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Wednesday, August 3, 2016

Financial Focus - Our Quarterly Market Outlook

Looking Back: First Half in Review
Global interest rates continued to drop in the first half of 2016, providing a boost to bond returns. U.S. and emerging market stocks rose slightly, but international developed-market stocks declined. The rebound in oil prices was joined by other resource prices, making commodities the best performing asset class in the second quarter and near-top in the first half.

The U.S. presidential election and the U.K.’s vote to exit the European Union are examples of the wave of rising populist movements and global political uncertainty. Higher market volatility can be addressed with better-diversified portfolios that include a variety of investment types. Start with an appropriate mix of stocks and bonds based on your comfort with risk and your financial goals. In addition, consider adding smaller companies (small- and mid-cap stocks) that historically have performed better but also tend to be more volatile. A well-diversified bond portfolio starts with a variety of investment-grade bonds but also includes appropriate allocations to high-yield bonds, international bonds and cash.

Economic Outlook
After slower first-quarter growth, the U.S. economy should resume growing at a modest pace of 2%-2.5%, in line with its average during the seven-year expansion. That’s strong enough for solid but slower job growth as the labor market tightens. Current indicators suggest inflation will remain moderate, so the Federal Reserve will continue to be in no hurry to raise short-term interest rates. 
Modest growth and low inflation make a good environment for investors.
Presidential campaigns frequently highlight concerns about the strength of the economy, and it could be better – but it’s not getting worse. Consumers continue to power the economy, and low interest rates have sparked strong housing and motor vehicle sales. In addition, manufacturing rebounded in the second quarter after slowing last winter, helping push economic growth above its 2% long-term average. As the expansion enters its eighth year, we don’t see any signs it’s faltering– it’s now the fourth-longest since World War II.

Equity Outlook
U.S. large-cap stocks remain near record highs, even if it doesn't seem like they’ve made much progress recently. Returns over the past 18 months were underwhelming. But our outlook is more favorable, since better performance has typically followed past market pauses. Support should come from continued economic growth and better company earnings. And stocks of smaller companies appear more attractively valued than large-cap stocks.

Low stock market returns also shrunk returns for well-diversified portfolios. And if you were wondering why your investment returns lagged the stock market, remember that stocks have been very volatile, and you probably don’t want to take that much risk. In addition to rebalancing your portfolio to align with the appropriate mix of stocks and bonds based on your comfort with risk and your goals, consider diversifying your equities by owning broad-based international stock and real-estate investments as well as stocks of smaller companies (mid-cap and small-cap stocks) if appropriate.

Fixed Income Outlook
Interest rates have continued to decline globally, and almost 60% of government bonds from other developed countries have negative rates. While we don’t believe U.S. rates will fall below zero, such extremely low rates elsewhere will continue to help keep U.S. interest rates low as well. Although they performed well in the first half of 2016 as rates fell, international fixed-income investments don’t seem likely to provide attractive returns in the future. Even with low rates, domestic investment-grade bonds play an important role in your portfolio because they can help stabilize its value when stocks drop.

International Outlook
Despite worries about the United Kingdom’s vote to exit the European Union and still-sluggish global economic growth, we believe broad based international stock investments are attractive. They’ve lagged behind U.S. stocks for more than five years but outperformed after similar times in the past.

On June 23, the U.K. voted to exit the European Union (known as Brexit). Slow economic growth and rising populist movements have fostered greater political uncertainty globally. Although U.K. and European economic growth could be slower short-term, policymakers are likely to reduce regulations and provide more stimulus to lessen the chances of other exit votes. That could spark better growth and better stock returns. We continue to see international developed-market stock investments as an opportunity based on their better valuations and recent underperformance.

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