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Investment Letter

1st Quarter 2016

The first quarter of 2016 was another unpredictable and wild ride for the financial markets.  January marked the worst monthly start for stocks since 2009, and the beginning of a double-digit decline in domestic and international equity returns that ended on February 11th.  The fall in stocks was a result of concerns over the slowing global economy and the additional decline in oil prices.  Fortunately, market turbulence subsided during the last half of the quarter as asset prices started the climb upward.  The V-shaped trajectory of returns was nerve-wracking for most investors, but at quarter end the final impact of the market’s volatility was mostly negligible.  As of March 31, 2016, the Dow Jones Industrial Average (DJIA) closed at 17,685.09 and had a total return of +2.20%.  The S&P 500 Index closed the quarter at 2,059.74 with a total return of +1.35%.  Unfortunately, the turnaround in asset prices was not a rising tide that lifted all ships equally.  Domestic small stocks and international stocks finished the quarter slightly negative.

The table below recaps the 1st Quarter performance of other major indices:

Asset Class

Index

1stQtr. 2016 Total Return

Cash

BofA/ML Three-Month U.S. Treasury

0.07%

U.S. Bonds

Barclays Intermediate-Term Treasury

2.35%

U.S. Large Co. Stocks

S&P 500 Total Return

1.35%

U.S. Small Co. Stocks

Russell 2000 Total Return

-1.52%

International Stocks

MSCI EAFE (net div.)

-3.01%

Real Estate

DJ Select Real Estate Securities Total Return

5.12%

     Source: Morningstar

The S&P 500 rally ensured the aging bull market would celebrate its seventh birthday on March 9th.  However, the index has gone 10 months without recording a new high and fortune will need to favor large company stocks to make this bull market’s anniversary official.  If stocks stumble and fall into bear market territory (decline of 20%) before a new high is reached, the record book will show the bull market ended on May 21, 2015.

The first quarter panic attack was more of an emotionally driven event rather than one based on the economic environment.  Conditions may have seemed dreary at the time, but economic data proved that growth in the U.S. continued to be resilient.  The most recent information showed fourth quarter GDP increased at an annual rate of 1.4%.  While data is still being collected for the first quarter of 2016, muted growth is estimated for the three-month period.

The labor market continued to show improvement as the U.S. economy added a net 215,000 jobs in March and the unemployment rate ended the quarter at 5.0%. Personal income and spending ticked upward during the quarter.  Manufacturing numbers rose, and despite a drop in vehicle sales, overall readings remained elevated.  The housing sector is poised for additional improvement as mortgage rates remained low and housing starts were up.  In addition, warmer weather should help improve sales of new and existing homes.  These indications lead us to believe that the economy is not in a weakening situation, and that the consumer is healthy due to reduced debt loads, low unemployment, and diminishing energy prices.

The Federal Open Market Committee (FOMC) latest meeting in March confirmed the positive economic news.  They suggested that economic activity had been expanding moderately and agreed that the U.S. economy had been resilient despite recent global economic and financial developments.  The meeting minutes also revealed a more dovish stance on monetary policy actions.  The target range for the federal funds rate remained at ¼ to ½ percent, and the projected path for rate increases was lowered.  At the current federal funds rate, the committee noted they could quickly raise rates if future data indicated the economy was starting to overheat or to head-off rising inflation.[1]

Overall, economic conditions overseas remained challenging, but Europe is looking better.  Easy monetary policy, moderate energy prices, a lower Euro, falling unemployment, stronger credit conditions, and rising corporate profits have helped expand economic growth.  Going forward, geopolitical events in Ukraine and the Baltics bear attention, as well as the mounting tensions over the United Kingdom’s possible “BREXIT” from the European Union.

In Asia, Japan’s struggles continued as recent data pointed to a contraction in economic growth.  The Bank of Japan introduced a new strategy of negative interest rates to spur loan growth; so far the policy has not produced the desired results.   Officials are considering additional policy changes to support economic improvement.  China’s growing pains persisted as they adjust to a deceleration in economic growth.  The government continues to stimulate the Chinese economy to stabilize and prevent it from stalling.  However, the consequences of their short-term actions might pose a greater threat to the sustainability of long-term growth.

We are still cautiously optimistic about the domestic economy in 2016, and we are confident that most of the data still supports favorable conditions for investors.  We expect growth to pick up later this year as the spending and tax-cut package passed by Congress plays more of a significant role in increasing consumer and business spending.  The strong labor market should persist.  Oil prices are likely to remain at a low range until the supply level stabilizes.  Despite a slight rise in inflation, we don’t anticipate a dramatic change in the long-term forecast.  2016 should be a better year for corporate profits as macroeconomic headwinds start to fade.  We expect international economies to show some improvement this year, but their recovery will be a slow and arduous process.  We anticipate the frequency of future rate hikes to be reduced from four quarter point hikes down to two in 2016. The next opportunity to raise rates will be in late April, but the popular belief is that rates will remain unchanged until the June meeting.  Updated economic data will drive the FOMC’s rate hike decisions, so stay tuned.

This past quarter was a great reminder to investors that the stock market is not always favorable even with a solid economic backdrop.  Uncertainty is the root cause of market volatility and investors tend to act emotionally during uncertain times.  The two significant U.S. stock market corrections over the past year were evidence of this fact.  It is important to remember that stock market corrections are a normal and healthy part of the investment process.  Given a long time horizon, investors will experience many corrections of varying durations and strengths. Thankfully, the past two corrections were not severe and the stock market recovered quickly. While we expect periods of price volatility to continue, we do not believe the volatility will lead to a broad-based bear market in the near future.  Looking forward, we do believe slower global growth, oil price instability, Federal Reserve monetary policy actions, and thegeopolitical or terrorist wild card will be the biggest threats to economic prosperity. 

Market volatility can be unsettling, but investors can mitigate the effects of market volatility by following these recommendations: 

DO

·         Be patient

·         Remain invested

·         Maintain a diversified portfolio

·         Understand your risk tolerance

·         Consult your financial advisor periodically to make sure you are on track

DON’T

·         Panic

·         Attempt to time the market

·         Lose focus of your long-term financial goals

 

As I have often stated, our investment philosophy remains based on the fundamentals.  We believe it is time---not timing---that matters most.   History shows the successful long-term investor is patient, weathers market swings, and adheres to a disciplined investment process that includes a diversified asset allocation strategy based upon a tolerance for risk and need for return.

In closing, I want to thank you for the opportunity of working with you and for your continued confidence and trust.  Please contact me if you have any questions.  

With kindest personal regards, I am

Very truly yours,

WILLIAM HOWARD & CO. FINANCIAL ADVISORS, INC.

 



[1]Source: Federal Reserve System.  FOMC statement Press Release. 16 March 2016. http://www.federalreserve.gov/monetarypolicy/files/fomcminutes20160316.pdf

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