“The only certainty is that nothing is certain” – Pliny the Elder
If there is one thing for certain, the market does not USUALLY like uncertainty. This quarter appears to be an exception to that rule as U.S. markets staged an impressive rally in the third quarter of 2016 and the mood was “risk-on”. Despite questions about the health of the domestic economy, the timing of the next Fed interest rate hike, the potential outcome of the upcoming presidential election, and economic concerns in Europe, investors shrugged off all these uncertainties. The market’s appetite for risk assets, with higher returns, was not deterred.
Leading the way in the U.S. was the tech-heavy NASDAQ which posted a 10.02% gain during the quarter. Small cap stocks also advanced with the Russell 2000 Index up 9.05%. Large cap stocks lagged their more aggressive peers, but the S&P 500 Index still added 3.85% for the quarter.
As we enter the final quarter of the year, U.S. markets remain solidly in positive territory. The S&P 500 Index is up 7.84%, with the Dow trailing just slightly, up 7.21%. Small cap stocks (Russell 2000) have rallied an impressive 11.46% year-to-date.
Developed international markets delivered positive returns for the quarter, up 5.8%, but remain in negative territory for the year, down 0.85% due primarily to weakness in Europe. Emerging Markets have been rewarded, along with other risk assets, with handsome gains, up 8.32% for the quarter and 13.77% for the year.
In the face of interest rate uncertainty and warnings of a “bond bubble”, fixed income returns, as measured by the Barclay’s Aggregate Index, were muted in the third quarter, only managing to eek out a 0.46% return. The Index has managed to deliver 5.8% for the year. Other interest rate sensitive segments of the market such as REITs and utilities struggled during the quarter against the backdrop of premium valuations and rate hike uncertainty.
Going into the fourth quarter, market uncertainty remains unresolved. After six-consecutive quarters of year-over-year earnings declines, the fourth quarter may signal the return to positive earnings growth. According to FactSet, analysts are expecting a 5.2% positive earnings growth rate in the fourth quarter, thanks largely in part to the sharp rebound in energy and materials. Analysts are also optimistic about next year’s earnings prospects with annual projections for 13% earnings growth in 2017, with revenue growth of 6.1%
That is not to say that all the bad news is behind us. Economic data for September was mixed, with manufacturing and housing data both weak. Auto sales also appear to have peaked which is resulting in downward earnings revisions there. Third-quarter GPD estimates were recently revised downward as well. OPEC production cuts have spurred a rally in oil prices, which is good for some segments of the economy, but harmful to others.
The Fed held rates steady in September, but most Fed-watchers believe the Fed will still raise rates before the end of the year. And then there is all the uncertainty surrounding the outcome of the U.S. election. All these factors combined mean more uncertainty and more volatility in the fourth quarter and going into next year.
As we enter the last quarter of the year, most investors are sitting on comfortable gains. The Bull market rally still appears sustainable given the resumption of positive corporate earnings growth in Q4. Interest rates remain low, and in some places negative, around the world which could keep Fed action at bay even if economic conditions at home appear to warrant an increase. So given that uncertainty and conditions for heightened volatility remain, we continue to remind clients to stay well-diversified and remain focused on their long-term investment objectives.
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