“Between a rock and a hard place”…It’s a phrase we’re all familiar with and also happens to be where the stock market finds itself. The first quarter of 2016 saw our growth benchmark, The All Country World Index (ACWI) drop 12.15% at its nadir in early February, only to rebound in full by quarter’s end – thanks Chair Yellen! As of this writing, the ACWI is only 0.14% away from where we started the year- yes, volatility is here to stay – more on that to follow.
As mentioned in my earlier post in late January, BSW rebalanced portfolios near this low point, taking money off the table in appreciated bonds and adding to growth equities. Nice move in retrospect, but again, we were not trying to call “a bottom”, rather we were sticking to our proven, disciplined approach.
Interestingly, the above mentioned idiom was first coined in the early 1900’s and referred to the struggles that the Arizona and California mining industries were experiencing as a result of the US Bankers Panic of 1907. This financial crisis hit the mining industry the hardest, pushing many mining companies to declare bankruptcy or cut wages. It is surmised that the phrase came about due to the mineworkers’ choice between harsh and underpaid work on the “rock” and unemployment and poverty on the other – “a hard place.”
Today’s version of this saying might be: “Caught between a barrel of oil and a hard place.” Although, instead of the mining industry, we now have worries about oil-related companies going bankrupt and, despite low (headline) unemployment, many in this country find themselves in a hard place – a product of stagnant wages, a manufacturing slowdown and a drought of capital spending by U.S. firms. People want change. The frustration can be seen in the electorates’ willingness to take on radical thinking on both the Left and Right.
The stock market is currently constrained on the upside by fears of the Fed tightening and conversely, has a floor on the downside – created by the exact same institution flip-flopping and indicating that it will hold off on raising rates. At the heart of this perverse dynamic is the fact that the Fed is the only central bank on the block that is on a rate-rising path. All around the world – Japan, Europe, China – central banks are flooding their markets with liquidity and implementing extreme measures (like negative interest rates) to try to stimulate their economies. This sharp juxtaposition of the Fed tightening and the rest of the world loosening, sets up the potential for a very strong dollar – something that Chairperson Yellen has recognized, “can have serious destabilizing effects on the world economy.”
So on the one hand, the U.S. economy is doing OK. Hiking rates to get back to some semblance of a “normal” market environment is what the markets desire. On the other hand, the U.S. is bound by fragile global markets. Rising U.S. interest rates could crush any market rally by pushing the dollar higher. It’s no wonder that when we look around, we find lower return expectations, pockets of mispriced asset classes and volatility that ebbs and flows with the thoughts-du-jour of a Fed that is clearly figuring it out as they go. The market is ignoring macro-economic numbers, micro-economic numbers (i.e. earnings expectations – remember when earnings mattered) and is squarely focused on the Fed. The chart below does a good job of illustrating the relationship between James Bullard’s (the most vocal of Fed governors) speeches and comments, and the S&P….when the Fed signals, the market moves.
Despite the challenging world stock markets, fixed income (especially municipal bonds) did well in Q1. With the Fed holding off on rate hikes, bond prices increased and yields decreased. Our fixed income managers beat their benchmarks and delivered solid results that helped insulate portfolios from stock market swings. Although yields are low by any standard, we continue to value fixed income for its sustained inverse relationship to the stock market, steady cash flows and importantly, currency for buying more growth equities when the market dips.
As a preview of things to come, the BSW Investment Policy Committee is reviewing several promising investment “ingredients” that might find their way into client portfolios – as appropriate to each individual client situation. Given the current, persistent market environment, BSW has been looking closely at how we can maximize risk/return and generate more income in portfolios. These ingredients will not replace the core of what we do in the growth or fixed income buckets of the portfolio, but may be added as a complement to the core. We see opportunity with active stock managers that can take advantage of disconnects in valuation and also see some good opportunity to capture stock-market-like returns with a lot less volatility through the use of some liquid, alternative funds that have the ability to take advantage of a falling market as well as a rising market. We are also exploring how to monetize the increased volatility in the market as a means to boost cash flows in portfolios, without taking on interest rate risk.
As a final thought, times are most definitely interesting. We have talked with clients about oil, the political climate, China and geopolitical threats. There will always be noise. The press – which is now in our faces more than ever – will continue to dramatize to sell advertising space. BSW is filtering through all the noise to avoid potholes and pitfalls and to ensure that we are keeping portfolios on track to meet each BSW client’s individual goals.
As always, if you have any questions or comments, or would like to discuss your portfolio in detail, your BSW team is standing by and would enjoy the opportunity.
Thanks for reading and Happy Spring!
Craig Seidler, Director Public Investments