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Weekly market insights from the Global Investment Strategy team
What it may mean for investors
Asset Class Performance—November Was a Mixed Bag
Financial markets have moved significantly since the election. But not all assets have moved in the same direction. U.S. stocks are up, while international stocks, as a group, are down. Most bond prices are lower as yields have moved up in sympathy with higher expected inflation and interest rates. The U.S. dollar has been stronger than other developed-market currencies such as the euro and yen as relatively higher interest rates and growth favor the U.S. currency.
Chart 1. Asset Class Returns Since the Election Favor U.S. Stocks (11/8-11/30/16)
Source: FactSet, 12/2/16
Year to date, U.S. stocks and, in particular, U.S. small-company stocks (Russell 2000 Index), are among the top-performing asset classes. However, nearly all asset classes are positive, including high-yield bonds, emerging-market equities and U.S. and developed-market fixed income on a year-to-date basis. Only municipal bonds and developed-market equities show negative returns (Chart 2).
Chart 2. Year-to-Date Asset Class Returns (1/1-11/30/16)
Source: FactSet, 12/2/16.
How Should Investors Respond?
Looking into 2017, we expect yields on longer-dated bonds to remain about where they are today as the Federal Reserve (Fed) gradually raises the fed funds rate. That means that bond investors are likely to earn a bit more in yield in the coming year than they did in 2016. We caution investors not to invest too heavily in very long-term bonds (more than 10-year maturities) as these bonds’ yields are still lower than historical averages. We could see significant negative price moves in these types of bonds if inflation expectations rise from current levels. Similarly, municipal bonds have repriced given the expectation of lower tax rates in the future (coupled with the Treasury-yield rise). We believe that the repricing in this asset class may represent an opportunity for investors in higher tax brackets.
U.S. equities may see bifurcated results as we head into 2017. We expect the positive growth trends in the U.S. to continue in 2017, and earnings growth also should see gains in the coming year. The stocks of larger companies should continue to move higher at least until midyear. However, smaller-company stocks may have already seen their upward adjustment, so we have valuation concerns that keep us underweight this asset class. International-stock returns have been combating both a rising dollar and the perception that curtailed trade under the new U.S. administration would be negative for economic-growth prospects abroad. We think these negative forces will subside in the coming months as investors turn back to fundamentals and away from speculation.
Real assets could benefit from modest inflation and any infrastructure spending that is implemented under the new U.S. administration. Much higher interest rates, however, would compete with real estate investment trust (REIT) yields and make financing of real-estate ventures more costly.
Alternative investments may benefit a portfolio should a more volatile market result as geopolitical stresses continue to impact financial markets around the globe. That is because certain alternative strategies are designed to hedge risks and provide absolute returns even when markets are in flux.
We believe that investors should evaluate their portfolio holdings in light of what they are designed to do within the portfolio. Stocks are considered the growth engines of a portfolio. If you have a "Growth" objective, you should be holding more stocks than other types of assets. Bonds are an important part of an investment portfolio, because they provide income and often stability in times of market unrest. If your objective is "Income," then we believe you should have a higher allocation to bonds in your portfolio. It should be noted, however, that bonds, while typically less volatile than stocks, also can experience declines in value, as we have seen in the month of November. REITs and commodities (real assets) can provide an inflation hedge and growth and income opportunities for investors. Alternative investments may provide a diversifying element to your portfolio. That is, they may not move in the same direction as traditional asset classes, thus helping to smooth (and potentially improve) your returns over time.
All investing involves some degree of risk, whether it is associated with market volatility, purchasing power or a specific security. Stocks offer long-term growth potential, but may fluctuate more and provide less current income than other investments.
Asset allocation and/or diversification cannot eliminate the risk of fluctuating prices and uncertain returns.
The prices of small and mid-cap company stocks are generally more volatile than large company stocks. They often involve higher risks because smaller companies may lack the management expertise, financial resources, product diversification and competitive strengths to endure adverse economic conditions.
Investing in foreign securities presents certain risks not associated with domestic investments, such as currency fluctuation, political and economic instability, and different accounting standards. This may result in greater share price volatility. These risks are heightened in emerging markets.
Investments in fixed-income securities are subject to interest rate and credit risks. Bond prices fluctuate inversely to changes in interest rates. Therefore, a general rise in interest rates can result in the decline in the bond’s price. Credit risk is the risk that an issuer will default on payments of interest and principal. High yield fixed income securities are considered speculative, involve greater risk of default, and tend to be more volatile than investment grade fixed income securities. If sold prior to maturity, fixed income securities are subject to market risk. All fixed income investments may be worth less than their original cost upon redemption or maturity.
Municipal bonds offer interest payments exempt from federal taxes, and potentially state and local income taxes. These bonds are subject to interest rate and credit/default risk and potentially the Alternative Minimum Tax (AMT). Quality varies widely depending on the specific issuer.
Investing in commodities is not suitable for all investors. Exposure to the commodities markets may subject an investment to greater share price volatility than an investment in traditional equity or debt securities. Investments in commodities may be affected by changes in overall market movements, commodity index volatility, changes in interest rates or factors affecting a particular industry or commodity. Products that invest in commodities may employ more complex strategies which may expose investors to additional risks.
There are special risks associated with an investment in real estate, including the possible illiquidity of the underlying properties, credit risk, interest rate fluctuations and the impact of varied economic conditions.
Alternative investments carry specific investor qualifications which can include high income and net-worth requirements as well as relatively high investment minimums. They are complex investment vehicles which generally have high costs and substantial risks. The high expenses often associated with these investments must be offset by trading profits and other income. They tend to be more volatile than other types of investments and present an increased risk of investment loss. There may also be a lack of transparency as to the underlying assets. Other risks may apply as well, depending on the specific investment product.
3AG portfolio: The Moderate Growth & Income Portfolio composition is as follows: Barclays U.S. Treasury Bills (1-3M): 3%, Bloomberg Barclays U.S. Aggregate (1-3Y): 4%, Barclays U.S. Aggregate (5-7Y): 16%, Bloomberg Barclays U.S. Aggregate (10+Y): 7%, JPM GBI Global Ex-US: 3%, Bloomberg Barclays U.S. Corporate High-Yield Bond: 6%, JPM EMBI Global Index: 5%, FTSE EPRA/NAREIT Developed: 5%, S&P 500: 21%, Russell Midcap®: 9%, Russell 2000®: 8%, MSCI EAFE: 6%, MSCI Emerging Markets: 5%, Bloomberg Commodity: 2%
Performance results for the Moderate Growth & Income and the 60/40 Portfolios are hypothetical and for illustrative purposes only. Hypothetical results do not represent actual trading and the results achieved do not represent the experience of any individual investor. In addition, hypothetical results do not reflect the impact of any fees, expenses or taxes applicable to an actual investment. The indices reflect the historical performance of the represented assets and assume the reinvestment of dividends and other distributions. An index is unmanaged and not available for direct investment. Hypothetical and past performance does not guarantee future results. Different investments offer different levels of potential return and market risk. Please see below for the definitions and risks associated with the representative indices.
Bloomberg Barclays 1-3 Month U.S. Treasury Bill Index includes all publicly issued zero-coupon U.S. Treasury Bills that have a remaining maturity of less than 3 months and more than 1 month, are rated investment grade, and have $250 million or more of outstanding face value. In addition, the securities must be denominated in U.S. dollars and must be fixed rate and non-convertible.
Bloomberg Barclays U.S. Aggregate Bond Index is unmanaged and is composed of the Barclays U.S. Government/Credit Index and the Barclays U.S. Mortgage-Backed Securities Index, and includes Treasury issues, agency issues, corporate bond issues, and mortgage-backed securities.
Bloomberg Barclays U.S. Corporate High Yield Index covers the universe of fixed-rate, noninvestment-grade debt.
Bloomberg Barclays U.S. Municipal Bond Index is an unmanaged index composed of long-term tax-exempt bonds with a minimum credit rating of Baa.
Bloomberg Barclays U.S. Treasury Index includes public obligations of the U.S. Treasury with a remaining maturity of one year or more.
Bloomberg Barclays U.S. Corporate High Yield Index covers the universe of fixed-rate, noninvestment-grade debt.
Bloomberg Commodity Index is a broadly diversified index comprised of 22 exchange-traded futures on physical commodities and represents 20 commodities weighted to account for economic significance and market liquidity.
Developed Mkt ex US: MSCI EAFE Index (Europe, Australasia, Far East) Index (MSCI EAFE) is a free float-adjusted market capitalization index designed to measure the equity market performance of developed markets, excluding the U.S. and Canada. The 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.
Developed Mkt ex US Fixed Income: JPMorgan Global Ex United States Index (JPM GBI Global Ex-US) is a total return, market capitalization weighted index, rebalanced monthly, consisting of the following countries: Australia, Germany, Spain, Belgium, Italy, Sweden, Canada, Japan, United Kingdom, Denmark, Netherlands, and France.
Emerging Mkt Fixed Income: JPMorgan EMBI Global Index is a U.S. dollar-denominated, investible, market cap-weighted index representing a broad universe of emerging market sovereign and quasi-sovereign debt. While products in the asset class have become more diverse, focusing on both local currency and corporate issuance, there is currently no widely accepted aggregate index reflecting the broader opportunity set available, although the asset class is evolving. By using the same index provider as the one used in the developed-market bonds asset class, there is consistent categorization of countries among developed international bonds (ex. U.S.) and emerging market bonds.
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.
MSCI Frontier Markets Index is a free float-adjusted market capitalization index that is designed to measure equity market performance of frontier markets. The MSCI Frontier Markets Index consists of the following 24 frontier market country indexes: Argentina, Bahrain, Bangladesh, Bulgaria, Croatia, Estonia, Jordan, Kenya, Kuwait, Lebanon, Lithuania, Morocco, Kazakhstan, Mauritius, Nigeria, Oman, Pakistan, Romania, Serbia, Slovenia, Sri Lanka, Tunisia, Ukraine, and Vietnam. The MSCI Saudi Arabia Index is currently not included in the MSCI Frontier Markets Index but is part of the MSCI Gulf Cooperation Council (GCC) Countries Index. The MSCI Bosnia Herzegovina Index, the MSCI Botswana Index, the MSCI Ghana Index, the MSCI Jamaica Index, the MSCI Palestine IMI, the MSCI Trinidad & Tobago Index and the MSCI Zimbabwe Index are currently stand-alone country indexes and are not included in the MSCI Frontier Markets Index. The addition of these country indexes to the MSCI Frontier Markets Index is under consideration.
Public Real Estate: FTSE EPRA/NAREIT Developed Index is designed to track the performance of listed real-estate companies and REITs in developed countries worldwide.
Real Assets is a broader asset class category includes Public Real Estate and Commodity
Russell 2000® Index measures the performance of the 2,000 smallest companies in the Russell 3000® Index, which represents approximately 8% of the total market capitalization of the Russell 3000 Index.
Russell Midcap® Index measures the performance of the 800 smallest companies in the Russell 1000 Index, which represent approximately 25% of the total market capitalization of the Russell 1000® Index.
S&P 500 Index is a market capitalization-weighted index composed of 500 widely held common stocks that is generally considered representative of the US stock market.
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The information in this report was prepared by the Global Investment Strategy division of WFII. Opinions represent GIS’ opinion as of the date of this report and are for general information purposes only and are not intended to predict or guarantee the future performance of any individual security, market sector or the markets generally. GIS does not undertake to advise you of any change in its opinions or the information contained in this report. Wells Fargo & Company affiliates may issue reports or have opinions that are inconsistent with, and reach different conclusions from, this report.
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