This month, the S&P 500 and Dow Industrial Average set all-time highs. And while the seems impressive, it’s also important to note that those two market averages are only 2% higher than they were over a year ago. More importantly is the fact that all of the big moves have been to the downside. During the past year, we’ve had two periods of intense selloffs of roughly 11%. Each time, the markets have taken months to claw their way back to break-even. So it has been a frustrating way to achieve a few percentage points of growth lately.
This type of market action really speaks to the condition of the global economy: there’s not a lot to look forward to and a whole lot to worry about. Quarter after quarter, actual economic growth and future forecasts in the major economies have be plagued by weak demand. The most notable slowdown has been in China. Beyond that, the Eurozone has proven to be the next biggest trouble spot. This past quarter, the British decision to leave the European monetary union has cast further doubt about the continent’s prospects.
Lacking conviction, each negative event has led to a sharp selloff in equities and predictions of doom. Another byproduct of these events is further drops in interest rates. After the British exit vote, the benchmark 10-year treasury bond dropped to around 1.5%. While this may be good for borrowers, it speaks poorly of the market’s attitude about the economy’s condition and is leading to some very interesting situations in the bond market. We are now seeing for the first time negative yields on the shortest term bonds in several countries such as Germany and Japan. This means that on several maturities investors are having to pay to park their money in these bonds. This is something that has previously been unheard of.
In light of all this, investors are not left with many choices as to where to save. Bond yields are likely to stay down for the foreseeable future and, lacking a catalyst for accelerated grow, stocks will continue to be vulnerable to more selloffs. This is a challenging time. Our investment strategy continues to be to invest domestically as the U.S. markets gain in popularity relative to foreign ones. It’s like having the best house in a bad neighborhood.
We’re also continuing to emphasize investments that provide a meaningful income stream. The cash flow component of all asset classes has proven to amount to a significant portion of the total return during this time period. This has also slanted our equity positions to be more defensive and value oriented. On the fixed income side of our portfolios, we have seen a nice recovery in the prices of the alternative income producing assets. Many of these issues have come under significant price pressure in the past year which has masked their cash flow performance. Since the cash flow has remained strong during this time, now that the prices are coming back, this portion of our portfolios has done especially well.
Going forward, our guess is that the election cycle will dominate the news and take much of the focus off foreign events. It’s hard to say whether that news will be good or bad for the markets though. Neither candidate has a particularly inspiring message on the issues that are actually important to growing the economy. If you want to vote in your financial self-interest, focus on tax reform, deficit spending and the outstanding debt, and reducing the regulator cost and burden on business.