Summer Client Investment Letter {Part I}

We are going to run in a serialized form our most recent investment letter this week.  The letter was written between the 10th and 15th of July and was mostly sent out to clients at the end of last week.   Below is part I.  

How have the markets done so far this year?

The S&P 500 ended the first half of 2016 with slight gains.  That’s a pretty good run after last winter’s 10% decline.  However, those gains had more to do with timing.  If the quarter had ended on June 9^th then stocks would have grown about 4%.  If it had ended after the shock of Great Britain voting to leave the European Union then we would have instead seen about a 3% decline for the same period.  We still face the same conundrum we’ve been in for quite some time.  Stocks are not historically cheap as they trade around 17 times next year’s estimated earnings.  But low interest rates make valuation less of a concern to investors, as there seemingly is no other place to put money.  Lower rates are likely one reason stock prices have been able to sustain current prices.  Also, stocks might not appear to be so expensive if corporate earnings start to accelerate in the coming quarters. Some analysts suspect this might occur. As I’ve said before, being able to buy the S&P 500 with a 2% yield may be attractive to investors with miniscule short-term rates and a US Treasury 10-year bond yield of 1.57%.  At least you are getting paid to wait for that growth.  Markets seem to have received this message as we’ve seen a nice rally in the last three weeks. 

What ETFs or strategies worked for investors in the first half of the year?

Anything that boasted a dividend strategy had a good first half.  The dividend oriented ETFs we follow posted gains of around 10% as investors relentlessly searched for yield.  ETFs related to emerging markets also grew between 8-10% through June 30^th as they recovered from a horrendous 2015.  Beyond this most other investment categories in the aggregate were break-even.  The major market ETFs we follow gained on average a little over 1%. On average the foreign ETFs we follow declined 1.5%.  Sector performance reflected the defensive nature of the markets. Consumer staples and utilities posted double-digit gains.  These sectors also on average pay relatively high dividends. Other solid performers were sectors that last year saw severe declines such as the energy sector.  But technology, healthcare and the financial sectors, three of the largest components in the S&P 500, were basically a combined break-even.  Please note that client results will depend on their exposure to each sector or strategy and that is based on individual preferences.**

What does Great Britain’s vote to leave the European Union, the so-called “Brexit” mean to markets?

There is a lot of speculation on what will come of this decision.  Understand though that nobody knows what the long-term economic outcome will bring.    Some time and distance needs to take place between the recent vote and possible investment implications of the outcome.  The market sold off after the vote because investors had been anticipating a “remain” win.  Markets rebounded after a few days when it became apparent that at least on an economic basis not much had changed in the short run.  If you take the week before the vote and the week after out of the picture then stocks basically were unchanged.  While individual stocks experienced very sharp volatility, ETFs for the most part saw less of that, which is one of their advantages.

The sun still came up in the east after the vote and business still needs to get done.  Regardless of whether Britain leaves the EU, people will figure out how to sell oranges from Spain, olives from Greece and cars from Germany into the country.  The English will also figure out how to sell oil and wool products to the continent because it is in their advantage to do so.  There may be some long-term repercussions but those are currently unknowable. We’re just going to have to see how it unfolds before we can understand any economic and market implications from this. 

We will continue with Part II of this letter tomorrow.

**Discussions on the performance of the ETF strategies discussed in this letter are taken from sources we deem to be reliable but cannot be guaranteed.  Performance does not include dividends returns.  Dividends would have likely improved the total return of all strategies listed in this letter. Information on these indices is available upon request.

*We owned ETFs related to the S&P 500 in client and personal accounts at the time this article was written.  Please note these positions can change at any time without notice.