October 11th, 2016
2016 Third Quarter Report: The Bull Continues
In the third quarter, the markets once again confounded the instincts of nervous investors and went up instead of down. Fed Chairperson Janet Yellen told the world that the United States economy is healthy enough to weather a rise in interest rates, but the Fed governors met in September and declined to serve up the first rate hike since December 15th of last year. This decision was reassuring news to Wall Street traders, as well as investors, helping to provide yet another quarter of positive gains in U.S. stocks.
The widely quoted S&P 500 Index of large U.S. company stocks posted a gain of 3.85 percent in the third quarter and is up 7.84 percent for the year so far. The Russell Midcap Index gained 4.52 percent for the quarter and is up 10.26 percent for the year. Small company stocks, as measured by the Russell 2000 Small-Cap Index gained 9.05 percent, posting an 11.46 percent gain so far this year.
Looking abroad, the U.S. remains a haven of stability in a very messy global investment scene. The broad-based EAFE (Europe, Asia and Far East) Index of companies in developed foreign economies gained 5.80 percent in dollar terms in the third quarter of the year, but it is still down 0.85 percent year-to-date. In contrast, a basket of emerging markets stocks of less-developed countries, as represented by the MSCI Emerging Markets index, gained 9.03 percent for the quarter and are sitting on gains of 16.02 percent for the year so far.
The U.S. stock market returns have been so good for so long that many investors are wondering: why are we bothering with foreign stocks? A recent Forbes column suggested the answer: historically, since 1970, foreign stocks have outperformed domestic stocks almost exactly 50 percent of the time, meaning the long-term trend we’ve become accustomed to could reverse itself at any time.
On the bond side, the interest rate story is essentially unchanged: rates are still low, once again baffling all the experts who have been expecting significant rate rises for more than half a decade. Ten-year U.S. government bonds are currently yielding 1.73 percent.
Three-month notes were yielding 0.27 percent at the end of the quarter, while 12-month bonds were paying just 0.58 percent. Go out to 30 years, and you can get a 2.46 percent annual coupon yield.
What’s keeping stock prices high while sentiment appears to be, let’s call it, “restrained?” Nobody knows the answer, but a deeper look at the U.S. economy suggests that the economic picture isn’t nearly as gloomy as it is sometimes reported in the press. Economic growth for the second quarter has been revised upwards from 1.1 percent to 1.4 percent due to higher corporate spending in general and especially as a result of increasing corporate investments in research and development. In addition, America’s trade deficit shrank in August. Consumer spending—which makes up more than two-thirds of U.S. economic activity, rose a robust 4.3 percent for the quarter, perhaps partly due to higher take-home wages this year.
Meanwhile, if someone had told you five years ago that today’s unemployment rate would be 5.0 percent, you would have thought they were highly optimistic. However, after the economy gained 156,000 more jobs in September, unemployment remained at 5 percent. At the same time, average hourly earnings for American workers have risen 2.6 percent so far this year.
It’s difficult to dispute that the economic statistics are weak as tea leaves for trying to predict the market’s next move, and it is certainly possible that the U.S. and global economy are weaker than they appear. However, the slow, steady growth we’ve experienced since 2008 appears to show no visible signs of ending, and it’s hard to find the usual euphoria and reckless investing that normally accompanies a market top and subsequent collapse of share prices. At the current pace, we might look back on 2016 as another pretty good year to be invested.