Commentary & Insights

Markets Prepare for Expected Rate Hike

Posted at January 13, 2016 » By : » Categories : Commentary & Insights » 0 Comment

December 2015,

Economists say it may be coming in December. Are you ready?

The Facts:

Global markets ended up mixed in November after a fairly wild ride. Here’s why. The Fed signaled it may likely raise interest rates at its December 16th meeting, leading investors to reassess bonds, income-producing stocks, and other assets. Plus, the shock of the terrorist attacks in Paris added significant uncertainty to November’s trading.

The Impact:

U.S. markets were especially volatile in November, though large caps clung to a fractional monthly gain.

International markets slumped after last month’s broad rally.

In fixed income, bond yields rose across the maturity spectrum (especially at the short end), as investors braced for higher rates.

What It Means for You:

In investing, as in many things, a simple approach may often be the most effective. Like having a well-thought-out plan and sticking to it. Such an approach can help keep your portfolio balanced when the world and financial markets seem askew—and help bring you closer to reaching your financial goals. Of course, if you ever need assistance, just contact your E*TRADE Financial Consultant or give us a call at 1-800-ETRADE-1 (1-800-387-2331).

A Closer Look

November was a volatile month for global markets, as coordinated terrorist attacks in Paris grabbed the world’s attention, and the U.S. Federal Reserve (the Fed) signaled its resolve to raise interest rates in December. These events strengthened the U.S. dollar against most major currencies, pressured international markets lower, and left U.S. equities unchanged to slightly higher. In bonds, investors took their cue from the Fed, and sold across most sectors and maturities. Because yields move inversely to prices, this action had the effect of essentially increasing borrowing costs for both consumers and corporations—even before the Fed makes its first move.

Markets resilient in face of Paris attacks: On Friday, November 13, a series of terrorist attacks in Paris shook the world, and caused heightened volatility in global markets. By late Monday, however, authorities in France, Belgium, and other countries were already on an aggressive hunt for suspects, and Wall Street had started a week-long rally. It may be counterintuitive, but as attacks like these have sadly grown more frequent, markets have become increasingly resilient to them. It may be that investors are proceeding more calmly by looking back to similar events in London, Spain, and elsewhere, when markets were able to bounce back from losses in either days or weeks.

Rate hike expected for December: After seven years of holding near-term interest rates close to zero, the Fed is expected to raise rates in December—at least according to over 90% of economists surveyed by The Wall Street Journal (as reported on November 12). In fact, from the minutes released of the Fed’s October meeting, investors learned that “some [Fed] participants thought that the conditions for beginning the normalization process had already been met.” Fixed income markets reacted swiftly to the news, as investors sold U.S. Treasuries and other bonds, especially those with short- to intermediate-term maturities. What may have reassured some bond investors, however, is that the Fed reiterated its intention to take a gradual approach to raising rates after the first hike goes into effect.

Strong GDP, jobs reports: A number of major economic indicators released in November pointed to an increasingly strengthening U.S. economy. For example, the second estimate of gross domestic product (GDP) for the third quarter came in at 2.1%, significantly higher than the 1.5% of the first (“advance”) estimate. Plus, the U.S. economy added a stronger-than-expected 271,000 jobs in October, the most recent month for which we have data, while the unemployment rate ticked down a tenth of a point to 5.0%, an eight-year low.

Domestic Equities

In spite of a number of worrisome headlines, U.S. equity markets ended November higher, with domestic small caps outperforming their large-cap counterparts.

The large-cap-oriented S&P 500 finished up just 0.30% in November, essentially returning to earth after an impressive October surge. On a year-to-date basis, the index remains in the black with a gain of 3.01%.

U.S. small caps were the star performers for the month, as the small-cap-oriented Russell 2000 Index jumped 3.25%. For the year-to-date period, this is the first time since July that the index is in positive territory, having now advanced 0.64%. Why the outperformance in November? It may be that, because small caps tend to be less dependent on economies outside the U.S., investors felt that component companies of the Russell 2000 would be less pressured by a stronger dollar.

Among the sectors that make up the U.S. equity markets (based on the S&P 500 sector indexes), financials, industrials, and IT showed the biggest gains in November, while utilities, telecom, and consumer staples were the worst performers. Some of the latter group may have been dragged down by increasing expectations for a Fed rate hike in December, which could provide competitive opportunities for income—and possibly at lower risk. Year to date, the consumer discretionary sector continues to be the best performer, while energy, utilities, and materials have been the weakest.

When it comes to the equity styles, both growth and value stocks were higher in November, though value was a slight outperformer. (We track these using the Russell 3000 Growth and Value Indexes, respectively.) On a year-to-date basis, growth is significantly ahead, now leading value by almost nine percentage points.

International Equities

International markets were generally soft in November, as emerging markets led their developed counterparts lower.

The MSCI EAFE Index, a widely followed measure of developed market performance, lost 1.56% in November. Europe and the UK were generally weak, while Asian economies outperformed, even as Japan officially dipped into recession territory. For its part, the Bank of Japan suggested that the worst is now in the past, and that the nation’s economy continues to “recover moderately.” With a year-to-date gain of 0.54%, the MSCI EAFE Index remains in positive territory, though just barely.

Emerging markets also moved lower in November—and, in fact, were the weakest monthly and year-to-date performers of any major index we track. The MSCI Emerging Markets Index dropped 3.90% for the month, increasing its year-to-date loss to 12.98%. Weakness across Europe contributed to the monthly losses, as investors grew concerned about the effects of the dollar’s strength and higher U.S. interest rates on less-developed economies.

Fixed Income

The U.S. fixed income market lost ground in November, as investors essentially “pre-tightened” borrowing costs in advance of an expected Fed rate hike in December. The Barclays U.S. Aggregate Index was down 0.26% for the month, though it’s returned 0.88% year to date.

In the U.S. Treasury arena, the yield on the benchmark 10-year note increased five basis points to end the month at 2.21%. (A basis point is one one-hundredth of a percent.) Year to date, the yield on the 10-year is now up four basis points. The U.S. Treasury yield curve flattened in November, as yields for securities in the short- to intermediate-term sections of the curve rose the most.

Among the various U.S. fixed income sectors, Treasury bills and TIPS were the strongest performers in November, while high-yield bonds (also known as “junk” bonds) and long-term U.S. Treasuries were the weakest. Year to date, intermediate-term U.S. Treasuries have gained the most, while high-yield bonds have been the biggest laggards. The latter have been weighed down by weak performance from energy companies (which make up a sizable portion of the high-yield market), and greater competition from what may be considered “lower risk” income sources.

The Bottom Line

As we all know, the world can be unpredictable. Unforeseen events like those that happened in Paris this past month may trigger unusual market volatility, not to mention immeasurable human and emotional cost. Plus, questions about the future direction of monetary policy can make investing seem much more complicated than it really is.

There’s a lesson to be learned in all this: To be proactive instead of reactive, investors may consider holding a diversified, risk-appropriate portfolio of domestic and global equities, fixed income securities across the credit and maturity spectrum, and cash. While there are no guarantees, by adopting such a strategy, you may help position your portfolio to better weather ever-changing market conditions—and even, perhaps, unanticipated international events.

In investing (as in many things), a simple approach may often be one of the most effective. Having a plan and sticking to it may help keep your portfolio balanced when the world and financial markets seem askew—and help bring you closer to reaching your financial goals.

Thank you for reading.

Mike Loewengart

Vice President, Investment Strategy

E*TRADE Capital Management

Mike Loewengart is the Vice President of Investment Strategy for E*TRADE Capital Management, LLC. Prior to joining E*TRADE in 2007, Mike was the Director of Investment Management for a large multinational asset management company, where he oversaw corporate pension plan assets. Mike started his career as a research analyst and an investment manager due diligence analyst for the consulting divisions of several high-profile investment firms. He also graduated with a degree in economics from Middlebury College.


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Data and statistics contained in this commentary are obtained from what E*TRADE Capital Management considers to be reliable sources; however, its accuracy, completeness, or reliability cannot be guaranteed.

All investments involve risk, including the loss of principal amount invested.

Diversification, asset allocation strategies, automatic investing plans and dollar-cost averaging do not ensure a profit and does not protect against a loss in declining markets. Investors should consider their financial ability to continue their purchases through periods of low price levels.

Stocks fluctuate in response to the activities of individual companies and general market conditions, domestically and abroad. Investments in mid and small-cap stocks typically have higher risk characteristics than large cap stocks and may be subject to greater price fluctuations than large-cap stocks.

All bonds and fixed income products are subject to a number of risks, including the possibility of issuer default, credit risk, and market risk. All bonds and fixed income products are subject to a number of risks, including the possibility of issuer default, credit risk, interest rate risk, market risk and prepayment and extension risk. In general, bond prices rise when interest rates fall and vice versa. This effect is usually more pronounced for longer-term securities. Lower-quality fixed income securities generally offer higher yields, but also carry more risk of default or price changes due to potential changes in the credit quality of the issuer. Adverse conditions may affect the issuer’s ability to pay interest and principal on these securities and, as a result, they may have a higher probability of default.

Foreign investments involve greater risks than U.S. investments, including political and economic risks, concentration risks, liquidity risks, and the risk of currency fluctuations, all of which may be magnified in emerging markets. Emerging and frontier market investments are subsets of foreign investments. Emerging markets are rapidly developing politically and economically, but present a greater degree of these foreign investment risks because of the developing stage of the emerging market. Frontier markets are in early stages of economic and/or political development and are even less developed than emerging markets. As such, risks associated with foreign investments can be significantly greater in a frontier market compared to emerging markets and foreign investments generally.

Investing in commodities and international or global investments carries certain risks such as price volatility, currency risk, market risk, interest rate risk and credit risk. An investor should fully understand these risks before making an investment. The commodities industries can be very volatile and significantly affected by commodity prices, world events, import controls, worldwide competition, government regulations, and economic conditions.

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Investment advisory services are offered through E*TRADE Capital Management, LLC, a Registered Investment Adviser.

Indexes used in this presentation are intended to provide a general measure of the market performance for a particular asset class or type. An Index is an unmanaged portfolio of predetermined securities and does not reflect any initial or ongoing expenses such as brokerage fees, commissions, principal mark-ups, management fees or taxes. The inclusion of any one of these items would reduce the performance shown. It is not possible to invest directly in an index.

Index definitions:

Dow Jones Industrial Average: Computed by summing the prices of the stocks of 30 companies and then dividing that total by an adjusted value—one which has been adjusted over the years to account for the effects of stock splits on the prices of the 30 companies. Dividends are reinvested to reflect the actual performance of the underlying securities.

Barclays Capital U.S. Aggregate Index represents securities that are SEC-registered, taxable, and dollar denominated. The index covers the U.S. investment grade fixed rate bond market, with index components for government and corporate securities, mortgage pass-through securities, and asset-backed securities.

Dow UBS Commodity Index: The DJ-UBSCI is composed of futures contracts on physical commodities. Unlike equities, which typically entitle the holder to a continuing stake in a corporation, commodity futures contracts normally specify a certain date for the delivery of the underlying physical commodity. In order to avoid the delivery process and maintain a long futures position, nearby contracts must be sold and contracts that have not yet reached the delivery period must be purchased. This process is known as “rolling” a futures position. The DJ-UBSCI is composed of commodities traded on U.S. exchanges, with the exception of aluminum, nickel and zinc, which trade on the London Metal Exchange (LME).

MSCI EAFE Index is a free float-adjusted market capitalization index that is designed to measure the equity market performance of developed markets, excluding the US & Canada. The MSCI EAFE Index consists of the following 21 developed market country indexes: Australia, Austria, Belgium, Denmark, Finland, France, Germany, Hong Kong, Ireland, Israel, Italy, Japan, the Netherlands, New Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland, and the United Kingdom.

The MSCI Emerging Markets Index is a free float-adjusted market capitalization index that is designed to measure equity market performance of emerging markets. The MSCI Emerging Markets Index consists of the following 23 emerging market country indexes: Brazil, Chile, China, Colombia, Czech Republic, Egypt, Greece, Hungary, India, Indonesia, Korea, Malaysia, Mexico, Peru, Philippines, Poland, Qatar, Russia, South Africa, Taiwan, Thailand, Turkey and United Arab Emirates.

S&P 500 Index is a market capitalization-weighted index of 500 widely held stocks often used as a proxy for the US stock market.

The Russell 2000 Index measures the performance of the small-cap segment of the U.S. equity universe. The Russell 2000 Index is a subset of the Russell 3000® Index representing approximately 8% of the total market capitalization of that index. It includes approximately 2,000 of the smallest securities based on a combination of their market cap and current index membership.

The Russell 3000 Growth Index measures the performance of the broad growth segment of the U.S. equity universe. It includes those Russell 3000 companies with higher price-to-book ratios and higher forecasted growth values. The Russell 3000 Growth Index is constructed to provide a comprehensive, unbiased, and stable barometer of the broad growth market. The Index is completely reconstituted annually to ensure new and growing equities are included and that the represented companies continue to reflect growth characteristics.

The Russell 3000 Value Index measures the performance of the broad value segment of the U.S. equity universe. It includes those Russell 3000 companies with lower price-to-book ratios and lower forecasted growth values. The Russell 3000 Value Index is constructed to provide a comprehensive, unbiased, and stable barometer of the broad value market. The Index is completely reconstituted annually to ensure new and growing equities are included and that the represented companies continue to reflect value characteristics.

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