The 2016 business news cycle has been hijacked by the U.S. presidential election. Combine that with a bit of hand wringing regarding the next move by the Federal Reserve Bank and unprecedented negative interest rates in Europe and Japan and we have an atmosphere filled with uncertainty. Yet those concerns have been unable to stall broad market advances so far.
Entering this year, global stocks had experienced almost 6 years of bull markets. That has continued in 2016 with the only change being the market leaders. Large U.S. stocks had bested small company stocks for the prior two years and developed international markets for the last four years. Emerging markets have had negative returns for 4 of the prior 5 years. This year to date the S&P 500 returned 7.8%, while the small company Russell 2000 returned 11.5%, of which 7.8% came in the third quarter. Emerging Markets returned 16%, with 9% coming in the third quarter. Developed international markets have been weak with anemic European economic growth and significant negative stock market returns in Japan.
Bond investors continue to be starved for yield as world central banks have kept a tight lid on interest rates. The 10-year U.S. Treasury has dropped in yield from 2.3% to 1.6% in 2016. So far, investors have been willing to take extra risk by investing in lower quality credits. Investor demand for yield has driven high yield bond rates down from 8.7% to 6.2%. While the drop in yield has been helpful to bond returns in the short run, we face an environment where prospective future returns look unappealing. Currently, bond yields provide approximately zero return above expected inflation rates without taking on substantial credit risks. Real estate investors have been significant beneficiaries of the low yield environment. Publicly traded real estate has returned 12.3% year to date.
Commodity pricing has rebounded in 2016. Oil prices reached a low in January of $26 per barrel, rebounding to $51 in June, and settled in at $45 today. Gold started the year at $1,060 per ounce and reached $1,313 at quarter-end, causing gold mining stocks to nearly double this year after languishing for the prior 4 years.
An abrupt change in market leaders is not unusual and reminds us that a successful investment strategy does not have to rely on predicting the next hot market sector. Thankfully, we also don’t rely on predicting the next U.S. President or determine the next move by the Federal Reserve to make investment decisions. Our strategy, that embraces broad portfolio diversification, is best prepared to weather market uncertainty.