Aldrich Wealth Advisors Share a Look Back on the Markets in Q1 of 2016
The S&P 500 Index advanced a respectable 1.4% in the first quarter, which belies a rollercoaster path that included an 11% decline and a 13% rally during the period. In fact, the Dow Jones Industrial Average, up 2.2%, recorded its largest drawdown for any quarter where this blue chip index closed in positive territory.
International developed equity fell 3.0% despite a 6.5% advance in March as Central Banks in Europe and Japan expanded their stimulus efforts. Emerging market equities outperformed their developed market counterparts with a 5.7% increase led by a recovery in energy prices from levels not seen since 2003.
Despite good domestic economic data, the Fed left rates unchanged during the quarter citing economic instability globally. On the fixed-income side, a flight to safety sent the yield on the 10-year Treasury Bond down to 1.78% from 2.24%, while high-yield bonds rallied in response to a sharp rebound across the energy complex. The U.S. dollar recorded its worst quarterly performance, down 4.2% in over 5 years in response to a downshift in expectations on the pace of rising interest rates by the Fed.
The S&P 500 Index, a broad measure of the U.S. equity market, advanced for the twelfth time in thirteen quarters despite a volatile start to the year. Following a 6% drop in the first week of trading, the selloff continued with another 5% descent before bottoming out in mid-February. As concerns of decelerating global growth subsided, stocks rallied aggressively to close the quarter. Reported earnings for the 4th quarter exceeded analyst expectations for 69% of the companies in the S&P 500 Index. Large cap stocks outperformed small companies as investors sought the relative safety of larger companies. Eight out of the ten sectors within the S&P 500 Index posted gains for the quarter with value oriented segments besting their growth brethren. Investors preferred dividend-payers amid the volatility, as the Utilities and Telecommunications sectors were the top performers. Energy stocks were up 9.3% in March as oil prices rebounded.
Non-U.S. developed market equities, as measured by the MSCI EAFE Index, decreased 3.0% in the first quarter. The possibility of the United Kingdom leaving the European Union paired with concerns of slowing global growth weighed on returns.
For the second time in four months, ECB President Mario Draghi elected to cut deposit rates further into negative territory while increasing the size of the bank’s asset purchase program. Stronger easing actions from the European Central Bank sent the Index up 6.5% in March. Japan also forged a path to easing monetary policy, sending its rates into negative territory for the first time in history. Under pressure to revive growth and increase inflation, the country’s negative interest rate policy charges banks to hold excess reserves as an incentive to increase lending. Global divergence of monetary policies between U.S. and international markets continues to drive market volatility and currency movements.
Emerging market returns, as measured by the MSCI Emerging Markets Index, advanced 5.7% during the quarter and 13.2% in March. Performance was largely driven by the reversal of two trends: the decline of the U.S. dollar and an increase in the price of oil.
The appreciation of emerging market currencies against the U.S. dollar bodes well for import nations as well as those with large current account deficits. The rebound in oil prices and other commodities supported the export-reliant markets of Russia, South Africa, and Brazil. Asia trailed the benchmark by 1.8% due to the index’s largest constituent, China, as they continue to transition away from an investment-based economy to one that is more consumer-driven. In March, the country unveiled plans to stabilize its economy and mitigate currency volatility, which eased fears of rapidly decelerating Chinese growth and sent the market up 11.4% during the month.
Citing global economic instability, the Fed held rates unchanged during the quarter. The Barclays Aggregate Bond Index, a broad measure of U.S. fixed income markets, advanced 3.0% as a flight to safety and a change to Fed rate hike expectations sent the yield on the 10-year Treasury down to 1.78% from 2.24%. High-yield bonds, which had been under tremendous pressure since late last year, stabilized and rose nearly 3.4% for the quarter. The global bond market, as measured by the Barclays Global Aggregate Index, advanced 5.9% for the quarter as interest rates moved decidedly lower across the world. The ECB cut their key interest rate to zero, expanded their bond-buying program to include corporate bonds and increased their monthly purchases by 33% to 80 billion Euros(€).
The expanded bond-buying program put significant downward pressure on international yields with 10 Year sovereign rates for Germany and Japan now negative. The U.S. dollar shed over 4% against a basket of major currencies in the quarter, as turbulent global markets and an increasingly cautious tone from the Fed pushed back expectations for rate hikes, after the first increase in almost a decade in December. In addition to a drop in yield, the falling U.S. dollar added over 2.6% to returns during the period.
The high-yield and bank loan markets provided strong results during the period as investors returned to these asset classes following a rebound in energy prices. Better economic data coupled with a rebound for the energy market sent the high-yield bond returns up 4.4% in March.
Concerns over future defaults among Energy and Materials companies remain, but investors may believe the current rate environment compensates for this risk.
The U.S. economy grew by 1.4% in the fourth quarter due to positive contributions from consumer spending. Wage growth continues to move upward, a sign that labor markets may be approaching full employment. The unemployment rate in the United States rose unexpectedly to 5% in March 2016, from 4.9% in the previous month as more workers entered the workforce.
Meanwhile, the IMF expects global growth of 3.6% in response to rising interest rates in the United States and an economic slowdown in China. The Eurozone grew at a 0.3% rate in the fourth quarter. The bloc’s recovery has been led by its largest member, Germany, which has benefited from both reduced financing costs and the lower euro. Among the member states, Germany has the lowest unemployment rate at 4.3%. High unemployment and debt levels remain challenging headwinds for the region, but targeted monetary policies have begun to move the needle in the right direction. The seasonally adjusted unemployment rate in the Eurozone came in at 10.3% in February from an upwardly revised 10.4% in the previous month and matching market expectations. It is the lowest figure since August 2011.