“And now for something completely different.” – Monty Python
When one has written quarterly commentaries such as these for nearly two decades, there comes a point at which you feel like you are repeating yourself. But then a quarter like this one comes along, and it seems like simply turning the previous commentary inside out would suffice. While it may not be apparent from reading the headlines, or listening to the talking heads on CNBC, the third quarter of 2016 provides an example of why market timing is difficult, and why owning a diversified portfolio is important. It is also an example of why those writing market commentaries cannot simply cut and paste from the previous quarter’s missive.
To demonstrate the Freaky Friday nature of third quarter market performance, we need look no further than the performance of the individual sectors of the U.S. stock market. In the second quarter, the best performing sectors of the U.S. stock market were the Utility and Telecom sectors. In the third quarter, these were the worst performing sectors at -5.9% and -5.6% respectively. In the second quarter, Financial and Technology stocks were the laggards. In the third quarter, these were the best performing sectors, up 4.6% and 12.9% respectively. In the second quarter, U.S. stocks outperformed foreign stocks. In the third quarter, foreign stocks (MSCI EAFE) were up 6.43% and U.S. stocks (S&P 500) were up 3.85%. After starting the year off strongly, Commodities and REITs both declined in the third quarter. U.S. Small Cap stocks were one of the few market segments that did not completely change course; they performed better than U.S. Large Cap stocks in the second quarter, and this outperformance accelerated in the third quarter. With strong returns of 9.04% in the third quarter, the Russell 2000 Index is now up 11.46% year-to-date.
Fixed income markets did not undergo the complete reversal that much of the equity market seemed to experience in the third quarter. However, U.S. fixed income markets behaved in a way that might seem just as puzzling. Despite the continued reluctance of the Federal Reserve to raise short term interest rates, the bond market still experienced a bit of a bearish quarter. Fixed income markets were influenced by the continued flattening of the U.S. Treasury yield curve. Long rates stayed fairly stable, with the 30-year Treasury closing the quarter at 2.32%, up from 2.30% at the beginning of the quarter. At the 10-year point of the curve, rates closed at 1.60%, up from 1.49% on June 30th. And short-term rates rose most of all, with the one-year Treasury closing the quarter at 0.59% after starting the quarter at 0.45%.
As we enter the fourth quarter, the Monty Python quote above seems even more apropos. We will cross the finish line of an election that, to date, has been unlike any other in this writer’s lifetime, with a global interest rate environment still near record setting lows, all while awaiting the next move from central bankers. One thing of which we can be reasonably certain: there will be something interesting to write about next quarter.