Markets Remain Steady as Election Heats Up

Mike Loewengart, VP of Investment Strategy

E*TRADE Capital Management, LLC

09/06/16

The Facts:

While the U.S. Fed and presidential campaigns made some noise in August, U.S. equity markets were unusually quiet. But that doesn’t mean there wasn’t a lot going on beneath the surface. We’ll take a closer look.

The Impact:

  • U.S. large-caps edged higher in August, trailing small-caps.
  • Developed markets rose fractionally, while emerging markets continued to rally.
  • Bond prices dipped on new rate-hike hints from the Fed.

What It Means for Investors:

Remember emerging markets? Well, they’re back—and they’ve been climbing steadily all year (along with a few other key asset classes). Read on for tips regarding what this might mean for you.

 

A Closer Look

After a strong July, markets took a bit of a breather in August. While all major equity indexes ended higher, U.S. blue chips and international developed markets barely budged. Emerging markets, however, continued to make up ground, reclaiming levels last reached in mid-2015. In fixed income, prices ticked down month-to-month for the first time all year, as yields rose in response to a renewed sense that the U.S. Federal Reserve (U.S. Fed) would lift interest rates over the next few months.

The election everyone’s talking about: Many investors are wondering: How may the upcoming U.S. presidential election impact the markets? Of course, no one knows for sure, and there are a number of important variables at play. But here’s one thing we do know: Both Hillary Clinton and Donald Trump have proposed increased fiscal and infrastructure spending, which—if passed—could result in greater near-term economic growth. That could be good for markets. We’ll cover additional policy differences over the coming weeks. But keep in mind that, as the election nears, questions about the outcome could bring what markets fear most: increased uncertainty. It’s fair to say, then, that we could see additional volatility in the days and weeks ahead. 

What’s up with interest rates?: At the Economic Policy Symposium in Wyoming, Fed Chairwoman Janet Yellen suggested that the case for raising benchmark interest rates had grown stronger. Plus, according to minutes from the Fed’s most recent meeting, participants stated that “near-term risk to the domestic outlook” had diminished. These increasingly hawkish Fed statements have led many investors to believe that a rate increase by year’s end has grown more likely—if not in September, then after the Fed’s December meeting. But there’s one important caveat: Softer-than-expected reports on second-quarter GDP (revised down a tenth of a percent to 1.1%) and August employment (155,000 new jobs added, below expectations) may have given the Fed pause, perhaps bumping out its timeline by a month or two.

major asset class trailing returns graph as of 7/31/16 test

Domestic Equities

While U.S. large-caps stood still in August, investors continued to bid up higher-risk sectors of the U.S. equity market.

The large-cap-oriented S&P 500® Index ticked higher by 0.14% during the month, and is now up 7.82% year to date. With a dividend yield of approximately 2.1% (slightly lower than in recent months), the index may still be benefiting from a lack of competitive yield opportunities in U.S. fixed income markets.

U.S. small-caps outperformed large-caps for the month—again. The small-cap-oriented Russell 2000 Index advanced 1.77% in August, and is now up 10.23% for the year so far.

As we do each month, let’s take a quick look at the sector-by-sector breakdown. Based on the S&P 500 sector indexes, investors in August seemed to gravitate toward some of the higher-risk areas of the market. This also lines up with the outperformance of the Russell 2000, which is generally more volatile than the S&P 500. The month’s strongest sectors were financials, information technology, and energy, while the weakest were telecom, utilities, and health care. On a year-to-date basis, however, defensive sectors have outperformed, with telecom, utilities, and energy leading the pack. Health care, consumer discretionary, and financial stocks have been the weakest in 2016, though all sectors remain in positive territory.

When it comes to the equity styles, value stocks have outperformed their growth counterparts all year, and August was no different. According to the Russell 3000 Growth and Value Indexes, value stocks are now outperforming growth by almost five percentage points year to date.

International Equities

International markets were relatively quiet in August. Japan announced more stimulus measures, and the European Union agreed not to levy fines against Spain and Portugal for missing deficit targets. This could prevent financial disruption in both countries.

After two months of significant gains, developed markets—as measured by the MSCI EAFE Index—were only fractionally higher in August. The index inched up 0.07% for the month, settling in at a modest year-to-date gain of 0.49%.

Emerging markets, however, continued their run to the upside. The MSCI Emerging Markets Index finished 2.49% higher, the best performance of any major index we track. It’s up a sizzling 14.55% for the year so far, and is now near its highest level in over a year.

After months of weakness in emerging markets in 2015 and early 2016, many investors may have left this major asset class behind. Its recent comeback could offer an essential lesson: Past performance is no guarantee of future returns. An investment that’s lagging may find new energy, while another that’s flying high may come down to earth. It’s important to keep perspective.

Fixed Income

In August, for the first time in 2016, bond prices posted a monthly decline. The Barclays U.S. Aggregate Index dipped 0.11%, trimming its year-to-date gain to a still-healthy 5.86%. Market activity was strongly influenced by the growing sense among investors that the U.S. Fed is likely to raise interest rates sooner than previously expected.

In the U.S. Treasury arena, the yield on the benchmark 10-year note rose by 12 basis points to 1.58%—and is now down 69 basis points year to date. (A basis point is one one-hundredth of a percent.) The yield curve flattened moderately during the month, as yields rose more at the short than the long end. Given increased expectations for a rate hike, we could see more flattening in the months ahead.

Among the sectors that make up the U.S. fixed income market, high-yield bonds (also known as junk bonds) were far and away the best performers in August, as income-hungry investors continued to seek yield. Long- and intermediate-term Treasuries were the weakest. On a year-to-date basis, the story’s somewhat different: Long-term Treasuries have been the biggest winners (advancing by more than 16%), followed closely by high-yield bonds. T-bills and short-term Treasuries have lagged. As with U.S. stocks, all sectors remain positive for the year.

The Bottom Line

Recently, several underperforming asset classes, such as emerging markets and energy, have come back to life, turning into some of the year’s biggest winners. Investing in once-struggling asset classes like these—while they’re struggling—isn’t always easy. But they can be valuable as part of a diversified portfolio if and when those investments recover.

Let’s consider a couple of key ways to stay focused through all the ups and downs:

  • Let your goals guide you. For long-term goals (for example, preparing for retirement 10 or more years in the future), what happens in the market tomorrow, next week, or even next month isn’t likely to make all that much difference. On the other hand, when saving for vacation, a down payment on a home, or another short-term goal, an investor’s funds may be better off in a lower-risk, more liquid account, like a money market or CD.
  • Don’t get caught up in the day-to-day. Remember: Stocks and bonds are assets—in some ways, similar to owning a home. But while some investors check the value of their portfolios several times a day, it’s unlikely they’re checking the value of their homes anywhere near as frequently. Along the same lines, investors in stocks and bonds are potentially better served by focusing on the fundamental properties of the assets they own (and why they own them), rather than the value of those assets at any given moment.

It may also be worth noting that the lessons above could be especially useful as the presidential election heats up, potentially creating new market volatility. But over the long term (say 10 or 15 years into the future), any market movements this fall will probably seem like a distant memory. Staying focused on the future may help you weather the short-term fluctuations, while keeping you on a steadier path toward your financial goals.

Thank you for reading.

Mike Loewengart

Vice President, Investment Strategy

E*TRADE Capital Management, LLC

 

Additional contributor:

Andrew Cohen, CFA

Director, Investment Strategy

E*TRADE Capital Management, LLC

 

Mike Loewengart is the Vice President of Investment Strategy for E*TRADE Capital Management, LLC. Prior to joining E*TRADE in 2007, Mike was the Director of Investment Management for a large multinational asset management company, where he oversaw corporate pension plan assets. Mike started his career as a research analyst and an investment manager due diligence analyst for the consulting divisions of several high-profile investment firms. He is a graduate of Middlebury College with a degree in economics.

Andrew Cohen is a Director of Investment Strategy for E*TRADE Capital Management, LLC. Prior to joining E*TRADE, Andrew was the Director of Investments and Operations for a large Registered Investment Advisor, where his responsibilities included investment manager research, asset allocation, and portfolio construction. Previously, he was a Senior Research Analyst and Team Leader for a leading wealth management platform. He is a CFA charterholder and a member of both the New York Society of Security Analysts and CFA Institute. He is a graduate of Virginia Tech with a B.S. in Finance.