Market & Economic Review - Fourth Quarter 2015
Third Quarter Review
The quarter started with anticipation of the U.S. Fed raising rates and ended with the possibility that rates may not move higher until next year. U.S. employment has continued to improve, and inflation has stayed in check. As the end of the quarter approached, it became evident that inflation was likely to remain low through year- end, and that the weakening of China was going to weigh on equity and economic markets. The highlights of the quarter were China’s weakness, continued lower energy prices, and the Fed holding off on raising rates. This all lead to the largest quarterly equity selloff since the third quarter of 2011.
Asset Class Returns, 3Q 2015
On August 11th, the Chinese central bank devalued its currency causing a ripple affect across markets. Of primary concern is the slowdown in growth in the Chinese economy. China is a large consumer of commodities, and this was a signal that demand was likely to be slow. We also saw U.S. equity markets get hit as a cheaper Yuan makes competition tougher for U.S.-based companies competing overseas. In the chart below we see that the S&P 500 sold off dramatically a couple of days after the devaluation. Energy prices plunged in the second quarter, with West Texas Intermediate (WTI) finishing at $46 per barrel—down 24% since June 30th. OPEC supply remained at high levels, and the U.S. and Iran reached a nuclear agreement. Part of the agreement will see Iran enter the world oil market again putting more downward pressure on prices.
The biggest headline of the quarter was the Fed’s decision to forego an increase in rates. While the decision was not necessarily a surprise, it did raise more questions about how and when they will start the process of normalizing interest rates. The Board has laid out the metrics at which they are looking, and it is a mixed bag. Unemployment has certainly reached levels worthy of an increase, while inflation continues to hover just below the 2% target. The key indicator that seemed to delay the decision to raise rates was likely the weakness in China. The marginal buyer of commodities has been China in recent years, and with their economy slowing, it is less likely that inflation will get too far out of control.
Long-term U.S. Treasuries were the best performer, while high-yield bonds got hit for about a 5% decline in the quarter. With uncertainty in the global markets, U.S. Treasuries saw a flight to safety while high-yields moved with equity markets. The 10-year Treasury bond fluctuated in yield from a high of 2.34% in July to 2.04% at the end of September. Global weakness and low inflation along with the Fed on hold to raise rates made Treasuries attractive to buyers even at historically low levels. We continue to see the odds of the Fed raising rates by year end fluctuate from around 40% up to 60%. We believe that the Fed will need to start in December, or it will become difficult to start during an election year. We continue to maintain our position on 4-7 year Municipal bonds and high quality corporate bonds. Municipals have become more attractive as increased supply has caused the spread between Treasuries and Muni’s to widen out. We believe this will provide some cushion when rates start to move higher.
The 3rd quarter 2015 saw the largest quarterly decline since the 3rd quarter of 2011, as a slowing China and Fed delay pushed the S&P 500 down -6.44%. The market had a dramatic decline following the currency devaluation by China in August, and then a second leg down following the Fed’s announcement in mid-September. The U.S. outperformed international markets with emerging markets getting hit the worst. Large-cap stocks outperformed small-cap, and growth outperformed value. Utilities were the only positive performing sector in the S&P 500, while Energy, Materials, and Healthcare had big losses.
We have continued to be overweight Large Cap and U.S. stocks, but believe we will have the opportunity to move towards international and emerging markets as the effects of a rate hike become priced in. Emerging markets took a major hit with a strengthening dollar and lower commodity prices in the quarter. We believe the pace will slow and provide a good entry point.
We were able to avoid most of the carnage in emerging markets, as we have been underweight since early in the summer. We have been early overweighting to value but believe that is the place to be when the Fed begins to normalize policy. Alternatives provided some protection from the market decline, as our funds were ahead of the S&P 500 YTD through September 30th. As we indicated in our 1st quarter commentary, diversification is likely to start working again, and we have indications that it is beginning to happen.
Synovus Family Asset Management Investment Team
Michael S. Sluder, Chief Investment Officer & Sr. Portfolio Manger
Andrea R. Parker, Senior Portfolio Manager
Zachary D. Farmer, Senior Portfolio Manager
Catherine E. Hubbard, Reporting & Operations
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