February 9, 2016
EXECUTIVE SUMMARY
•
Equity markets have come under renewed pressure in recent days. High
quality bonds have rallied though, allowing balanced investors to limit their
downside. In short, diversification has worked.
•
The story continues to revolve around a slowdown in global economic growth,
a stalled bull market in U.S. equities, investor reaction to the daily flow of
news and data, and increased volatility.
•
Among the various leading indicators for the economy is stock prices,
although a downturn in equities is not always a precursor to recession.
•
In real time, it’s impossible to determine when either the market or the
economy will turn.
Whether the current downturn is a precursor to a recession
or simply a mid-cycle correction will only be clear with the benefit of hindsight.
So what is an investor to do?
•
We encourage investors to refrain from making critical investment decisions
based on short-term volatility. Instead, investors should reaffirm they have
appropriate cash reserves to meet near-term spending needs, ensure current
positioning aligns with their long-term investment goals and tolerance for risk,
and avoid trying to time the market, particularly during sharp downturns.
JIM BAIRD
CPA, CFP®, CIMA®
Partner,
Chief Investment Officer
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Plante Moran Financial Advisors (PMFA) publishes this update to convey general information about
market conditions and not for the purpose of providing investment advice. You should consult a
representative from PMFA for investment advice regarding your own situation.
The information provided in this update is based on information believed to be reliable at the time it
was issued.
Any analysis non-factual in nature constitutes only current opinions, which are subject to
change.
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PMFA SPECIAL MARKET COMMENTARY
Volatility continues as global economic concerns persist
Concerns about the state of the
global economy have resurfaced in
recent days and equity markets
have come under renewed
pressure. In the U.S., stocks closed
lower on Friday to end the week on
a softer note after two consecutive
weekly gains for the S&P 500 Index.
Domestic small caps have
underperformed larger companies in
the U.S. year-to-date, while value
stocks have held up better than
growth stocks across the
capitalization spectrum. As of the
close of trading on February 8, the
S&P 500 Index had dipped 9.1%
since the start of the year, as
compared to a 14.6% decline for the
Russell 2000 Index.
International
equities, as measured by the MSCI
ACWI ex U.S. Index, have also
slipped in recent days, although
they have moderately outperformed
the broad U.S. market thus far in
2016.
Conversely, high-quality
bonds have rallied, as the flight to
quality drove long-term interest
rates lower. The 10-year Treasury
yield remains well below 2%, and
performance for both the Barclays
Aggregate and various muni bond
indexes are positive year-to-date.
As a result, although global equities
are down nearly 10% since the
beginning of the year, a balanced
portfolio has lost much less,
supported by modestly positive
returns in bonds. Diversification, as
expected, has worked.
Ultimately, the story is largely the
same as it has been in recent
months: the global economy has
slowed, the bull market in U.S.
equities has stalled, investors
appear to be reacting to the daily
flow of news and data, and volatility
has increased.
The economic
expansion is nearing its seventh
year, which is long by many
standards. Most economists would
acknowledge that recession risk has
risen since the start of the year, but
few have suggested that the
economy has already entered
recession or that one is inevitable.
We would certainly acknowledge
that risk has increased, both in the
market and with regard to the global
economy. However, it is impossible
to determine what the path for either
will be from here.
There are a number of leading
indicators for the U.S.
economy.
Among those are equity prices,
which tend to decline in value
before a recession actually begins.
As such, by the time that it is clear
that a recession has started,
markets have already largely
adjusted to that reality. The
converse is also generally true:
stocks generally find a floor and
rebound before the economy
actually bottoms, making stocks a
leading indicator of an economic
recovery. Nonetheless, as a
forecasting tool, a bear market in
stocks is hardly foolproof.
Economist Paul Samuelson once
famously quipped that “the stock
market has called nine of the last
five recessions.” The bottom line is
that markets can often overreact
and a selloff in risk assets is not a
consistent harbinger for an
economic recession.
Another leading indicator for the
economy is the performance of the
industrial sector.
Manufacturing is
highly cyclical, and a downturn there
often presages a broader slowdown
in the economy. The decline in oil
prices and diminished profitability in
the energy sector has crimped
capital expenditures in the U.S.,
which was apparent in the fourth
quarter GDP report. The slowdown
in manufacturing is not limited to the
U.S.
and is perhaps being felt most
acutely in China. Policymakers
there are attempting to engineer a
gradual transition away from an
export and infrastructure driven
economy to a more domestically
oriented, consumer driven economy
similar to that in the U.S. and other
developed economies.
However, as
with stock prices, not every
downturn in manufacturing is prerecessionary, and several measures
of the health of the manufacturing
sector are still more consistent with
a mid-cycle slowdown.
In real time, it’s impossible to
determine when either the market or
the economy will turn. Whether the
current downturn is a precursor to a
recession or simply a mid-cycle
correction will only be clear with the
benefit of hindsight. So what is an
investor to do?
First, we would advise against
making critical decisions about your
portfolio based on short-term
volatility or the latest piece of data.
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3
Your investment policy and asset
allocation were determined based
on your long-term financial goals,
your tolerance for risk and long-term
return goals, and an investment
time horizon that may extend over
many decades. Inherent in that
decision was the expectation that
periodic bouts of volatility, such as
this one, would result in returns that
may fall short of one’s goal over
some periods. Conversely, that plan
also contemplated periods of
unusually strong returns as well.
Over time, your investment policy
provides a framework for decisionmaking to guide you on the path
toward reaching your long-term
goals.
Second, we believe it’s reasonable
and appropriate to evaluate your
cash holdings and expected needs
to insure that you have sufficient
liquidity. Having adequate cash
reserves should allow you to meet
your foreseeable spending needs in
the near-term, while keeping your
portfolio invested in a manner that is
consistent with your investment
policy.
Third, investors may want to
evaluate their current positioning
relative to your long-term goals and
reconfirm your long-term return
objectives and tolerance for risk.
Finding the right balance is critical
to success and is different for every
investor.
It’s important to take
enough risk to allow you to meet
your objectives, but not to take more
risk than you can tolerate when
markets become more turbulent.
Finally, we would once again urge
any investor to avoid trying to time
the markets. We recognize that the
market environment over the past
few weeks has not been
comfortable, but making quick
decisions during sharp downturns
may lead to suboptimal results for
your portfolio over the long-term.
We will continue to closely monitor
market conditions and valuations
across equities, bonds, and various
alternatives to identify any potential
opportunities that may arise to
enhance your long-term portfolio
returns. We will also continue to
monitor your portfolio specifically for
opportunities to rebalance and
harvest tax losses and to maintain
adequate liquidity consistent with
your goals and objectives.
In closing, we want to acknowledge
that the uncertainty that exists and
the recent performance of equity
markets may be a source of anxiety.
As your advisor, we believe that our
role is to help you to craft a plan that
will allow you to achieve your goals
and then consult with you along the
way to help you evaluate your
progress and make sound
decisions.
As always, if you have
questions or concerns, please do
not hesitate to contact us.
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