2016 Summer Commentary

2016 Summer Commentary

Prestwick Capital Advisors 1

Prestwick Capital Advisors

Table of Contents

A Letter to the Readers – Pg. 3

Themes for Second Half of 2016 – Pg. 4

Central Bank Policy – Pg. 5

Fixed Income – Pg. 9

Global Equity Markets – Pg. 12

U.S. Economic Outlook

Looking Ahead – Pg. 16

Additional Links – Pg. 17

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A Letter to the Readers

As we conclude the second quarter of 2016, it is on the heels of yet another bout of volatility with global equity markets selling off after the surprising decision by Britain to leave the European Union (EU), also known as the “Brexit” vote. This historical vote and decision has rattled markets as the general consensus believed that the ultimate vote would be to remain in the EU. Global markets are continuing to digest the news and determine what the short and long term implications are going to be, and whether or not other countries in the EU are going to follow in the footsteps of Britain. Before the Brexit vote , global markets had rallied back from their 2016 lows after the global pullback in equity markets that occurred during the first five weeks of this year. In the first half of the year we have already seen a double digit decline followed by a double digit recovery, and as we begin the second half of the year, we do so with volatility seen in January and February. The Federal Reserve has yet to raise the fed funds rate from the historical low of .25 % , and with the most recent uncertainty surrounding Brexit, the likelihood of the Fed raising again in 2016 has significantly diminished. As I touched on in the 1st quarter update, the current bull market that began in March of 2009 is now nearing 88 months in duration, and is one of the longest bull markets that the S&P 500 has ever experienced. Corporate earnings have been declining for the last 18 months, so while the market could push higher, there are certainly risks to the downside. As I would expect, volatility tends to pick up in the later stages of a bull market, especially as earnings growth slows and uncertainty begins to brew. Given this uncertainty surrounding the Brexit vote, global central banks will most likely remain accommodative in an effort to mitigate the fears of a slowing global economy causing a recession. While the accommodativeness will likely buoy the equity markets from falling dramatically, corporate earnings growth is going to have to resume in order for the market to move higher. There remain a number of uncertainties for the remainder of 2016 with the upcoming Presidential election, the implications of the recent Brexit vote, and growth that has slowed domestically as well as globally. Central Banks remain very accommodative, but the looming question is whether or not they have enough firepower left to combat the slowing global economy. Over the next several pages we will revisit the themes that were laid out at the beginning of the year, taking a look out how those have played out, and we will review my thoughts on what the remainder of 2016 may hold in store for the economy and markets. Best Regards, ~ L. Grier Williford

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Themes for Second Half of 2016 Themes for Second Half of 2016 Central Bank on Track to Policy Normalization

Economic data have been consistent with moderate growth in 2016, but with mixed strength across sectors.

The labor market has continued to strengthen with the unemployment rate now at 4.9%1

Monetary policy will remain data-dependent. The Fed will most likely delay raising again until December, or later, in light of the recent volatility.

The 30 year Bull Market for Fixed Income appears to be concluding Interest Rates have been on a downward trend

since their peak in 1982. Through the first half of 2016 yields have

continued to decline to historical lows. Global Stock Markets Cautious Amid Recent

Brexit Vote and a Slowing Global Economy. The unlikely outcome of the Brexit vote has

caused a spike in volatility and left everyone trying to determine the short and long term implications.

Corporate earnings growth has slowed dramatically, both domestically and internationally, limiting the upside for the equity markets.

Many of the global central banks continue to maintain very accommodative monetary policy thereby buoying the equity markets.

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Central Bank Policy Themes for Second Half of 2016 Central Bank on Track to Policy Normalization

Economic data have been consistent with moderate growth in 2016, but with mixed strength across sectors.

The labor market has continued to strengthen with the unemployment rate now at 4.9%1

Monetary policy will remain data-dependent. The Fed will most likely delay raising again until December, or later, in light of the recent volatility.

The recent Brexit vote will most likely cause global central banks to rethink their interest rate strategy, and postpone any raises in interest rates until there is more clarity as to the implications.

The Fed continues with its dual mandate of maintaining a reasonable inflation and unemployment rate, although the targets continue to fluctuate.

Inflation currently stands below the 2% target, unemployment currently at 4.9% and recent GDP numbers of 1.1%.1

After the initial rate hike in December of 2015, the Fed stated that monetary policy will remain data dependent leaving some ambiguity to the timing and pace of tightening. This also leaves the market vulnerable to short term over reactions due to the data being undependable with revisions commonly being made.

After the recent speech by Janet Yellen on June 6th , in which she acknowledged the weakness in the global markets, the likelihood of more hikes continues to diminish, especially with the recent outcome of the Brexit vote.

Yellen touched on the positives such as the increase in employment, the rise in equity and home prices, low oil prices supporting household purchasing power.

She acknowledged some of the weaknesses as being economic headwinds abroad, growth in China slowing, and a decrease in business investment.

The Fed is continuing to put themselves in a difficult situation by electing not to raise rates. If the economy and markets really begin to falter and the Fed has not raised rates, they will not have a lot of options to address the issues.

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The current bull market has been expanding for 84 months (or 88 depending on when you believe it began), which is one of the

lengthier expansions that the U.S. economy has experienced.


As illustrated below, the recent result of the Brexit vote coupled with increased volatility globally has changed the outlook for

an increase in the Fed Funds Rate for 2016.

As of 06/29/2016 the likelihood of a rate increase had dropped to a mere 9.4%.

The market could be over-reacting. The July 8th jobs report is a key report.

Source: Bloomberg


As illustrated below, returns in the S&P 500 have been mixed during rate hike cycles, with an average return

of 3.1%.


Conclusion of The Fixed Income Bull Market Themes for Second Half of 2016

The 30 year Bull Market for Fixed Income

appears to be concluding Interest Rates have been on a downward trend

since their peak in 1982. Through the first half of 2016 yields have

continued to decline to historical lows in light of the volatility in the equity markets, global growth slowdown, and recent results of the Brexit vote..

The current bull market for fixed income began in 1982 when interest rates started their downward trend from a Fed funds rate target of 20% to it’s current target of 0 - .25%.

The current environment is favorable for borrowers but not investors.

Borrowers are able to access credit at historically low rates, thus encouraging spending. Investors, on the other hand, have historically low yields with a looming environment of interest rate increases.

The Fed raised the fed funds rate in December by .25% and

insinuated that they would likely hike them four more times, but in small increments.

This has not played out as they insinuated. Due to the increase in volatility, slowing growth, a poor jobs report in May, and the recent Brexit vote, no additional hikes have occurred. It is unlikely another hike will occur at least until December after the election.

Fed Chair Janet Yellen indicated in a recent speech on June 6th in Philadelphia that Global uncertainty justifies a slower path of rate increases.

Fed officials left rates unchanged in June and have decreased the projected path of rate increases with Yellen saying that “if incoming data are consistent with labor market conditions strengthening & inflation making progress toward our 2% objective, I expect, further gradual rate increases in the fed funds rate are likely to be appropriate….”

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There are diverging expectations on the path of future rates.

As seen below, the market’s expectations are significantly lower than the expectations of the FOMC.

Despite the historical lows of the fed funds rate and bond yields, they have dropped even further during 2016 in light of the volatility

and uncertainty.

FOMC Estimates vs. Market Expectations


After the initial rate hike in December of 2015 the expectation was that there were going to be several rate hikes in 2016, with a

target rate of 1 – 1.5% by year end.

As evidence below, rates have actually fallen so far this year thereby driving positive returns for fixed income.

The projected path of total rate hikes has been reduced to half a percentage point for 2016.


Global Equity Markets

Themes for Second Half of 2016

Global Stock Markets Cautious Amid Recent Brexit Vote and a Slowing Global Economy. The unlikely outcome of the Brexit vote has

caused a spike in volatility and left everyone trying to determine the short and long term implications.

Corporate earnings growth has slowed dramatically, both domestically and internationally, limiting the upside for the equity markets unless there is a resumption in earnings growth.

Many of the global central banks continue to maintain very accommodative monetary policy thereby buoying the equity markets.

The economy has been affected by a mix of positive and negative data.

During the first two months of 2016, global markets

continued their precipitous decline in lock step with the decline in oil prices. The domestic markets rallied back to about flat for

2016 until the unexpected results of the Brexit vote sent a shockwave through the global equity markets, causing a massive selloff the Friday and Monday after the vote.

Long term, the Brexit vote will have very little implications on the domestic economy.

The domestic economy has made considerable progress over the past couple of years as unemployment has continued to decline, and that increase in employment has contributed to higher household incomes and a strengthening in consumer confidence. Unemployment currently stands at 4.9%1, below

the Fed’s target of 5%. Gains in disposable income and wealth have led to

increased consumer spending.

Market valuation with a P/E ratio of approximately 16.6x seems a bit full with the likelihood of further valuation expansion not very good, unless corporate earnings can resume their growth.

Economic growth remains mediocre domestically & internationally, with earnings expectations and results continuing to decline.

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As illustrated below, corporate profits and returns for the S&P 500 tend to go hand in hand. As corporate profits slow, or fall, the S&P

500 usually follow suit.

Over the past 18 months corporate profits have slowed significantly with many companies already in an earnings recession.

Source: Stockcharts.com


U.S. Economic Outlook – Key Themes

Moderate growth

Domestic economy

Consumer fundamentals remain strong

Although the pace of job growth appears to have slowed

The June Employment Report surprised to the upside, exceeding expectations

Benefit of low gasoline prices will fade over time

Housing fundamentals are strong

Business fixed investment has been weak (energy contraction, but soft otherwise)

Little help from rest of the worked

Direct impact of Brexit likely to be small

The U.K. accounted for 3.7% of U.S. exports in 2015, less than 2.6% of imports2

Financial market turmoil isn’t going to help

Slower global growth

Continued concerns elsewhere

Chinese economic restructuring

Continued weakness in Latin America

Federal Reserve

Fed will be cautious & gradual in raising short-term interest rates

Still in tightening mode, but in no hurry

Job Market data will play a key role in the policy outlook


Current Gauges

Real GDP (still positive)

Employment (still growing)

Personal Income (still growing)

Real Business Sales (still growing)

Industrial Production (trending down, but mostly energy)

Recession Forecasting

Yield Cure (still positively sloped)

Stock Market (not down sharply)

Initial Jobless Claims (still a very low trend)

Oil Prices (off the lows, but not up sharply)

Could we talk ourselves into a recession?

Consumer Spending (70% of real GDP)2

No sign of consumer retrenchment

Business Fixed Investment (16-17% of real GDP)2

Contraction in energy exploration should come to an end

Many businesses delayed capital projects in 1Q16 (and have hoarded cash)

Election-year uncertainty generally leads to greater caution

Recession? (not on the immediate horizon)


Looking Ahead

As I look ahead to the remainder of 2016, and despite elevated volatility due to the Brexit vote, my theses remain the same as they did in the beginning of the year. There is quite a bit of conflicting data and a positive outcome for the remaining half of 2016 will be dependent upon a resumption of corporate earnings growth and an economy that continues to strengthen, albeit at a slow pace. I believe that we are in the third phase of the current bull market that began in March of 2009, and therefore volatility is expected to increase. That coupled with 2016 also being an election year, uncertainty is likely to remain until its conclusion in November. Positives: The U.S. job market remains healthy and continues to improve as it has done over the past several years. Despite weak GDP growth in Q1 and Q2, GDP is still expected to grow moderately in 2016. Most central banks continue with their easy monetary policies which have been a benefactor for global equity markets. Europe has extended their monthly asset purchases through March of 2017 and will reinvest principal payments as long as possible. More recently they have moved to a negative interest policy (NIRP). China cut their benchmark interest rate and reduced their bank reserve requirement in 2015, and Japan followed suit by continuing with their asset purchases. The U.S. is the only central bank to begin tightening monetary policy, but given the volatility in the first quarter of 2016, this will be much more gradual than originally anticipated. All of these factors coupled with the potential for earnings bouncing back could bode well for the global capital markets and domestic economy. Neutrals: The valuation of the S&P 500 is slightly expensive with a P/E ratio of just under 18x trailing earnings and in the past year rallies have stalled at a trailing P/E near 18x. In order for the P/E ratio to meaningfully expand, the uncertainty that has been prevalent regarding the markets and economy will have to be positively resolved. Earnings growth and valuation expansion will have to continue otherwise there is little likelihood for the market to continue higher. The recovery continues with growth, albeit at a very small pace; the recovery remains slow, fragile, and downside risks have increased. As Christine Lagarde, Managing Director of the IMF, recently suggested, countries should embark upon a “three prong approach – structural, fiscal, & monetary” to spur growth. Negatives: In December of last year the Fed began it’s transition of policy moving towards tightening and unwinding the years of quantitative easing, and while the Fed has recently indicated that it will be much more gradual than originally anticipated, the implications to the remainder of the world are unknown. The bear market in commodities that has brought the price of oil down to prices not seen in decades leaves emerging markets vulnerable and will most likely hamper growth, although the price of oil has rebounded. This leaves the emerging markets at an elevated risk for a potential negative financial event. In addition to growth being weak, inflation remains low and the negative interest rate policies could create a deflationary atmosphere. The remaining half of the year will prove to be pivotal for global markets, especially as they try and digest the implications of Britain electing to leave the EU. The central bank policy makers must make very important decisions as to how to best navigate these diverging factors, not only with their economies and markets in mind, but the global economy as well. It is my view that while downside risks have increased, there is still opportunity for slow growth and the equity markets will most likely stay range bound.


Additional Links

“Happiness is not in the mere possession of money; it lies in the joy of achievement, in the thrill of creative effort.”

~ Franklin D. Roosevelt

We manage capital with the mindset of managing the risks that we see in the capital markets, which are constantly changing, but doing so with a long term mentality. We think about the implications of every decision in terms of years and decades.

~ Prestwick Capital Advisors

Joseph Carson (Alliance Bernstein)

“Wealth Cycles: The Untold Story” https://www.abglobal.com/Instrumentation/Economic-Weeklies/EconPerspectives_20160617_US.pdf

Investment Strategy Quarterly

Raymond James Investment Committee http://www.raymondjames.com/branches/library/features/investment_strategy/investment_strategy.pdf

Beyond Brexit: The Investing Implications (Blackrock)

Richard Turnill, Blackrock Global Chief Investment Strategist

https://www.blackrockblog.com/2016/07/06/beyond-brexit/

How Millennials Can Save the World While Saving for Retirement

Ann Ackerley, Blackrock Head of Defined Contribution Group

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https://www.abglobal.com/Instrumentation/Economic-Weeklies/EconPerspectives_20160617_US.pdf










Contact Information

L. Grier Williford, CFP® Financial Advisor O: 843.720.3507

C: 478.714.5358

[email protected]

Cowles Whitley, Registered Sales Associate II O: 843.720.3509

[email protected]

360 Concord Street, Suite 210

Charleston, SC 29401

www.prestwickcapitaladvisors.com

Raymond James & Associates, Inc., Member New York Stock Exchange/SIPC

“An objective and pragmatic approach

to comprehensive wealth management.”


Footnotes 1. Data according to the Bureau of Labor Statistics as of 06/30/2016

2. Data according to Office for National Statistics as of 12/31/2015

Disclaimers The views in this commentary do not take into account the particular investment objectives, financial situations, or needs of every individual client. Investments are subject to market risk, including possible loss of principal. International investing involves additional risks such as currency fluctuations, differing financial accounting standards, and possible political and economic instability. These risk are greater in emerging markets. Links are being provided for information purposes only. Raymond James is not affiliated with and does not endorse, authorize or sponsor any of the listed websites or their respective sponsors. Raymond James is not responsible for the content of any website or the collection or use of the information regarding any web site’s users and/or members. Commodities are volatile investments and should only form a small part of a diversified portfolio. There may be sharp fluctuations even during periods when prices are rising overall. The price of gold has been subject to dramatic price movements over short periods of time and may be affected by elements such as currency devaluations or revaluations, economic conditions within an individual country, trade imbalances, or trade or currency restrictions between countries. As a result, the market prices of securities of companies mining or processing gold may also be affected. Past performance does not guarantee future results. There is no assurance that these trends will continue. Raymond James & Associates, Inc. member New York Stock Exchange/SIPC Views expressed in this newsletter are the current opinion of the author and are subject to change without notice, and not necessarily those of Raymond James Raymond James & Associates is not affiliated with Joseph Carson or Alliance Bernstein, or Blackrock.

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Disclaimers The S&P 500 is an unmanaged index of 500 widely held stocks. It is not possible to invest directly in an index. The Dow Jones Industrial Average is an unmanaged index of 30 widely held securities. The NASDAQ Composite Index is an unmanaged index of all stocks traded on the NASDAQ over-the-counter market. U.S. Treasury securities are guaranteed by the U.S. government and, if held to maturity, offer a fixed rate of return and guaranteed principal value. Material is provided for informational purposes only and does not constitute a recommendation. It has been obtained from sources believed to be reliable, but accuracy is not guaranteed. There is an inverse relationship between interest rate movements and bond prices. Generally, when interest rates rise, bond prices fall and when interest rates fall, bond prices rise. Alternative investment strategies involve greater risks and are only appropriate for the most sophisticated, knowledgeable and wealthiest of investors. Technical Analysis is a method of evaluating securities by analyzing statistics generated by market activity, such as past prices and volume. Technical analysts do not attempt to measure a security’s intrinsic value, but instead use charts and other tools to identify patterns that can suggest future activity. Asset allocation and diversification do not ensure a profit or protect against a loss. Investments are subject to market risk, including possible loss of principal. P/E is the price of the stock divided by its earnings per share.

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Disclaimer VIX is the Chicago Board Options Exchange (CBOE) Volatility Index, which shows the market’s expectation of 30-day volatility. It is constructed using the implied volatilities of a wide range of S&P 500 index options. The VIX is a widely used measure of market risk. Gross Domestic Product (GDP) is the annual total market value of all final goods and services produced domestically by the U.S. The charts above are for illustrative purposes only. Certified Financial Planner Board of Standards Inc. owns the certification marks CFP®, CERTIFIED FINANCIAL PLANNER™ and federally registered CFP (with flame logo) in the U.S., which it awards to individuals who successfully complete CFP Board's initial and ongoing certification requirements. Raymond James & Associates, Inc. Member New York Stock Exchange/SIPC 360 Concord St., Ste. 210 Charleston, SC 29401 843-720-3507

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Documents

2016 Summer Commentary