In a Nutshell
- U.S. stock markets spent the first 6 weeks of the year continuing the slide which began last quarter. They then turned around and spent the rest of the quarter gaining back everything they had lost. However, sectors which lagged the market last year led the recovery.
- Bonds bucked the December Fed rate hike and steadily gained in value.
- International stocks were mixed. After lagging significantly in 2015, Emerging markets outpaced Developed markets this quarter.
- Commodities stabilized and were led by Gold, which had its biggest quarterly gain in 30 years.
U.S. Stocks – Continued Volatility
Much like my youngest daughter’s new favorite toy, the market looked like a yo-yo this quarter. After spending the first 6 weeks completing its second drop of more than 10% in the past year, it managed to reverse course and actually finish slightly positive for the quarter. Smaller companies did a little better than larger companies and value stocks did a little better than growth stocks.
However, in what’s known as a ‘laggard rally’, the areas of the market that had been performing poorly led the market higher. Some examples: Energy companies, down 22% last year, were up 3%. Basic material producers (i.e. chemicals, steel) were up 4% this quarter after losing 12% last year. And Utilities were up 15% this quarter after dropping 5% last year. (Source: iShares)
On the flip side, market sectors that had been leading the way, in some cases for years, fell back. Biotechnology companies, which have averaged 21% annual returns over the past 5 years, lost 22% this quarter. Pharmaceutical companies suffered a similar fate, dropping 15%, after having 17% annualized returns over the past 5 years. (Source: iShares)
During these times, strategies which invest in market leaders also tend to temporarily fall behind as they look for opportunities to replace yesterday’s leaders with stocks ready to begin their period of outperformance. A portion of Ataraxia’s stock portfolios utilize this type of strategy.
Emerging Markets – Bouncing off the Bottom?
Emerging markets had positive returns in the 1st quarter, its second in a row. That said, continuing with the laggard rally theme, it still has been the 2nd poorest performing asset class over the past 12 months. Developed markets didn’t rebound as strongly as emerging or the U.S. stock markets and finished the quarter in the red.
Countries which export oil and raw materials led the way higher. Russia (+12%), Brazil (+27%) and Canada (+10%) had particularly strong quarters. Only time will tell whether emerging markets will continue to build on the positive performance seen the past 6 months.
Bonds Provided Stability
With the Federal Reserve raising interest rates for the first time in several years and explicitly telling markets to expect 4 more rate hikes in 2016, common logic was that bonds would have a tough time.
Funny thing, no one told the bond market itself as it did as well or better than the stock market this quarter. Some of the strength was due to the stock market’s volatility.
Another reason is that most of the rest of the world is trying desperately to either climb out of recession or keep from going back into one. To combat this, many governments have pushed their interest rates into negative territory. In fact, about a quarter of government bonds around the world are paying a negative interest rate. This means that investors in those bonds not only are not getting paid any interest, but are actually losing principal. Just like you would switch banks if it began taking money out of your account each month, these international investors are flocking to U.S. bonds.
This increased demand, along with the markets now not expecting more than a couple of interest rate increases this year, has helped bonds increase in value. The flip side of negative interest rates is that some European homeowners are now earning interest on their mortgages!
Commodities – All That Glitters
Although broad based commodity indexes were flat this quarter, some commodities, led by gold, had a laggard rally of their own. With its strong performance last quarter, gold now has a positive return for the last 12 months. However, over the past 5 years it still has averaged a negative 3% annualized return. Gold historically has appreciated in value during during periods of unanticipated inflation or extreme economic uncertainty. Inflation continues to be very low globally so the recent strength is more likely due to weak growth, especially in Asia and Europe.
Other commodities which had strong quarters include oil, silver and platinum. Weakness in agricultural products such as rice and cotton along with continued weakness in natural gas were drags on the asset class.