“To be an investor you must be a believer in a better tomorrow.” – Benjamin Graham
As the third quarter began, investors were only one week removed from the Brexit vote. The financial market focus at that time was on the potential near-term and long-term global implications of the United Kingdom’s decision to exit the Eurozone. Three months later, as the third quarter came to a close, investors had shifted their focus to the upcoming U.S. Presidential and Congressional elections. In addition to the election of our 45th President, the control and make-up of the Senate and House of Representatives will be determined. This divisive Presidential election has gone well beyond the normal debates on tax and regulation policies. There has been substantive engagement on the issues of immigration, trade, protectionism, corporate tax policy, repatriation of overseas earnings, and the war against terrorism.
In addition to the focus on the election, Central Banks around the world continue to be of a “dovish,” or easy money, mindset. The Bank of Japan recently announced they would keep their short term interest rate target at minus 10 basis points and their 10-year government bond yield target at zero percent, as their rate of inflation remains stubbornly low and their economy continues to barely grow.
Negative yields continue to prevail in Europe, too. Growth for many of these major economies is minimal. Most central banks continue to purchase large amounts of debt in an effort to stimulate capital investment and economic growth.
Our Federal Reserve communicated at their meeting in September that they expect a 25 basis point hike in the Federal Funds rate by the end of 2016. The Fed also said for us to expect two more rate hikes in 2017 based on the current state of the economy. Earlier this year, the Fed thought they might increase the Fed Funds rate up to four times in 2017. However, our economy continues to grow at a slower pace than originally anticipated. Therefore, our Federal Reserve has reduced their projected increase in the Fed Funds rate.
The benchmark US Ten-Year Treasury Note currently yields about 1.75%, which is approximately 35 basis points higher than where it was at the end of the second quarter. Foreign investors continue to be attracted to the safety of the US with our modestly positive yields, well above negative yields elsewhere. This flow of funds into our country has stifled the Federal Reserve’s course towards normalizing interest rates.
As we stated in our First Quarter 2016 Review & Outlook, “We maintain the opinion that it will be difficult for the Federal Reserve to move rates higher by any significant measure given the propensity of other central banks continuing and/or expanding stimulative monetary policy.” We see no compelling reason to alter our opinion.
Our outlook has not changed from our previous quarterly reports. Our view is lower interest rates will most likely persist for the foreseeable future. However, the Federal Reserve will probably increase the Fed Funds Rate in December. Additionally, we recognize that a meaningful pick-up in economic activity and/or inflation could result in an increase in interest rates, particularly on longer maturity fixed income investments. Therefore, we maintain a cautious approach towards bond investing by purchasing short and intermediate term fixed-income investments.
Given our current economic outlook, we remain cautiously optimistic with respect to equities. Recent economic data, including figures on home sales and manufacturing, continues to show a slow growing economy. Investors recognize tepid economic growth and modest inflation in our economy will allow the Federal Reserve to only slowly raise rates. If the Ten-Year US Treasury rate continues to offer investors a sub-2% yield, then a yield of 2-3% or more from dividend paying companies will likely keep stocks of well capitalized companies in demand. The likelihood of a continuance of low global yields remains a major support for maintaining our preference for solid dividend paying equities.
Many investors can become very emotional in regards to the potential market impact of the outcome of the November election results. The conventional wisdom is if you think Donald Trump will win, you should buy coal-miners, small company stocks (because their sales are predominantly in the United States), and construction companies that can build walls. If you think Hillary Clinton is the likely winner, then you should buy clean energy stocks, multinational companies and defense contractors. However, if you go back to the election in 2008 when President Obama ran for office, the conventional wisdom was that gun makers would go out of business, health care providers would struggle and alternative energy companies would flourish. Instead, the conventional wisdom proved wrong and the opposite largely occurred. Smith & Wesson, a gun manufacturer, has surged during Obama’s administration. The health care sector has done very well over the past eight years and many clean energy stocks have struggled and declined in value.
Some type of financial market over-reaction commonly occurs during a presidential election cycle. We believe it is wise to remain unemotional regarding the election results. Our strategy is to actively monitor and manage our clients’ investments in diversified, high-quality portfolios. We believe this should serve us well regardless of the results of the upcoming election.
Marietta Wealth Management, LLC