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Midyear 2016 Investment Outlook

Between a stock market correction to begin the year and concerns over Britain’s vote to leave the EU in late June, 2016 is giving investors a bumpy ride. Brian Kilb and Marc Amateis reflect and project ahead in a Money Talk Video. A transcript of their discussion follows.

Brian Kilb: Marc, we’ve made it halfway through the year, it’s gone pretty quickly. Lots of volatility and lots of things for people to be concerned about. Yet, markets are up. Stock markets are up slightly. For the most part, the bond market has been surprisingly strong. Maybe if I were to pick a word for the first six months, I’d pick “resilient,” in terms of overall performance.

Marc Amateis: You’re right. A lot of things happened in the first half of the year. We had a 10%-plus correction early in the year, came out of it nicely. And here we are halfway through the year, and the S&P 500 finished the first half of the year up 3.8%, that’s dividends reinvested, so total return. The bonds, as you mentioned, have done great, up 5.5% on the aggregate bond index. Again, a reminder of how important it is to have a well-balanced portfolio.

Looking forward to the second half of the year, we’re cautiously optimistic that we can move higher in the stock market, but there’s going to be some trials and tribulations along the way, like there always are.

Brian: Isn’t it fascinating through the first six months how bonds have performed? Since the financial crisis, we’ve heard, “Hey the bond market has to have some massive correction at some point in time.” So here we are with the 10-year U.S. Treasury starting the year at 2.25% give or take now down to a yield of just a little under 1.5% in recent days.

Bond returns through the mid-part of the year, in the aggregate, up 5%-6%, municipals – 4%. What a great reminder to keep invested in bonds for safety and to understand that at times they’re going to be the best performer in your portfolio – unexpectedly, perhaps.

Marc: Bonds are doing very well this year, not because of yield, obviously. Yields are very low. It’s because of price appreciation. Remember that relationship: falling interest rates, the value of a bond that you own, everything else being equal, goes up. And that’s what we’ve experienced.

But that’s also a warning sign to investors to be careful with the bonds that they own. What goes down, eventually is going to come up, and those yields will start to rise at some point. And you really want to watch your durations, because if you get caught long duration, that’s where you’re really going to get hurt when interest rates rise.

And then the other thing you want to watch is your credit quality. The high-yield, low-quality bonds have done well over the years, but that’s a pretty expensive trade right now, we think. And you’re playing with fire if you stay real low-quality in your bonds – and especially if you’re longer duration.

If you’re not sure what you own, if you don’t know the duration your bond portfolio, if you don’t know the credit quality of your bond portfolio, talk to your advisor, and make sure you understand how you’re positioned.

Brian: Marc, if we circle the bases on other asset classes, real estate had a pretty good first half of the year. The select REIT index is up a little over 9% through the middle of the year. That’s not bad. Commodity prices in part have rallied fairly significantly. Oil, which bottomed in February, now is close to $50. You’ve seen a nice comeback there. So it’s been a good first six months for diversified portfolios, as you look at some of the alternatives to just traditional bonds and stocks, as well.

Marc: Right, and when you’re talking about REITs, you’re talking about yield. Again, a global search for yield in this low-interest rate environment. And REITs – real estate investment trusts – offer some pretty high yields. So, that’s a good alternative for income investors, as is the stock market.

Look at the dividend yield on the S&P 500, I guess right around 2.3%. And we just talked about the yield on the U.S. 10-year – down at about 1.5%, even 1.4%.

So, there you go. You can get more income off the S&P 500, and hopefully you get capital gains. But if not, if you’re a long-term investor with a well-diversified portfolio, you can hang in there with good blue-chip stocks, wait for them to appreciate – even if they fall – if you don’t need to touch that money. And you can accumulate the dividend for your income.

Brian: Let’s talk about domestic stocks a little bit, Marc. It’s been a bit of a swing in the rotation of stocks from what had been doing well, which is larger growth stocks, to value. Value did a little better this last six months. So you’ve seen a little bit of a shift there, a little bit of a flight back to safety. That may be in part due to the attractiveness of dividends you just spoke about.

Marc: Yeah, absolutely. Growth stocks have outperformed value stocks up until this year for a few years. So they were leading the charge. Around the first of the year, the baton seemed to be passed to the value stocks, and for the first half of the year, value stocks have outperformed the growth stocks.

But it’s, again, a real good lesson for investors that things do change over time. They have to watch their portfolios. They have to make adjustments where opportunity exists but also maintain that balance. We talk a lot about never going too far one direction or the other.

Brian: As we look toward the second half of the year and start to think about some themes that may play out, the Brexit was the big story as we ended this six-month period.

I think what the Brexit may have done is give us some reassurance, if you will, that the dollar has to remain strong, at least for the short-term. And that interest rates aren’t going anywhere. I think the Brexit probably gave the Fed ample reason not to do anything for at least the next few months.

Marc: I would tend to agree, Brian. The Brexit: Great Britain voting to leave the eurozone. And we’ll see if it actually happens. But I think clearly that’s going to have a negative effect on Great Britain and to a lesser extent the eurozone, but even a lesser extent on the United States. So, I think if there is a safe haven out there, you’re probably looking right here at our own shores.

Brian: If you start thinking about the next six months, and you think, “Well, interest rates ought to remain low.” I think there is a good argument that earnings in corporate America, for the second half of the year have to have to make a significant comeback. In a low-interest rate environment with positive earnings results, that seems to speak positively for the opportunities in stocks, as we look into the third and fourth quarter. Agreed?

Marc: Right. Low interest rates are good for stocks, everything else again being equal. However, you know, we’re in negative interest rates in many places around the world now.

Just because we have a low interest rate environment doesn’t mean that stocks are just going to take off or continue the nice run. There are other things at play.

Brian: I think, for me, for the second half of the year, we’ll go back to the term resilient. If U.S. markets have been resilient, it’s because I think the U.S. economy has been resilient. I think that might be something that plays out over the second half of the year.

Plenty of concerns in Europe. Plenty of concerns remain in China and other parts of the world. Where I think there is room for optimism, perhaps your money is better suited toward staying home for the foreseeable future.

I see some cautious optimism for the months ahead, but it will be interesting to see how this volatility either increases or settles as we look toward the second half.

Brian Kilb is executive vice president and chief operating officer at Landaas & Company.

Marc Amateis is vice president and an investment advisor at Landaas & Company.

Money Talk Video by Jason Scuglik and Peter May

(initially posted July 28, 2016)

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