2nd Quarter 2016 Market Commentary | Fischer Financial Services

2nd Quarter 2016 Market Commentary

By Gary C. Sanger, Ph.D., CFA
The biggest event this quarter has been Brexit – the referendum by U.K. voters to leave the European Union (more below). U.S. real GDP grew by 1.1% in Q1, revised up from an initial estimate of 0.8%. Forecasts for the complete 2016 year are in the range of 2.5% – 2.8%, still below the long-term trend growth rate. Oil prices have rebounded modestly from a low of $32 per barrel to around $50, signaling some improvement in global economic growth. U.S. leading economic indicators advanced in March and April, but fell -0.2% in May, confirming at best, weak near term growth. Details in several key areas follow below.
Consumers – Unemployment continued to decline over the first half from 5.0% to 4.7%. This decline was due to both new job creation and unemployed workers leaving the labor pool. Personal spending rose by 0.4% in May following a 1.1% (seven-year high) increase in April. This follows weakness in the first quarter, but supports the prediction that U.S. GDP growth will accelerate in the second half of 2016. Consumer confidence rose to 98 in June, up from 92.4 in May, but the impact of Brexit may dampen confidence in the short run. According to the National Association of Realtors existing home sales rose to a nine-year high, up 1.8% in May. The national median sale price of an existing home rose 4.7% from a year earlier – the highest since the NAR began collecting data. Also, new U.S. single-family home sales rose to an eight-year high in April. Steady job growth and continued low inflation contributed to the positive trend in housing. The percentage of U.S. consumers with subprime credit scores dropped to 20.7% in April. This is the sixth consecutive annual decline, and the lowest level since 2005 (the percentage peaked at 25.5% in 2010). If consumers choose to use this credit capacity to borrow and spend, it could help both U.S. banks and overall economic growth.
Businesses – Business conditions in the first half of 2016 continued at a modest pace. The U.S. Institute for Supply Management manufacturing index rose to 53.2% in June, up from 48.2 in December. This is the fastest increase in the past 15 months. However, the ISM services index declined to 52.9. Measures above 50 indicate expansion. One potential effect of Brexit is a stronger U.S. dollar, which makes U.S. exports more expensive, thus reducing growth.
Government –The Fed initially targeted four increases in the Fed funds rate by the end of 2016. Due to global economic and political turmoil, most do not expect any further rate increases for 2016. On a positive note, the Fed announced that most large U.S. banks passed the most recent round of stress tests, which are simulations of a crisis such as the 2007 – 2009 housing crash. Since banks have stronger balance sheets they are now cleared to increase payouts to shareholders.
International – The major international development this year was the Brexit vote. Much has been written about the potential consequences, and I will spare much detail in the interest of brevity. At this point all evidence points to a long drawn out process for the U.K. to depart from the EU, creating political uncertainty in Europe. It is also expected that Scotland will hold its own referendum to withdraw from the U.K. to remain in the EU. Even if all goes smoothly the process will likely take about two years, and must be approved by the EU countries. S & P Global Ratings estimates the exit could reduce U.K. GDP growth by 0.5% to 1.3% in 2017. For reference, the U.K. has the ninth largest economy, contributing about 4% to global GDP.
Closing – Both the U.S. and global economies continue on a modest growth path. The impact of Fed policy (number and size of rate increases) and the unfolding of the Brexit process will play major roles in economic growth going forward. The Brexit episode provides an excellent learning opportunity. One week after the initial panic, most major stock indices have recovered all of their initial losses. Those who panicked and sold in a kneejerk reaction missed out on the best US weekly market return since November 20, 2015. Although impulsive trading is hazardous to your wealth, the Brexit event may also be a good opportunity to reexamine your risk tolerance. If the episode made you queasy, it may be time to lower your risk exposure a notch or two. If not, you are probably right on track to reach your long term goals.

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