U.S. markets were initially range-bound for most of the quarter until June, when the relative calm in global stock markets came to an abrupt end. Upending most forecasts and taking world financial markets by surprise, the United Kingdom voted to leave the European Union on June 23. In the wake of the vote, British pound sterling fell 11% overnight against the U.S. dollar, its lowest level since 1985. The euro fell 2.4% to 1.10 versus the dollar. Global equities plummeted.
Then in the week following Britain’s historic vote, global equities rallied despite significant uncertainty regarding the economic, political, and financial market implications of Brexit.When the dust had settled, developed international and European stocks remained in the red, while U.S. stocks edged into positive territory. The big winners in the quarter were emerging-markets stocks, which gained 2.6% and are now up 6.6% year to date.
As the second quarter ended, investors could be forgiven for feeling both bruised and battered. In the aftermath of the Brexit vote, global financial markets initially hit the panic button. Following the vote, stocks fell, bond yields dove, and both the British pound and the euro swooned. The markets demonstrated the typical flight to safety, with U.S. Treasurys, the U.S. dollar, Japanese yen, Swiss franc, and gold all rising sharply.
Here are the broad index returns through the Second Quarter of 2016:
| U.S. Large Cap Stocks | 3.7% | Emerging Market Stocks | 6.6% |
| U.S. Small Cap Stocks | -2.2% | Commodities | 13.3% |
| U.S. Real Estate | 13.3% | U.S. Aggregate Bonds | 5.3% |
| Overseas Stocks | -4.0% | International Bonds | 10.7% |
There are a number of positives in the U.S. economy. Historically low oil prices and high domestic production have lowered the cost of doing business and the cost of living in the United States. Both are a boon to the economy, which is on track to grow at a 2.0% rate this year. Although hardly dramatic, this growth rate is sustainable and not likely to overheat the different sectors of the economy which could lead to a recession. Manufacturing activity is expected to grow 2.6% for the year based on the numbers so far, and the unemployment rate has fallen to 4.7%, below the Federal Reserve target. The unemployment statistics are almost certainly somewhat misleading in the sense that many people are underemployed, and a sizable number of working-age men are no longer participating in the labor force. But for many Americans, the employment picture is much better now than a few years ago. By a number of measures, the U.S. economy seems to be comfortably plodding along.
Uncertainty remains in the Eurozone. A recent report by Thomas Friedman of Geopolitical Futures suggests that the EU, at the very least, is going to have to reform itself and the vote in Britain could be the wake-up call it needs to make structural changes. The Eurozone has been struggling economically since the common currency was adopted. It is still dealing with the Greek sovereign debt crisis, a potential banking crisis in Italy, economic troubles in Finland, political issues in Poland and a wealth disparity between its northern and southern members. Nevertheless, Friedman thinks the UK will be just fine, because Europe needs it to be a strong trading partner. Britain is Germany’s third-largest export market and France’s fifth largest. Would it be wise for those countries to stop selling to Britain or impose tariffs on British exports? Cooler heads are likely to prevail.
The quarter’s market upheaval was yet another reminder that successful investing requires patience. Investing is part of a process, not a one-off decision, toward achieving your long-term financial goals. On the first day of July, the Dow, S&P 500 and Nasdaq indices were all higher than they were before the Brexit vote took investors by surprise. This suggests, yet again, that the people who let panic make their decisions lost money while those who kept their heads sailed through. There will be plenty of other opportunities for panic in a future where terrorism, a continuing mess in the Middle East, a refugee crisis in Europe and premature announcements of the demise of the European Union will deflect attention away from what is actually a decent economic story in the U.S. There will be inevitable and unpredictable shorter-term market ups and downs along the way, and through these periods, it is our job to remain focused on the long-term objectives of our clients, maintaining a consistent investment discipline to guide our decisions over time.