July 11th, 2017
Dear Valued Clients & Friends:
Second Quarter 2017 Market Review:
The second quarter of 2017 was a period during which U.S. economic data were mixed, while stock market results continued to be favorable. Positive economic aspects include the unemployment rate which fell to 4.3% in Q2, as well as consumer confidence which remains strong. Below-expectations data in the quarter came primarily from the “demand side” and included weaker housing starts, light vehicle sales, net exports, as well as inventory growth. On balance, it would be wise to consider the recent so-so data in the context of the long-term drivers of economic growth.
As illustrated in the below chart, real GDP growth is driven largely by the “supply side”, specifically private payroll growth. We can glean from this data that investors should not be overly concerned with less-than-desired recent quarterly GDP numbers, as the consistency of employment growth seems to indicate that this phenomenon may be poised to reverse. With private payroll growth staying stable at the same time that exports, inventories, and government spending were weaker in the 1st half of 2017, many economists believe the U.S. economy is positioned for a rebound during the 2nd half of 2017.
This suggests that the most likely outcome is for moderately favorable economic expansion throughout the remainder of 2017. Investors may be wise to stay focused on their long-term investment strategy and not worry so much about any blips in near-term volatility.
Data provided by J.P. Morgan as of 6/26/17.
International stocks again outperformed U.S. stocks in the second quarter (see below). International developed stocks, as measured by the MSCI EAFE index, rose 6.4% for the quarter and are now up 14.2% YTD. Emerging market stocks again performed well, also rising 6.4% in the quarter and now stand at a year-to-date return of 18.6% through June. The S&P 500 returned 3.1% in the quarter and is up 9.3% YTD. The Russell 2000 Index returned 2.5% in the 2nd quarter and is now up 5.0% for the year.
Data provided by J.P. Morgan as of 7/3/17.
Despite the increase in the Fed Funds rates, longer term interest rates fell a bit in the quarter, with the yield on the 10-year Treasury finishing the quarter at 2.3%, slightly lower than the starting yield of 2.4%. As such, higher quality bonds performed well in the quarter.
We continue to look for opportunities to reposition our clients’ portfolios to withstand short-term pullbacks, but still be positioned for longer-term global growth. The two main portfolio changes are described below in detail:
- At the beginning of May, we stepped up the buffer level in one of our S&P 500 Structured Notes. By way of background, in late February of 2014, we collaborated with Goldman Sachs to create a customized 5-year structured note for our clients. The terms included uncapped upside participation with a bit of leverage, allowing clients to outperform the S&P 500 Index should it have a materially positive return. The note also had a downside buffer which protected against the initial 10% of any decline in this index. With U.S. markets hovering near new highs, we went back to Goldman Sachs this spring and asked them to unwind this note early. We were able to redeem the note without penalty at a 36.4% gain, outperforming the 28.8% return of the S&P 500 during the February 2014 to May 2017 period.The primary rationale for redeeming the old note early was that the market would need to decline by more than 20% before the protective buffer on the old note would come into play. By retiring the appreciated note and creating a new note, we have established a new “floor” for the protective buffer at the much higher current market level, thereby improving downside risk protection*. Additionally, this 24 month Goldman Sachs note will be able to capture 1.5515 times the price return of the S&P 500 Index, up to a maximum return cap of 26%. Adding a cap allows us to increase the leverage on this shorter-term note. A cap of a 26% cumulative maximum return over two years would be equivalent to the S&P 500 averaging an annualized return of over 12%, which we believe to be very unlikely. For additional details, please read the enclosed “July 2017 Structured Notes Program” PDF.
- In early June, we also stepped up the buffer level for clients’ Russell 2000 Structured Note. This note originated in October 2014 when we collaborated with The Royal Bank of Canada to create this 5-year structured note. The terms again included uncapped upside participation with some leverage, allowing clients to outperform the Russell 2000 Index should the index be positive at maturity. The note had a downside buffer which protected against the first 10% of any decline in this index. Just like we did with the S&P 500 note, we went back to the note issuer and were able to redeem, without penalty, locking in the note’s 33.03% gain. The Russell 2000 was up 28.88% over the same time period.Again, the primary rationale for redeeming the Russell 2000 note early is the same thought process as to why we redeemed the S&P 500 note early (see* above). The new note is with Morgan Stanley, and will pay out 2.08 times the price return of the Russell 2000 Index, up to a maximum return cap of 32.8%. For additional details, please read the enclosed “July 2017 Structured Notes Program” PDF.
We thank you again for your continued loyalty and trust and we welcome any questions you may have about your financial situation.