October, 2016
By Darren Nyce, CFA
Senior Research Analyst, Castle Investment Advisors®, LLC

Before we get to a market recap, an economic checkup and some riveting discussion about data measurement, let’s address the topic that is near the top of most people’s minds these days. No, I’m not talking about the concern people have wondering if this will finally be the year that the “coloring book” makes it into the National Toy Hall of Fame (yes, that is a real thing, find it here: http://www.toyhalloffame.org/). Of course the pressing topic is the U.S. elections. The debate on September 26th was watched by 84 million people. An amazingly high number considering this year’s Super Bowl drew 114 million viewers.

In a year where the candidates involved may be causing ballots to be cast based on who voters dislike the least, it is easy to become fearful and overemphasize the historical ramifications of the result. In fact a recent survey indicated that 61% of Americans viewed the outcome of the election as the “single biggest threat to the economy.” Read more about the survey at http://www.bankrate.com/finance/consumer-index/financial-security-charts-0916.aspx. The truth is that we always do this; we view the current election as the most monumental in our lifetime and beyond.

A few years ago, the New York Times published the following collection of quotes made during various election cycles over the past 150 years:
        1864 Lincoln vs. McClellan
        “We have had many important elections, but never one so important as that now approaching.” Gen. James H. Lane

        1888 Harrison vs. Cleveland
        “The Republic is approaching what is to be one of the most important elections in its history.” New York Times editorial

        1924 Coolidge vs. Davis
        “I look upon the coming election as the most important in the history of this country since the Civil War.” Joseph
        Levenson

        1976 Ford vs. Carter
        “I think this election is one of the most vital in the history of America.” President Ford

        1980 Carter vs. Reagan
        The International Union of Electronic Workers said it felt it was important to take a stand early because the critical
        problems the nation faces may make the 1980 election “the most important of this century.” Associated Press

        1984 Reagan vs. Mondale
        “This is the most important election in this nation in 50 years.” Ronald Reagan

        1988 Bush vs. Dukakis
        “It may be the most important election of this century.” Senator Robert C. Byrd

        1992 Bush vs. Clinton
        “I ask you to join with me for these last three days to reach out and call your friends and family and neighbors to 
        tell them this is the most important election in a generation.” Gov. Bill Clinton

        1996 Clinton vs. Dole
        “It’s the most important election of our lifetime.” Ralph Reed

        2000 Bush vs. Gore
        “2000 historically is the most important national election in my lifetime.” Rep Zach Wamp

        2004 Bush vs. Kerry
        “For that reason, ladies and gentlemen, the election of 2004 is one of the most important, not just in our lives, but
        in our history.” Vice President Dick Cheney

While there is indeed much at stake, keep in mind that 4 years from now, someone will claim that the 2020 election is the most important election in our history.

How will the election impact my investment portfolio? This is the most common question clients have been asking of late. While of course no one really knows this answer, our perspective on the question has 2 main components.

First of all, especially for those who are investing for a longer time frame, the answer is “insignificantly.” Reactions to specific events tend to be exaggerated but short lived; just think back a few months to the market’s reaction to the Brexit vote. A few days of sharp declines followed by a quick recovery as stock prices stop trading on headlines, but on the expected cash flows of companies. Our system of checks and balances combined with our partisan culture that leads either to compromise or stalemate, tends to lower the probability of either candidate’s ability to implement drastically new policies.

Secondly, and a bit more specifically, market gyrations are typically associated with unknown or unexpected outcomes. As we approach November 8th, if no real consensus regarding the result is reached, then expect to have days of increased volatility in the markets. In the same way, if the result is contrary to what the consensus expected, a market reaction will undoubtedly occur. However, it would be quite common for a market bounce to occur in the months following the election, regardless of which candidate wins. Election year aside, 20 of the past 25 fourth quarters have produced a positive gain for the S&P 500.

As we recap the past quarter, all of the major stock market indexes were positive, with international investments actually helping investors for the first time in a while. The technology sector was the clear winner for the quarter, up 12.86%, though for the year, the energy sector still leads. Among the 30 stocks of the Dow Jones Industrial Average, Apple was the leader and Exxon Mobile was the laggard. The year-to-date leaders of the Dow are 3M, United Health Group, and IBM with the worst performers being Goldman Sachs, Boeing, and Disney.

Index 3rd Qtr
2016 Return
1 Year Return 3 Year
Annualized
Return
5 Year
Annualized
Return
S&P 500 3.9% 15.4% 11.2% 16.4%
Dow Jones Industrial Average 2.8% 15.5% 9% 13.8%
Nasdaq Composite 10% 16.4% 13.5% 18.5%
Russell 2000 – Smaller Companies 9.1% 15.5% 6.7% 15.8%
MSCI EAFE – International 6.4% 6.5% 0.5% 7.4%
Barclays US Aggregate Bond 0.5% 5.2% 4.1% 3.1%

Other significant events of the quarter included the Summer Olympics in Rio, the Federal Reserve’s decision to leave interest rates unchanged, and the continued analysis of what the Brexit decision will mean for the world economy.

With another good year so far, the S&P 500 is on pace to record another positive year. There has only been 1 down year in the past 13 years (2008). Like the doctor that tells his patient, “you are in pretty good health, for your age,” the U.S. economy is in pretty good shape, especially considering the length of the time we have been in recovery since the crisis in 2008 (now the 4th longest expansion on record). However, there seems to remain a prevailing sense of dissatisfaction with the amount of economic growth we have seen, particularly as it relates to GDP (Gross Domestic Product). Notice in the following chart how our current expansion has lagged the historical growth that we have become accustomed to experiencing.

3rd qtr 2016 in review chart

One aspect of this lag (certainly not the only one) is the challenge that economists now have in dealing with the “New Economy” – the part of the economy made possible by the internet and the digital age. A country’s GDP has been for some time, a pretty good indicator of its economic growth and is calculated by combining the growth of the workforce and the growth of productivity. But that was much more straightforward when our economy was primarily based on making stuff. Now, a significant amount of economic utility is gained by things that are available for free – think of Google Maps as one example among thousands. Growth in this segment is not captured by the way GDP is calculated. So it is hard to know by how much (research I’ve read suggests about 0.5% per year), but GDP as it is currently calculated, is certainly under-representing true economic growth. Visit the following website to read more: http://www.arpinvestments.com/downloads/Absolute-Return-Letter/2016/The%20Absolute%20Return%20Letter%201016.pdf.

Other economic items of note are the unemployment rate holding steady at 5%, with inflation at 2.3%. Once the election is over, the focus will again move to the Fed which is currently expected to raise interest rates in December, and to corporate earnings which are expected to begin rising after slumping for the past few quarters.

Thanks for reading and for allowing us to be your partners on your financial journey. We encourage you to maintain focus on your long-term goals. Have a great fall.

Sincerely,
The Castle Investment Team

                    
 
Disclosures: 
Tax, legal, and estate planning advice contained in this article is general in nature. Always consult an attorney or tax professional regarding your specific legal or tax situation.
This article was prepared for informational purposes only and does not constitute an offer to buy or sell, or a solicitation of any offer to buy or sell the securities mentioned herein. Information presented does not involve the rendering of personalized investment advice, but is limited to the dissemination of general information regarding products and services. It should not be regarded as a complete analysis of the subjects discussed. All expressions of opinion reflect the judgment of the author as of the date of publication and are subject to change. 
Any strategy discussed herein may not be suitable for all investors. Before implementing any strategy, investors should confer with their financial advisor. No current or prospective client should assume that the future performance of any specific investment, investment strategy or product made reference to directly or indirectly, will be profitable or equal to past performance levels.