The S & P 500 (Total Return) Index gained 2.46% in the quarter; but not without a whipsaw caused by the June 23rd vote in Great Britain to leave (Brexit) the European Union. Two days of steep losses (over 5%) were almost completely recovered in the last three days of trading. The index gained 3.99% for the first six months.
Portfolio components whose indexes also performed well were Real Estate (up 5.42%); Large Cap Value (up 4.58%) and Small Cap Value (up 4.31%). Commodities outperformed equities for the first time in five years; gaining more than 11% during the six months. Amazingly, even with interest rates at historic lows, bonds continue to make gains. The Barclays US Aggregate Bond Index increased 2.21%.
International markets continue to underperform, with both the Developed and Emerging Markets Indexes taking small losses for the quarter.
Market movement was dominated by the somewhat surprising result of the June 24th citizens’ referendum for Great Britain to terminate its 47 year membership in the European Union. The following day, the British Pound fell 10% against the dollar to its lowest level since 1985. European stocks fell 7% and the S & P 500 fell by 3.6%.
The European Community, predecessor to the EU, had been formed to promote peace following World War II and evolved into a common market allowing the free movement of goods and people among its 28 member states. There are currently 3 million EU citizens living and working in Britain.
The vote, prompted by considerable displeasure with the effects of globalization and immigration -especially by residents of rural England – is just a first step in what would be the messy and complex negotiation to implement an actual departure from the EU. The next step is Britain invoking Article 50 of the Treaty of Lisbon which starts the clock ticking on a maximum two year period to complete the excision. The negotiations may be difficult. And exactly what the final result may look like – anything from EU lite (like Norway’s agreements) to an acrimonious and economically perilous divorce – is anyone’s guess.
Given that none of the leaders of the “leave” movement (all of whom immediately backed out of the race to become the next Prime Minister) had a plan for its execution in the event the measure passed, there is considerable debate as to how fast the country should move toward implementation – or perhaps even consider a “do over.” In any event, it will take years for the eventual consequences to be digested by the markets and before we truly understand the consequences of the decision.
It’s summer. We want to take some time off. Go to the beach. Lop a few strokes off our handicap. But the market delivers its lessons all year long. So Brexit offers a great opportunity to stress test our plan.
Brexit was especially interesting because we knew the vote was pending. But it was impossible to reliably forecast the result. The polling was muddled and even the venerable British odds makers got it wrong.
Most news is even more unpredictable (which is, I guess, what makes it news.) And there will be worse news. Be it an election, a terrorist attack, a tsunami, or, as in 2008, termites in the real estate market. We don’t know exactly what or when the news will be. We just know it’s coming. The wise course is to use these moments as emotional practice for the inevitable bear markets.
Even before the internet age, new information was incorporated too rapidly into prices to be able to effectively do anything with it. Now it all happens in real time. Old news is already priced in to the values of individual securities and the market as a whole. This morning’s unpredictable revelations will be reflected in this afternoon’s prices.
So we spend considerable time baking into your strategy the absolute certainty that dispiriting economic news will be delivered with regularity. Accordingly, portfolios are constructed maintaining an asset allocation and sufficient cash reserves to take into account your need to take risk, your capacity to absorb risk and your emotional tolerance to the market’s gyrations. With any luck panic will never ensue.