Brexit was just another ‘brick in the wall’ of worry stocks continued to climb. (Cue the Pink Floyd)
In a Nutshell
- Brexit shocked world stock markets for a few days at the end of June but most quickly rebounded and ended the quarter with a positive gain.
- Commodities continued the rally which began in the first quarter and is now a leading asset class.
- Interest rates dropped again this quarter, continuing the 35 year bull market in bonds and providing another opportunity for homeowners to refinance.
- Stocks paying substantial dividends continue to be popular among investors as bond yields continue to drop.
U.S. Stocks – Dividends Rule
Defensive stocks performed well again this quarter as utilities, real estate trusts and other companies which pay a significant dividend continue to attract the most investor dollars. Many analysts believe that outperformance is a result of bond investors looking for more income. Elsewhere, smaller companies outperformed their larger counterparts this quarter. It looks as if the trend of outperformance by larger companies which held for most of last year has come to an end.
Playing off the strength in precious metals prices this year, gold miners continued their recent tear. As a group, they have doubled in value this year. Having lost 80% of their value over the previous 5 years, they were due for a rebound. That said, even after their outstanding recent performance, a dollar invested at the high in 2011 is still only worth around 35 cents today.
Although Brexit is primarily seen as a political event, global stock markets including the U.S. were not prepared for it and sold off for a few days after the June 23 vote. The drop was short lived for U.S. markets, rebounding to previous levels by the end of the month. It is said that markets climb a wall of worry and this event is now seen as just another brick.
Growth of $10,000 in U.S. Stocks
Jan 1, 2008 – Mar 31, 2016
International Stocks – Brexit and Brazil
The Brexit vote weighed on markets around the world and more heavily in Europe as to be expected. Once markets had a chance to digest the news they realized that although it could have far reaching implications about the long term stability of the EU, not much would be changing in the next 6 to 9 months. Since this is about how far out stock markets tend to look, this worry has been set aside for another day. By the end of the quarter, emerging markets had fully recovered and Europe had recovered about half of its losses.
In terms of specific country stock markets, Brazil and Russia continued their recent outperformance. At first glance, it would seem odd that the Brazilian stock market would be up over 40% this year, given all the negative news we’ve been seeing about not being ready for the Olympics, turmoil in the government and the general poor state of its economy. In fact, similar to gold mining stocks, Brazil’s stock market had lost around 80% of its value over the previous 4 years and was due for a rebound. The publicity Brazil has seen this year may have caused investors to take a closer look at its market and conclude that its market had become too cheap. We’ll see if investors continue to stick with Brazil after the Olympics are over.
Bonds – Yields Can Go Less Than Zero
Interest rates, which had been holding fairly steady for most of the quarter, dropped after the Brexit vote as investors looked for safer alternatives . Remember that bond prices go up as interest rates fall.
Interestingly, once stocks began recovering in the days after Brexit, interest rates continued to fall. Normally it would be expected that when stocks go up, it comes at the expense of bonds since they would normally be sold to buy stocks. One reason this time might be different is that investors are still concerned about potential aftershocks of Brexit (e.g. other european countries following Britain, global recession fears) and so are wary of jumping back into stocks right away.
Another reason, at least for U.S. bonds, is that currently over 70% of the developed world’s high quality debt is currently paying less than 1% interest and 30% is actually “paying” negative interest rates. (Source: Quartz.com). This means that global investors are willing to take a guaranteed loss on over $10 Trillion invested in these bonds. So while we think a 10 year U.S. Treasury bond paying 1.5% interest looks paltry, when compared to a 10 year Japanese paying -0.2%, it begins to look much better.
This latest drop in interest rates is also benefiting those who are buying homes or looking to refinance their mortgages. 30 year rates are at 3.5% and 15 year rates are at 2.75%. This is about 0.5% less than where they were a year ago and 1% less than 3 years ago. (Source: Federal Reserve Bank of St. Louis). If it’s been a few years since your last mortgage, it could be worth taking a look at refinancing.
Commodities – Taking the Lead
After spending the past 4 years lagging other asset classes, commodities continued the rebound they began in the first quarter and took over a leadership position relative to other assets. Precious metals and energy were the strong performing areas this quarter. In addition to gold gaining another 7.5%, silver was up 19% and oil and natural gas were up 18% and 30% respectively.
The last time commodities were outperforming other asset classes in 2012, their reign lasted only a few months. We’ll see if they have more staying power this time around.