The first half of 2016 demonstrated the importance of robust asset class diversification for investors. The chart below shows how key global economies performed in the first half of 2016; the BRIC countries (Brazil, Russia, India, and China) in particular have seen strong equity growth through the end of June. However, it’s important to keep in mind that the second half of this year may look very different -- as you’ll read more about below, global market movements can be unpredictable, so we continue to believe that the best approach is to capture global growth through a well-diversified portfolio built for the long term (rather than trying to guess at short-term market movements.)
Declining Interest Rates
After an interest rate hike by the US Federal Reserve in December of 2015, many investors expected US interest rates to increase in the first half of 2016. In the face of uncertain data, the Federal Reserve decided to delay raising rates and as a result, interest rates fell from 2.24% on the US 10 year Treasury to 1.48%. As a reminder, falling interest rates generally cause bonds to rise in price, and this put fixed income among the best performing asset classes so far this year. To us, this underlines the importance of a long-term allocation that holds both stocks and bonds within a portfolio. In addition, Real Estate Investment Trusts (REITs), which form part of our allocation, also benefited from falling interest rates.
The Challenges Of Uncertainty
The first half of the year also emphasized the challenge of correctly predicting market returns in the short-term. Just as many did not expect interest rates to decline, few expected the Republican party to reach a presumptive nominee in Donald Trump before the Democratic party selected Hillary Clinton. In the UK, the EU Referendum that backed ‘Brexit’ in late June was not expected by many polls or commentators, nor was the British Prime Minister’s resignation. Also, the energy markets rebounded off of lows made in February, close to the time when publications such as the Economist and Barron’s were discussing low oil prices for the medium term. These recent, and potentially unexpected, events serve as a reminder as to how, in our view, a portfolio based on stable allocations can be preferable to one based on near-term prediction given that the world is rife with uncertainty.
U.S. and Global Growth
Globally, the US continued to show solid growth with continued improvement in employment and an apparent strengthening in the housing market. The growth from these improvements was somewhat offset by sluggish business investment. The US market index rose 2.44% in H1 according to MSCI data. European economic growth also appeared to improve over the first half, though from a lower base, and with Brexit raising uncertainty in recent weeks. Partially as a result of Brexit, European developed markets declined 7.27% in H1 according to MSCI data.
Japan exceeded expectations by delivering Q1 GDP growth of 1.7%. China, which was a source of concern in 2015, appeared to stabilize, with GDP growth in Q1 of 6.7%.This serves as a reminder that even a potentially slowing China still offers high absolute growth rates compared to global averages.
However, Brazil and Russia are expected to see negative growth for 2016, according to IMF (International Monetary Fund) Projections. Despite negative economic forecasts for Russia and Brazil, it is worth noting that they are among the best performing stock markets so far this year according to MSCI data, with Russia rising 20.87% and Brazil rising 46.77% in the first half of 2016. We believe the relatively inexpensive valuations of these markets compensated for any bad news that occurred in H1.
Planning for the Rest of 2016
Looking to the second half of the year, we see FutureAdvisor portfolios well-positioned to deal with market fluctuations, as diversified global equity exposure has the potential to capture growth wherever it may occur. Fixed income (bonds) provides a potential hedge in weaker markets and real estate and Treasury Inflation Protected Securities (TIPS) bring protection should inflation arise ahead of forecasts.
Finally, remember that your savings rate and tax planning are critically important for your investment success. As we are now past the midway point for the calendar year, check in to make sure that your savings rate is where you want it. If it isn’t, consider upping your 401(k) or IRA contributions since they can be relatively tax-efficient ways to save. Research has suggested that small but steady increases in your savings rate can be an easier way to save, rather than trying to make infrequent but dramatic increases to your savings rate. Making a series of smaller adjustments may be easier for both you and your finances to tolerate, and will likely make it easier for you to ultimately hit your target savings rate.
Disclaimer: The views expressed are for informational purposes only and are not intended to serve as a forecast, a guarantee of future results, investment recommendations or an offer to buy or sell securities by FutureAdvisor. All expressions of opinion are subject to change without notice in reaction to shifting market, economic political conditions, and as subsequent conditions vary. The investment strategies mentioned are not personalized to your financial circumstances or investment objectives, and differences in account size, the timing of transactions and market conditions prevailing at the time of investment may lead to different results. This material may contain “forward-looking statements”: information that is not purely historical in nature. Clients may lose money. Past performance is not indicative of future results. Investments in securities involve the risk of loss. Any tax strategies discussed should not be interpreted as tax advice and do not represent in any manner that the tax consequences detailed will be obtained. Clients should consult with their personal tax advisors regarding the tax consequences of investing.