John Gorlow
| Jul 16, 2015
Q2 2015 MARKET REVIEW
Despite a bumpy ride throughout the second quarter, global markets remained calm and stocks traded in a narrow range as Wall Street weighed the debt crisis in Greece, credit problems in Puerto Rico, the see-saw in Chinese stocks and prospects for a U.S interest rate hike. Then, after approaching historic highs, the Standard & Poor’s 500-stock index declined in the last few days of June, finishing the second quarter with a barely positive 0.28 percent return (dividends included).
VALUE VS. GROWTH
Value outperformed growth in the emerging markets but underperformed growth stocks in developed markets, including the U.S. Large value and large growth recorded similar performances in the U.S. while mid-cap value and small-cap value indices underperformed their growth counterparts.
YTD, SMALL CAPS SHINE
While the S&P 500 index ended June more or less where it began in January, the Russell 2000 index returned a solid 4.75% YTD, a significantly better performance than the broad U.S. market.
EMERGING AND DEVELOPED MARKETS
Emerging markets outperformed both the U.S. and developed ex U.S. markets in U.S. dollars in Q2. The MSCI emerging markets index (a benchmark for large cap stocks in developing markets) returned 0.69%. The MSCI world ex U.S. index (a benchmark for large cap stocks in developed markets outside the U.S.) returned 0.48%. Year-to-date returns for the MSCI world ex U.S. and emerging market indices were 4.34% and 2.85% respectively.
The value effect was positive in emerging markets but negative in developed markets, including the U.S. (as noted above). Small caps outperformed large caps not only in the U.S., but in non-U.S. developed markets and emerging markets as well. Year-to-date returns for the MSCI world ex U.S. Small Cap and emerging market indices were 8.36% and 8.24% respectively.
Smaller countries recorded the highest performance for the quarter, with Ireland (7.40%) and Hong Kong (+5.58%) leading the way in developed markets and the UAE (10.85%) and Hungary (9.65%) performing well in emerging markets. Currency played a role in each of the countries that recorded the lowest performance in developed and emerging markets, as the New Zealand dollar and the Indonesian rupiah depreciated versus the U.S. dollar.
UTILITIES AND REITS DOWN, COMMODITIES UP
Dividend payers were punished by a slide in bond prices. In both U.S. and non-U.S. markets, REITS significantly underperformed broad equity markets during the quarter. The Dow Jones U.S. select REIT index declined 10%, while the S&P Global ex U.S. REIT lost 3.15%. The S&P Utility index continued to underperform, declining 6.28% in June, leaving the sector off 12.32% YTD.
Commodities were broadly positive, with the Bloomberg Commodity Total Return index gaining 4.66% in Q2. The energy component led the period with unleaded gas returning 17.99% and WTI crude oil returning 17.50%. Grains also posted positive returns; Chicago wheat added 19.26%, while soybean meal added 11.44%. Metals were negative: aluminum declined 7.25%, silver dropped 6.63% and gold fell 1.13%
INTEREST RATES INCH UP
Interest rates across the U.S. fixed income markets generally increased during the second quarter. The 5-year Treasury note added 25 basis points to end the period yielding 1.63%. The 10-year Treasury note increased 42 basis points to end the quarter at 2.35%. The 30-year Treasury bond added 56 basis points to finish with a yield of 3.10%. On the short end of the curve, the 2-year Treasury note added 8 basis points to finish at 0.64%. Yields on securities within one year to maturity were generally lower by 2 basis points. Short-term corporate bonds gained 0.06%, while intermediate corporate bonds lost 1.09%. Short-term municipal bonds were relatively unchanged, but intermediate municipal bonds declined 0.89%. Municipal general obligation and revenue bonds experienced similar returns. The broad Inflation Protected Treasury index lost 0.97% and intermediate term high yield debt dropped 1.5%.
ECONOMIC SUMMARY: A MIXED BAG
The unemployment rate fell to 5.3 percent, the lowest in seven-years. But many analysts believe the decline was driven mainly by an exodus from the workforce, rather than more people finding jobs. Wages remained flat. Median home prices rose 7.9% over the past 12 months. Residential real estate sales are on pace for their best year since 2007. The U.S. trade deficit widened slightly as exports continued to suffer from a strong dollar. Putting fears over Greece aside, the Euro was on the verge of its best quarterly increase in more than four years. The U.S. dollar had mixed performance during the quarter. The U.S. economy was weak in the first quarter and core inflation remained below target. Dragged down by a contraction in first quarter growth in the U.S., the International Monetary Fund lowered its global economic growth outlook to 3.3% for 2015.
A CASE FOR GLOBAL DIVERSIFICATION
In U.S. dollar terms, global equity markets as measured by the MSCI All Country World index had slightly positive performance in the second quarter and a 2.67% YTD gross return, not earth-shattering but more than double the S&P gain of 1.23%. Over the one-year period the MSCI all-country world index returned a mediocre 1.23%.
THE UNVARNISHED TRUTH
A normal distribution predicts a negative annual return on the All Country World index in 27% of the years between June 1989 and June 2015. The mean of the return is large, 8.9%. This is what attracts investors to stocks. However the standard deviation of the return is also large —14.85%, or almost twice the mean. In other words the year-by-year values of the returns are volatile. And for less diversified portfolios, uncertainty about outcomes is even higher. For an in-depth discussion on long-term risk and return please refer to the article titled Risk and Return published elsewhere on this site.
LONGER-TERM NUMBERS ARE MUCH BETTER
Over the trailing three, five and ten years, the globally diversified All Country World index returned 13.61%, 12.52% and 6.97%, respectively. In comparison, annualized returns for treasury bills over the trailing three, five and ten years were 0.03%, 0.04% and 1.30%, respectively.
Are you among those who wonder how you might have done better? Some investors believe an advisor’s role is to deliver market-beating returns year after year by making accurate forecasts. In truth, no one knows what will happen next in investment markets. Rough as the market may be at times and however mediocre the short-term results our advice remains the same: stay diversified, focus long-term, let us know if your situation changes, and stick to strategy.
TOP FINANCIAL ADVISORS 2015
On a closing note, Cardiff Park Advisors is pleased to announce that in June we were named for a second year to the Financial Times 300 Top Registered Investment Advisers. The list recognizes the top independent RIA firms from across the U.S.