6 Month Market Review - as at June 30, 2017

Overview

Like a good opera, the markets ended the quarter on a high note. The gains were seen across all asset classes: stocks, bonds, real estate, gold and even bitcoin. In the US, stocks continued to grind higher and higher with the maximum decline not exceeding 2.8% (as measured by the S&P 500), making for a very comfortable ride. What is unusual is not that volatility has been exceptionally low for an extended period of time, but that most major markets have been moving in tandem. This includes US, European, Asian and Emerging Markets. On the fixed income side, government, corporate and high yield all posted positive returns. Only commodities, particularly oil, have been weak. Cleary there was a very healthy appetite for risk assets.

Removal of uncertainty, particularly political, coupled with steady economic growth world-wide and the best quarterly earnings for US and European stocks in 6 years have been the drivers. With the French and the British elections completed, and an early Italian election ruled out, there was mainly President Trump on which to focus. While the political climate created by Twitter messages and aggressive negotiating tactics is not a safe path to a well-functioning economy, the U.S. market seems to have hardly noticed. The triggering of article 50 of the Lisbon Treaty by the UK (“Brexit”) didn’t interrupt the recent trends, and current activities show that a break-up of the Eurozone is not as imminent as some would like to believe.

Equities

Global stocks had one of the strongest six-month periods in many years. Only four of the 30 major indices did not have positive returns since the beginning of the year. Improving economies, central bank support, rising European consumer sentiment, strong earnings growth, and a vigorous tech industry in the U.S. and China have all contributed to robust capital market returns. For the first time since 2009, overseas stocks have outperformed the US. The global index MSCI World generated returns of almost 11% in the first half of the year, outpacing US large cap stocks return of 9.5%. Expectations of higher earnings and low volatility have driven stock markets. Lower volatility encourages investors to pay higher multiples for the same level of earnings. While the decline in the price of oil drove markets lower in 2016, investors believe the decline is a supply issue and not a demand issue. As long as the price of oil remains above $40 per barrel, earnings should continue to grow.

Emerging markets were stellar performers with the FTSE gaining 4.2% on the quarter and 14.7% so far for the year.

Bonds

Performance in the bond market in the first half of 2017 was characterized by a lack of inflation, optimism about economic growth and an insatiable demand for yield. The US Federal Reserve raised rates twice on the belief that the economy was strong enough to move inflation up to the 2% target level and introduced a plan to begin shrinking its balance sheet. The European Central Bank has also expressed the view that inflation will move higher but is likely to stay below 2%.

US Bonds (Barclays US Aggregate) were up 1.5% for the quarter and 2.3% for the year. Dow Jones US Select REIT index, which tracks US real estate, is up 0.7% for the quarter but down 0.5% for the year. The US Dollar continued to weaken against major global currencies.

Outlook

Markets cannot continue on their current path without a pause or a temporary pullback. In fact, some relief from the continuous grind higher would be welcome as it would set the stage for the next leg up. While the likelihood of recession is currently low, valuations remain stretched and interest rates are increasing. If the 10 year bond approaches 3%, this can be a difficult hurdle for equities to overcome. Sentiment can be very fickle, and it would not be surprising if an unlikely source causes investors to seek out safety. For the time being, we remain constructive, and focused on indicators that could foretell any change in the current trends.