Assessment of the economy, the markets, and its impact on you
From the worst start in stock market history, to the United Kingdom’s (UK’s) European Union (EU) referendum or “Brexit,” to the shocking Trump election victory, to the Italian referendum, and the continuation of monetary action by the major central banks of the developed world, 2016 started and ended with a bang. While multiple historic and exciting events unfolded, a quick review of past monetary policy could prove helpful in gaining some perspective on the financial implications of these major events.
In response to the Great Financial Crisis of 2007/2008, a coordinated effort by developed countries’ central banks flooded the major economies of the world with excess cash in order to drive down interest rates. The plan was enacted to restore stability and confidence in the markets and revive economic growth. Fast-forward eight years to 2015, after nearly a decade of near zero percent interest rates and an overabundance of accommodative monetary policy, the Federal Open Market Committee (FOMC) was finally ready to reverse course and raise interest rates.
The December 2015 FOMC meeting concluded with the decision to raise interest rates for the first time in almost a decade. This highly anticipated but monumental move broke the ice for the FOMC. The committee finally took action and started on a path to return interest rates to more normal levels. Bold and decisive it was not, but it was a start after years of uncertainty over the path toward rate normalization. As seen in the chart below, the quarter-point rise in interest rates is but a blip in the big picture of rate history since 2005. However, it was thought to be a good starting point for the FOMC’s plan to increase rates four times in 2016 from a .25%–.50% range to 1.40% by the end of the year. But few could have foretold the gravity of the events that would derail such a plan.
Stock Markets Tank
The first day of trading in 2016 saw a 7% drop in the Chinese stock market over fears of its country’s weakening economy. This fear rippled through international markets, causing similarly large drops in the major stock markets of the world. In the bond market, credit spreads, or the difference between the interest rate on risk-free US Treasury bonds versus corporate bonds and junk bonds, spiked higher. Also, the concerns over currency devaluations, declining earnings, and Japan’s introduction of negative interest rates further exasperated the panic in the world’s markets. The initial shock took market participants’ breaths away.
Throughout January and into early February, with the major stock indexes down over 10%2, market participants feared an oncoming recession. Economic weakness, accompanied by the FOMC’s recent decision to tighten monetary policy, would only fuel further economic weakness. However, the swift response from, the Bank of Japan, the Bank of China, and the European Central Bank coordinated an effort to support markets through monetary intervention. The change in sentiment was almost immediate and order was restored to the markets. Following suit, the FOMC quickly abandoned its plan to raise interest rates four times in 2016, even though it had just released its plan three months prior. The stress in the system would be relieved for only a short period of time before one of the more unthinkable events in history became a reality.
Brexit
On June 24th, the world witnessed one of the most dramatic voting outcomes in modern history—the UK’s decision to exit the EU, also known as Brexit. The world was shocked both emotionally and financially. The EU was created to unite the various countries’ cultures and economics to help ensure peace and prosperity. However, the citizens of the UK decided that the EU was no longer a beneficial arrangement for its countries’ future. The financial markets panicked. The pound sterling collapsed; the stock markets of the world dropped in dramatic fashion; and safe-haven investments, such as the US dollar and gold, soared. The perception at the time was that the UK’s fate would be sealed — that without EU membership, the economy would lose its trading abilities and global influence and would collapse.
Just two days following the vote, the major central banks of the world expressed their unconditional support for the markets and the pound sterling by way of accommodative monetary policy. The knee-jerk selloff in the markets, swiftly reversed over the following two weeks in spite of the unknown future for the UK, and ultimately left the EU without one of its strongest members.
Continued Support
While the world reconciled the UK’s decision, the US economy continued along in a very sluggish manner. The downward revision of the second-quarter Gross Domestic Product (GDP) figure to a paltry 1%2 annualized for the first half of 2016 suggested a further slowdown in growth. Correspondingly, inflation was still underperforming the FOMC’s metrics. Due to the delay in hiking interest rates prior to the UK referendum, all eyes moved to August’s meeting for some indication of whether the plan to raise rates could be salvaged. Anticipation faded when post-meeting comments were released, there would not be another rate hike until December 2016, one year following the last one.
The greatest monetary experiment in the history of the world continued in 2016 as the heads of central banks explored ever more unorthodox means to try to stimulate global economic growth. Ultimately, while the FOMC delayed rate increases to await further evidence of strengthening economic factors, artificially low interest rates continued to hurt retirees, pension funds, and life insurance companies. Without much evidence that ultra-low interest rates help an economy that is not in a crisis and ample evidence that it adversely impacts economic growth, retirees, and the programs they depend on, are forced to assume the role of the guinea pig.
November Shocker
History was going to be made one way or another. Would we elect our first woman president? Our first non-politician president? Based on the experts, the pundits, and the polls, this election was a formality. We would all participate in the process and go through the motions, but in the end, the heavily favored candidate would surely be the victor. However, it did not turn out as expected.
The world would once again bear witness to one of the most unexpected, unprecedented, and surreal moments in history—a Donald Trump presidency: a true shock-and-awe moment. An unlikely outsider with no political experience won the nomination for the President of the United States against a seasoned political veteran in Hillary Clinton. Ultimately, the electorate spoke, and they chose an unconventional candidate who challenged the establishment and the status quo.
The initial market reaction to the realization that Trump would win the presidency was sheer terror. The overnight futures markets traded so low that the circuit breakers were triggered to allow the markets to cool off prior to being brought back online. Correspondingly, bond yields plummeted, and gold spiked as traders ran to safe havens. But soon after Trump was announced president-elect and during his acceptance speech, the uncertainty that spooked the markets eased dramatically.
Interestingly, the next morning’s anticipated expected market weakness quickly turned into enthusiasm as the country received Hillary Clinton’s concession speech and President Obama’s encouraging words for the smooth transition of power. Some anxiety had been relieved by their comments; however, the future was still highly uncertain as the incoming president would be faced with economic challenges that have plagued this country’s and the world’s economies since the great recession.
Italian Referendum
Shortly after the US presidential election, Italian citizens voted on a pivotal constitutional referendum that resulted in an overwhelming vote of no. Following the global political trend, voters rejected the continuation of the status quo and once again supported anti-establishment ideals. While the details of the political implications of the referendum are important, the interest from the global community was more focused on the financial implications for its economy due to the precarious developments from this past summer’s bank stress tests.
Disturbing findings from the stress test performed in July on the oldest and third-largest bank in Italy, Monte de Paschi, showed abnormally high nonperforming loans on their balance sheet. Nonperforming loans are simply loans for which the borrower is not paying the lender. As a result, the bank was given a no-confidence vote by the examiners. The EU and the marketplace pushed for bailouts, bail-ins, or some mechanism for restructuring the bank in order to keep it solvent. The primary concern was that the third-largest bank in the third-largest economy in the EU could have serious negative effects on the EU’s partners and the global banking system as a whole.
The rejection of the referendum may make it more difficult for the government and the EU to implement these mechanisms to recapitalize the flailing bank. The presiding thought process was that Greece’s financial woes were a blip on the global financial radar compared to the size and scope of the Italian economy, and the reverberations from the 2011 Greek banking crisis almost plunged the world into another financial catastrophe.
Ultimately, as promised prior to the referendum vote, Matteo Renzi resigned, and the leading political groups that helped fuel the “no” vote pressed for new elections in order to secure more influence and power within the fractured Italian government. Only time will tell whether these new groups can tilt the political favor toward their ideals of anti-EU involvement and anti-bank bailout.
FOMC Raises Rates
With Brexit, the US presidential election, and the Italian referendum behind it, the FOMC was now able to make good on its promise of an interest rate hike. However, its move was telegraphed not by its own comments but by the markets. Market rates adjusted upwards from a July low of 1.36%2 and surged post-election to 2.60%2. This left the FOMC no choice but to raise the federal funds rate of a quarter percentage point to a .50%–.75% range or it would risk being “behind” the curve. The FOMC found justification for a slight rate increase, but the December hike was the only one in 2016 and only the second one in eleven years.
Looking ahead, the FOMC forecasts the possibility of three rate increases heading into 2017 and market consensus is in agreement. Whether it will keep up with its own forecasts will be closely scrutinized. However, the more likely scenario is that the market will continue to lead the way, leaving the FOMC no choice but to play catch-up. As the prospects for higher inflation and economic growth improve, the market may continue to increase interesting rates despite FOMC action or inaction.
Conclusion
In many ways, 2016 represented a year of unprecedented change with the continuation of the anti-establishment trend both in the US and abroad. However, in other ways, the status quo remained unchanged in the realm of global central bank monetary intervention. Whether the changes experienced can have a profound impact on both the political world and on the financial world, will certainly take time to develop. At some point in the future, the world economies must be able to return to more normal operations or they risk the continuation of sluggish growth. The hope in these times of unprecedented change is that the old-school way of thinking becomes en vogue whereby arithmetic returns to the world of global finance.
Author’s Note: Information, news, and figures about our country’s economic well being can be found anywhere. Without a good filter and translator, it is difficult to understand how it impacts you. As your filter and translator of the financial noise that is broadcast everywhere, I can help you clarify its meaning and explain how it makes sense to your situation. My goal is to simplify the meaning, provide perspective, and explain the context of the information. – Steve DeCesare, CFP®
About Steve DeCesare, CFP®
Founder and President of DeCesare Retirement Specialists
One of Philadelphia’s leading retirement transition specialists, Steve DeCesare, CFP®, is a second-generation financial planner who has spent the last decade of his career helping professionals transition into retirement with financial confidence.
His multi-disciplinary planning approach works to ensure that the investment, income, tax and estate strategies are in place to achieve each of his client’s financial and lifestyle goals for retirement. Steve specializes in offering guidance to corporate employees regarding their company sponsored retirement plans such as 401(k)s and pensions. He also advises on rollovers to and investment decisions within Individual Retirement Accounts (IRAs). Additionally, he helps employees who are facing workplace transition with the critical decisions and financial plan adjustments that need to be made to help ensure a smooth progression of their financial life as they enter into their next job or retirement.
Steve is a CERTIFIED FINANCIAL PLANNER™ professional and Investment Advisor Representative of DeCesare Retirement Specialists a Registered Investment Advisor, a Registered Representative under Triad Advisors. He is also life and health insurance licensed in the states of New Jersey and Pennsylvania. Steve is a member of the Financial Planning Association (FPA) and a recipient of the 2012, 2013, 2014, 2015, and 2016 Five Star Wealth Manager Award1. As a financial resource, Steve has been quoted in numerous media outlets including USA Today, Money, The Washington Post, The Wall Street Journal and Bankrate.com.
For more information about this Update and Steve DeCesare, CFP® please call 856.235.3830 or email info@DeCesareRetirement.com.