Just a week ago, I intended to write the third quarter commentary about the “Brexit” and the ramifications of the vote but these days the market moves so fast that by the time you read this letter, the Brexit will be in the rear view mirror if not entirely forgotten – by United States markets anyway. The aftershocks however, could be felt for many years as I believe the benefits to the British people will prove to entice other EU member states, particularly the financially stronger members, to break from the Union and begin to refocus on the needs of the individual country rather than the needs of the whole of a continent. While there will be short term dislocations, volatility, maybe even a British recession, the longer term benefits are significant for the UK including less regulation, savings on European Union contributions, the ability to strike trade deals that align more closely with the interests of the UK, and the addition of a skills based immigration policy.
Over the past week, those individuals in the know on global political issues have already discussed the European Union ad nauseam. I’m going to make the assumption Harding Financial clients are more interested in what we are doing in light of the current market movements.
In the days following the Brexit vote I spoke with many clients and explained I believed the selloff to be emotional in nature, especially for the United States, rather than a fundamental shift in the in our economic environment. Pressure to sell was great as evidenced by the sharp selloff for several days following the vote. However, HFG moved the opposite direction completing substantial purchase transactions in Vanguard Tax Managed, AT&T, Verizon, Flir Systems, Gilead, Amgen, Tesoro, Valero and many others during the period of June 27 – June 30.
Did we catch a bottom? I doubt it. But what we did do is continue to build on portfolios during an emotional period in the markets just as we did in the fall of 2015 and February 2016. Those who have long term experience in the markets understand that buying when everyone else is selling, is the best way to build a long term portfolio. Last quarter I focused on the positives in the market, and though not perfect, data is still improving. Employment is improving in fits and starts. The May ADP report was very weak, but June came in significantly higher than expected, including huge increases in hiring by small business. Industrial production, which declined over the past year, has shown new life over the past couple months. Perhaps this is an indication the worst of the industrial sector’s downturn is over now that the dollar has stabilized and oil prices seem to have leveled off. For nearly 6 quarters, GDP has been very weak but with the weakening dollar and improving employment, it’s not unreasonable to expect an uptick in GDP over the next couple quarters along with an increase in corporate earnings.
Unexpectedly, it is bonds which have significantly outperformed all other areas of the market. Admittedly, I own very few bonds for clients opting for income based annuities and cash because the risk reward ratio is too out of favor in the intermediate term for bond owners. After all, a client must commit their funds for 10 years to a US Treasury to earn 1.37% per year. The only way an investor makes more than 1.37% is if interest rates continue to fall which would indicate a significant economic problem. Because of my allocation decision, balanced portfolios are underperforming their respective indices by 0.25% – 1.00%. Even though the Brexit has likely eliminated additional rate hikes in the near term, as the economy recovers and rates rise, bond holders will lose exponentially. Cash positions have been reduced across the board as we have made substantial investments during each of the 3 previous pullbacks and I’m optimistic that with recent investments we can catch up and surpass comparable indices by year end.
So far 2016 has been dramatic, to say the least, and with the election around the corner things will only get more interesting. I’m reminded of the first time I was on a large ship. Someone advised me to look at the horizon if the movement was making me feel queasy. The tide of money moving quickly between global markets, industries and sectors will create a volatile, rough ride in the coming period of time, but those who stay focused on a horizon of 3, 4 or 5 years, buying with discipline throughout the volatility, will be will be satisfied as they look back at the course they have traveled, surviving the volatility and reaching the destination of paying fair prices to own solid companies, with strong earnings and reasonable dividends.
Thank you for your business and I appreciate the opportunity to work for you.
Michael R. Harding, CFP
President / Portfolio Manager