Where do the market benchmarks stand as we near the end of the second quarter?
As of the close of business on Thursday, June 23rd the Dow Jones Industrial Average (DJIA) finished the day at 18,011 and the S&P 500, which is another closely watched and broader benchmark for the U.S. equity capital markets ended the day at 2,113. Both benchmarks have increased 3.4% on a year-to-date basis, which seems pretty modest, but keep in mind that in mid-February the DJIA closed at 15,973, off 8.3% from the beginning of the year. The S&P 500 closed down 8.8% from the start of the year on the same day.
These were some of the measures of the capital markets when we left the office yesterday, June 23rd. The global capital markets look very different this morning, but despite the historic vote in Great Britain to leave the European Union, it is important to remember that this is not the end of the world. The United Kingdom’s economy is the 5th largest economy in the world with a population of 63 million people. In the short-run there is likely to be increased volatility and some market disruption, but new trade agreements will be negotiated and trade will continue.
Today, the global equity markets are suffering. This historic vote in Great Britain creates uncertainty. Investors typically dislike uncertainty and we are seeing a rapid shift in asset selection from risk taking to risk avoidance. Safe haven assets like U.S. currency and U.S. Treasury securities are up in value on the global markets. Risk based assets in Britain are being discounted.
What we want to be careful about is making long-term decisions on short-term market events. What is happening in Europe and around the world does impact us, but we want to keep some perspective about this event too. Just because the Britain has voted to leave the European Union it isn’t like they cease to exist.
What is happening with interest rates? “Last week Federal Reserve officials reduced their estimates of how their benchmark federal-funds rate is likely to move in the years ahead. They see it still below 2.5% by the end of 2018”1. Currently the federal-funds rate is at .25%. An expected increase in the rate in June was postponed. The Federal Reserve Open Market Committee, which sets this rate will next meet on July 26th and 27th. Recently Germany joined Japan in experimenting with negative interest rates. In testimony before Congress, Federal Reserve Chairwoman said negative interest rate policies are “not something we are considering”2.
U.S. Treasury securities continue to be a safe-haven asset.
This morning the U.S. 10-year Treasury note is trading with a yield of 1.54%. Yields have declined 20 basis points this morning due to the British vote. The Federal Reserve has expressed a desire to normalize interest rates after pushing the Federal Funds rate to zero following the credit crisis in 2008. Last September they were able to bump the rates up 25 basis points. At that time the U.S. 10-year Treasury stood at 2.25%. Theoretically, when the Federal Reserve raised the fed funds rate other interest rates should have moved up as well. Global pressure, the desire for safe havens, along with the wide margin between U.S. interest rates and rates in other developed nations attracted funds into the 10-year Treasury and prices rose and yields fell. This happening again today. I suspect this is not what the Federal Reserve Governors expected which complicates their monetary policy actions.
What is happening with Gross Domestic Production, Corporate Earnings, and Labor?
Christine Lagarde, Managing Director of the International Monetary Fund (IMF) announced at a news conference yesterday in Washington D.C. the overall condition of the U.S. economy is “in good shape”. She went on to explain that it isn’t perfect and work needs to be done to cause additional sustainable growth. The IMF is forecasting U.S. Gross Domestic Production Growth at greater than 2% for the year. This means we should see an increase in the GDP in the second half of the year. If you want to watch a brief video of the Managing Director’s new conference, click on the link below.
Corporate earnings for the second quarter will begin being reported when Alcoa makes their report on July 11th.
“A positive development that has not gone unnoticed is that earnings estimate revisions have stopped deteriorating.”
Unemployment remains at 4.7%, which is below (IMF Managing Director place the unemployment rate at 5%) the 5% threshold the Federal Reserve had established as a trigger point for raising interest rates. Job growth slowed in May, but previous job growth reports were good and the new claims for unemployment continues to decline.
The Brexit vote has the markets reeling today. U.S. equity markets are off some 335 points this morning. This is likely a temporary overreaction as the market place and investors try to figure out the impact of this vote. With better corporate earnings, and modest GDP growth being forecast over the second half of the year, we want to keep all of this short-term disruption in proper perspective. Folks in Great Britain are going to continue to go to work, buy homes, have families, buy groceries and other goods and services. Business will adapt to the new structure and look for opportunity.
1 Wall Street Journal, Fed Chief Minimizes Chance of Recession, Wednesday, June 22, 2016, Page A-2 2 ibid
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Unforeseen factors and other market events could impact the markets in ways not anticipated or discussed in this letter.
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