Just when you thought that we might make it through one quarter without financial markets being sent into a panic by a headline news event . . . . Brexit! The vote, which was held on June 23, sent ripples of panic across global financial markets as investors digested the news and quickly readjusted their portfolio exposures. Despite the swiftness and shock with which the news of Brexit hit financial markets, within a few days most markets around the world began to show signs of recovery. In the US, stocks rallied in the last 3 days of the quarter to finish both the quarter and the first half of the year in positive territory. While we have endured a year with heightened volatility in financial markets, most diversified portfolios will end the second quarter with positive performance for both the quarter and year to date.
In equity markets, value stocks have outperformed growth stocks thus far in 2016 by a wide margin, with the Russell 1000 Value up 6.3% and the Russell 1000 Growth up only 1.4% year-to-date through the end of the quarter. The best performing sectors have been telecoms and utilities, stocks that typically pay high dividends. These two sectors are a relatively small part of the market however, making up only 6.5% of the S&P 500 in total. Financials and technology stocks have been the laggards, and these are the two largest sectors, making up a total of 35.5% of the S&P 500. Foreign markets continue to trail US markets, with European and Japanese stock markets being hit particularly hard.
Since this year’s low in February ($26.19/bbl for WTI on February 11), oil prices have rallied 84% to close the quarter at $48.27/bbl. These higher oil prices provided support for the energy sector, which rallied strongly and was the best performing equity sector in the second quarter. Notwithstanding the price rally in crude, it remains well below where it stood in 2014 when prices were above $100/bbl.
Brexit also provided the pretext for another flight to quality in bond markets with investors across the globe rushing to buy US Treasuries and other assets perceived to be “safe.” This most recent buying spree caused the yield on the 10-Year US Treasury to fall to 1.49%. With an inflation rate of 2.24% the real yield on the 10-Year Treasury ended the quarter at -0.75%, well below the historical average (last 58 years) of a real yield of 2.44%. This dramatic flattening of the yield curve has been a positive for bond investors, particularly those owning longer-duration bonds. Those owning bonds denominated in US dollars have been further rewarded as the global flight to quality at quarter-end led to further strengthening of the US dollar against most other currencies.
Whether it’s you, your kids, your friend’s kids, or your kid’s friends, it’s likely that someone around you is facing student debt. In fact, 55% of households ages 21-29 have student debt as of 2013¹, and that number is increasing. Student loans outstanding have almost tripled in the last ten years, with a current balance of $1.319 Trillion at the end of 2015.¹ A recent study² from the Center for Retirement Research at Boston College tells us that the massive growth of student debt can have a significant impact on retirement for millennials.
The increase in student loan balances means that young people are waiting to purchase homes, and pushing their retirement savings until later. Couple that with the disappearance of defined benefit pension plans previous generations have seen, and the likelihood of a much smaller or even non-existent Social Security benefit, and it’s easy to see the risk of not being ready for, or running out of money during retirement is increasing.
The February 2016 study uses a metric called the National Retirement Risk Index (NRRI) to measure how growing student debt impacts retirement security. According to the study, “Calculating the NRRI involves three steps:
1. Projecting a replacement rate – retirement income as a share of pre-retirement income – for each household;
2. Constructing a target replacement rate that would allow each household to maintain its pre-retirement standard of living in retirement; and
3. Comparing the projected and target replacement rates to find the percentage of households ‘at risk.’”
The study applies the current student debt rates to previous generations and assigns the same percentages of lower home ownership and reduced retirement savings, and the increase in NRRI is 4.6%, from 51.6% to 56.2%.² That might not seem like a significant increase, but as of March of this year, the total civilian labor force was just over 159 million people,³ and 4.6% of 159 million means an increase of over 7 million people at risk of running out of money during retirement.
What to Do?
The elections have provided a significant sounding board for the importance of this issue. All of the current candidates realize that this is top of mind, especially for young voters.
While we don’t have a crystal ball for who the next president will be, or what types of policies will actually be put into place, it’s important to remember that small changes can have a big impact. Students, look into refinancing student loans, small changes in interest rates can mean big savings over time. Also, it’s important to make retirement savings a top priority, saving in your 20’s might seem inconsequential (especially if you don’t have much to save), but compounding growth is a benefit that outweighs the cost of waiting. Parents, talk to your kids about these issues, and if you have questions, we’re here to help.