Like Watching a NASCAR Race? — 3rd Quarter Financial Market Update

NASCAR is America’s biggest spectator sport in terms of attendance. For those unfamiliar with the sport, it is a form of auto racing. Its roots come from the rural south where moonshiners needed fast cars and fast drivers to transport their illegal cargo; maybe even to outrun the law on occasion. Today’s NASCAR is now a nationwide sport with huge corporate sponsorship that tries to embody patriotism, motherhood and apple pie. However, the reality is that many NASCAR fans do not watch the races just to see racing; they watch to see the wrecks! At some of the fastest tracks on the circuit, it is talked about openly: when will the “big one” happen? They are referring to the big wreck…a spectacular crash involving 15-20 cars (about half the drivers) that provides most of the excitement in an otherwise modestly entertaining event.

So, why does my financial market update contain a brief primer on NASCAR? Well, the analogy describes how this summer in the financial markets felt. It was as if we were all watching the markets, waiting for the “big one.” Most economists agree that our domestic financial markets are slightly to fully overvalued, but there are various reasons given for levels to remain high:

  1. Central bank (Fed) support via low interest rate policy
  2. Valuations are only bad on an absolute basis, but relative valuations are fine
  3. Least dirty shirt theory – markets are weak globally, but the US is the least weak, so our markets remain relatively attractive

All the reasons above are valid, but not very optimistic. Therefore, when any bad economic news comes out, I and many others glue ourselves to our computers waiting to see if this will be the big one. For the third quarter, Britain’s Brexit vote was almost the big one, but that wreck was very brief and within days was a nonevent to the financial markets. Late September’s Fed meeting might have been the big one had they raised interest rates. Alas, they did not.

Therefore, without our summer wreck, the financial markets went around in circles (like so many NASCAR races) and finished slightly higher. For the third quarter, the S&P 500 was up 3.9% and is up 7.84% YTD. Small-cap stocks were the best performers domestically, up 9.0% for the quarter and 11.46% YTD. Even international stocks were positive this quarter. For the third quarter, developed market equities were up 6.5%, bringing their YTD totals back into the black at 2.20%. The best overall category for the period was emerging market equities. They were up 9.2% for the quarter and are now up 16.36% YTD. Lower commodity prices and subdued inflation has fueled this category which has been a poor performer for the past three years. Core bonds, as represented by the Barclays US Aggregate Bond Index, were also positive. For the quarter, core bonds were up 0.50% and have returned a very respectable 5.80% YTD, despite historically low yields.

Will there be a “big one” in the fourth and final quarter of 2016? Obviously, two potential dates stick out. The first is the November presidential election. The second is the December Fed meeting, when the next interest rate hike is expected to occur. Either event could cause the start of the next big one. Yet, even with stretched valuations, the financial markets may climb higher. I remember in late 1998 thinking most internet stocks were extremely overvalued. They were, but it was well into 2000 before they started to fall. Ironically, whether this market grinds higher or has the big one, both outcomes would be positive. Obviously, the markets going higher benefits everyone’s account values. The occurrence of the big one would be a temporary setback, but one that would take some of the air (excess valuation) out of the current market, giving us a healthy basis from which to go forward. We are due a correction, but we do not foresee another 2008-2009 sell off. Instead, we expect just another 10%-plus sell off before the market hits new highs down the road. The next “big one” could be the best thing for our markets. It just might get us to quit looking for the negative and start refocusing on the positive.

Mike Kauffelt, CFA
Chief Investment Officer
Bill Few Associates, Inc.

Data Source: JP Morgan