Quarterly Investment Letter

 

3rd Quarter 2017

Global equity markets rose in US-dollar terms during the third quarter of 2017, boosted by continued signs of synchronized global economic growth. Despite rising tension around North Korea’s missile program, which led to periodic moves into perceived safe-haven assets, markets appeared to focus more attention on encouraging economic data from developed and emerging markets alike. Investors also weighed statements from central banks in the United States, Europe and Canada regarding the timing of interest-rate increases. The MSCI All Country World Index generated a 5.31% total return in US-dollar terms for 2017’s third quarter.1 Emerging stock markets, as measured by MSCI indexes, collectively topped their developed-market peers.1 Regionally, Latin American markets substantially outpaced European and Asian equity markets, with all three regions outperforming the global index. US stock markets rose solidly for the quarter but trailed the global index.1

US Second-quarter 2017 US gross domestic product (GDP) beat consensus expectations with 3.1% annualized3rd Qtr 2017 worldperf growth—the strongest rate of expansion since early 2015.2 Stepped-up consumer spending and exports (aided by US-dollar depreciation) were among the key drivers for the US economy. During the third quarter, consumer spending rebounded, supported by an improving labor market, low interest rates, and greater optimism about the economy. The impact of severe hurricanes on the United States and nearby countries did not seem to diminish long-term expectations for the US economy. The nation’s unemployment rate has held below 5% throughout year-to-date 2017, and there were more than 6.2 million job openings in the United States in September, the highest total on record.3 However, wage growth remained modest given the strong jobs numbers.3 Following two interest-rate hikes earlier this year, Fed officials signaled a third 2017 increase remains a possibility for December. The Fed also indicated it will start to gradually unwind its US$4.5 trillion balance sheet in October, which expanded to unprecedented levels in efforts to spur economic growth after the 2008 financial crisis.

Stock exchanges in Europe advanced in the third quarter, despite a strong euro during much of the period, driven by upbeat economic data and corporate earnings reports. Investors appeared to largely shrug off the outcome of Germany’s general election in September, in which Chancellor Angela Merkel’s party prevailed but with a lower level of support. The European Commission’s economic sentiment gauge hit its highest level in 10 years in August and September.4 

 Although worries about North Korea’s missile program and disappointing data from China restrained sentiment, Asian equity bourses generally rose in the third quarter. In July and August, China’s industrial output, retail sales, and fixed asset investment all showed strong growth but at lower rates than in previous periods.5 Japan’s GDP continued to improve, while India’s GDP grew at the slowest rate in three years.6, 7 Many analysts attributed the deceleration in India to a stronger currency, a new goods and services tax, and disruptions to the economy from the government’s recent demonetization (the withdrawal of certain high-value banknotes in an effort to combat corruption).

Latin American stock exchanges collectively soared ahead of the global index and other main regional groupings for the third quarter. Many investors appeared to cheer economic data from the major countries in the region, as well as hopes for reforms, especially in Brazil. Indexes in Brazil, Chile, and Argentina posted double-digit percentage gains, while Mexico trailed the broader region with a small advance.1

 

Looking Forward

The year thus far has been positive for most asset classes, with stocks outperforming bonds and real estate by a wide margin. We are sometimes asked, “why aren’t we up as much as the market”? Of course, the “market” to which they are referring is one of the common US stock indices such as the Dow Jones Industrial Average or the S&P 500. Most often, the simple answer is that their portfolio, which is a diversified blend of stocks, bonds, alternatives (real estate, commodities, and hedging strategies) doesn’t have as much risk as the “market.” Diversification is our friend, but it may not always feel that way. We would all prefer owning only the best performing investments over a given timeframe. Unfortunately, attempting to do so has been proven time and again to be an irrational strategy and/or goal.

 

It will soon be the 10-year anniversary of when, in early October 2007, the S&P 500 Index hit what was its highest point before losing more than half its value over the next year and a half during the global financial crisis. Opinions on how the environment today may be similar or different from the period leading up to the crisis are varied. It is difficult to draw useful conclusions based on such observations; financial markets have a habit of behaving unpredictably in the short run. There are, however, important lessons that investors might be well-served to remember: Capital markets have rewarded investors over the long term, and having an investment approach you can stick with—especially during tough times—may better prepare you for the next crisis and its aftermath.

 

In 2008, the stock market dropped in value by almost half. Being a decade removed from the crisis may make it easier to take the past in stride. The eventual rebound and subsequent years of double-digit gains have also likely helped in this regard. While the events of the crisis were unfolding, however, a future of this sort looked anything but certain. Headlines such as “Worst Crisis Since ’30s, With No End Yet in Sight,”  “Markets in Disarray as Lending Locks Up,”  and “For Stocks, Worst Single-Day Drop in Two Decades”  were common front page news. Reading the news, opening up quarterly statements, or going online to check an account balance were, for most of us, stomach-churning experiences.

 

While being an investor today (or during any period, for that matter), is by no means a worry-free experience, the feelings of panic and dread felt by many during the financial crisis were distinctly acute. Most investors reacted emotionally to these developments. In the heat of the moment, some decided it was more than they could stomach, so they sold out of stocks. On the other hand, many who were able to stay the course and stick to their approach recovered from the crisis and benefited from the subsequent rebound in markets.

It is important to remember that this crisis and the subsequent recovery in financial markets was not the first time in history that periods of substantial volatility have occurred. Exhibit 1 helps illustrate this point. The exhibit shows the performance of a balanced investment strategy following several crises, including the bankruptcy of Lehman Brothers in September of 2008, which took place in the middle of the financial crisis. Each event is labeled with the month and year that it occurred, note that the point of the crisis doesn’t always align with the stock market peak.

3rd Qtr 2017 mktresp

 

Although a globally diversified balanced investment strategy invested at the time of each event would have suffered losses immediately following most of these events, financial markets did recover, as can be seen by the three- and five-year cumulative returns shown in the exhibit. In advance of such periods of discomfort, having a long-term perspective, appropriate diversification, and an asset allocation that aligns with your risk tolerance and goals can help you remain disciplined enough to ride out the storm. We also believe one of our most important roles is to help you remain disciplined when things look their darkest.

 

In the mind of some investors, there is always a “crisis of the day” or potential major event looming that could mean the beginning of the next drop in markets. As we know, predicting future events correctly, or how the market will react to future events, is a difficult exercise. It is important to understand, however, that market volatility is a part of investing. To enjoy the benefit of higher potential returns, investors must be willing to accept increased uncertainty. A key part of a good long-term investment experience is being able to stay with your investment philosophy, even during tough times. A wellthoughtout, transparent investment approach can help you be better prepared to face uncertainty and may improve your ability to stick with your plan and ultimately capture the long-term returns of capital markets.

 

If you have thoughts or questions about any of the information we’ve shared or on any other subject, please don’t hesitate to call us. We are grateful you allow us to serve you and your family and we will continue to make every effort to earn the trust you’ve bestowed on us.

 

Sincerely,

 

Your CCA Investment Team

 

Advisory services offered through Cravens & Company Advisors, LLC, a Registered Investment Advisory Company.  Securities offered through, and advisory services may also be offered through, FSC Securities Corporation, an Independent Registered Broker/Dealer.  Member FINRA/SIPC and a Registered Investment Advisor.  Not affiliated with Cravens & Company Advisors, LLC.

 

Investing involves risk including the potential loss of principal. Investing involves risk including the potential loss of principal. International investing involves additional risks including risks associated with foreign currency, limited liquidity, government regulation, and the possibility of substantial volatility due to adverse political, economic and other developments. The two main risks associated with fixed income investing are interest rate and credit risk. Typically, when interest rates rise, there is a corresponding decline in the market value of bonds. Credit risks refer to the possibility that the issuer of the bond will not be able to make principal and interest payments. Investments in commodities may entail significant risks and can be significantly affected by events such as variations in the commodities markets, weather, disease, embargoes, international, political, and economic developments, the success of exploration projects, tax, and other government regulations, as well as other factors. No investment strategy can guarantee a profit or protect against loss in periods of declining values. Past performance is no guarantee of future results. Please note that individual situations can vary.  Therefore, the information presented here should only be relied upon when coordinated with individual professional advice. Any opinions or forecasts contained herein reflect the subjective judgments and assumptions of the authors only and do not necessarily reflect the views of FSC Securities Corporation. There can be no assurance that developments will transpire as forecasted and actual results will be different. Data and analysis do not represent the actual or expected future performance of any investment product.

 

1.             © 2017 Morningstar, MSCI.

2.             US Bureau of Economic Analysis.

3.             US Bureau of Labor Statistics.

4.             European Commission.

5.             National Bureau of Statistics of China.

6.             Cabinet Office, Government of Japan.

7.             Ministry of Statistics and Programme Implementation, India (MOSPI).

 

APPENDIX

Balanced Strategy 60/40

The model’s performance does not reflect advisory fees or other expenses associated with the management of an actual portfolio. There are limitations inherent in model allocations. In particular, model performance may not reflect the impact that economic and market factors may have had on the advisor’s decision making if the advisor were actually managing client money. The balanced strategies are not recommendations for an actual allocation.

 

International Value represented by Fama/French International Value Index for 1975–1993. Emerging Markets represented by MSCI Emerging Markets Index (gross dividends) for 1988–1993. Emerging Markets weighting allocated evenly between International Small Cap and International Value prior to January 1988 data inception. Emerging Markets Small Cap represented by Fama/French Emerging Markets Small Cap Index for 1989–1993. Emerging Markets Value and Small Cap weighting allocated evenly between International Small Cap and International Value prior to January 1989 data inception. Two-Year Global weighting allocated to OneYear prior to January 1990 data inception. Five-Year Global weighting allocated to Five-Year Government prior to January 1990 data inception. For illustrative purposes only.

 

The Indices used have been retrospectively calculated by Dimensional Fund Advisors LP and did not exist prior to their index inceptions dates. Accordingly, results shown during the periods prior to each Index’s index inception date do not represent actual returns of the Index. Other periods selected may have different results, including losses.