My F&M

Market Commentary 2nd Quarter 2016

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In spite of a January swoon after the Fed's interest rate hike in December and the Brexit shock and recovery in late June, the first half of 2016 was generally investor friendly.  The blended stock index was up 2.76% in the last six months: 3.8% for the S&P 500, 2.2% for small U.S. stocks, -4.4% for developed international stocks, and 6.4% for emerging market stocks. 

Of special note were bonds as the taxable bond index beat stocks in the first half with a total return of 5.5%.  That's an annualized return of about 11%!  Dramatic things have been happening to bonds.  The yield on the 10 year Treasury bond fell from an already low 2.27% at year-end to a lower 1.46% as of 6/30.  Put another way, 6 months ago, the 10 year Treasury bond’s 2.27% annual yield implied a cumulative return of just over 25% over its 10 year life.  But rather than being evenly spread out over 10 years, nearly 1/3 of that cumulative return occurred in just the first 6 months of its term (accounting for the price change), leaving only the other 2/3 of its total return for the remaining 9.5 years.

Propelled by lower interest rates, the REIT index (publicly traded real estate) was up 13.7% in the first half of the year, and within stock sectors, the telephone and utilities sectors were the strongest, each up nearly 25%.  Reversing large declines last year, gold was also quite strong, climbing 25% in price this year through 6/30. 

Markets are focused on political uncertainty, Federal Reserve policy, what the Brexit vote may mean, persistently slow economic growth, terror attacks, weak corporate earnings, China, the price of oil, etc.  The ebbs and flows of such issues constitute the market’s typical, short-term noise.  There is always something to worry about, and this is the current list, but these are mainly short term issues with short-term implications with respect to markets.  We, in contrast, are more focused on a long term problem that should be of greater concern to investors: very low bond yields.  And since they have been relatively low for years, essentially all other markets have adjusted and now offer very low yields too.  Consequently, stocks and bonds are priced to offer disappointing expected returns over the next ten years or more. 

"There Is No Alternative" (with its own acronym: "TINA") is the phrase that has worked its way into the lexicon of late as a rationale for broad oversized commitments to stocks.  We don’t think that is a reasonable basis for long term investment.  Rather, we think the modest appeal of traditional assets argues for intensified efforts to uncover alternatives beyond the obvious choices.  That's why we have been focused on expanding portfolio exposure to uncorrelated, non-traditional assets including private real estate and secured real estate lending where appropriate, insurance-linked securities, and most recently, direct lending.  Beyond that, there are some pockets in markets that are priced less expensively – most notably, value stocks and emerging markets securities – and we continue to emphasize them.  But the next 5-10 years looks like a particularly poor time to be an investor in index funds holding conventional stocks and bonds.