Returns (Thru June 30)

S&P 500 = 4.06%    All-World (excluding U.S.) = -1.02%
Dow Jones 30 = 4.45%Emerging Markets = 7.26%
NASDAQ = -2.25%U.S. Bonds Aggregate = 5.53%
Mid Cap Value = 9.2%Bloomberg Commodities = 13.25%
Small Cap Growth = -1.1%Cash = 0.1%

Other Notable 2016 Total Returns/Price Changes (Thru June 30)

Utilities = 23.3%Gold = 26.42%
Financials = -3.5%Oil (WTI) = 32.0%
Energy = 16.6%    Real Estate Investment Trusts = 7.4%
Technology = -0.2%Corn = -1.43%
Healthcare = 1.0%Dollar per Euro = -1.83%

Speaking of calamities … the universal worry unnerving markets at the moment isn’t equity prices, it’s the ultra-low interest rate environment that’s engulfing the planet. Perhaps the greatest variable from the Brexit fallout wasn’t the drop in stocks, but the ensuing reaction across world bond markets where the 10-year U.S. Treasury yield has now fallen to 1.37%. This is an all-time low. Is the bond market trying to tell us something – that things are going to get significantly worse for our economy? Possibly, but it’s still hard for me to envision with the U.S. economy in the near-term for a number of reasons: forecasts for 2nd quarter GDP remain around 2.5%; Friday’s June jobs report was much stronger than expected; inflation is virtually benign; housing could see its strongest summer in 10 years; consumer spending is ratcheting higher with cheap gas and gradually rising wages; and interest rates are likely staying ultra-low for the remainder of this year and next.

So, what could explain these ultra-low interest rates? Perhaps the wave of political instability encompassing the globe. The U.S.’s political future is uncertain with the upcoming election, Great Britain just exited the EU, Brazil is attempting the Olympics, a debt crisis is looming in Italy, and Japan and Germany are in negative interest rate territory. All that said, the U.S. is actually hanging in there economically. International investors are buying our bonds fervently – driving up prices and down interest rates (bond prices move inversely to interest rates). Although 1.37% on a 10-year Treasury bond sounds puny to us, it’s like hitting the jackpot in Germany or Japan. That’s right, German and Japanese investors are actually receiving negative interest on their 10-year government bonds, -0.14% and -0.25% respectively. Talk about two countries willing to give money away to incent borrowing, investing and spending amongst their banks, businesses and consumers. 

Posted by Ford Lankford

Ford N. Lankford is a Portfolio Manager at Russell Capital Management (RCM). He manages investment portfolios and consults on investment planning for personal and institutional clients, as well as retirement plan sponsors and participants. Read more ›