In the second quarter, ending June 30, 2016, the stock market roller coaster ride continued–markets fluctuated depending on the news about either oil or China.  Also during this quarter, investors showed greater attention to the slowing economy, interest rates, and finally “Brexit”. Great Britain’s vote to leave the European Union was a surprise to almost everyone. Because investors hate surprises and the uncertainty that ensues, they responded negatively. European stocks have been affected the most. Developed country stocks, which primarily includes European stocks, were down about -1.5% for the quarter and -10% over the past 12 months. In part because of improving oil prices, emerging markets fared slightly better. The emerging market index grew by just over 1/2% for the quarter but is still down -11% for the past 12 months. US stocks, given their relative strength compared to the world economy, continue to outperform the global market with growth of 2.5% in the S&P index for the quarter and 4% over the past 12 months. US real estate has done particularly well; the Morningstar US Real Estate index is up 7% for the quarter and 20% over the past 12 months.

It is unclear to what extent Great Britain’s decision to leave the European Union will impact the US and world stocks going forward. World stock indices were impacted immediately following the vote, because investors feared that Brexit would create a domino effect in other countries, increasing trade barriers, lessening trade, and lowering overall economic growth. An alternative would be that Great Britain and the European Union come to some arrangement that would look somewhat similar to their current agreement, allowing England continued free-trade access to European markets. In this optimistic scenario, not only Europe but world trade and economic growth would continue to recover. It is likely that European stocks, if not world stocks, will continue to show volatility as the impact of Brexit is being digested. Expect the volatility to continue, at least in the short run, for negotiations are not likely to even begin until fall, with the possibility that any final agreement may take upward to two years.

The interesting question is how long market volatility will continue to last. Although political uncertainty in the US and the world persists, economic fundamentals–at least in the US–remain good. US payrolls grew by 287,000 jobs in June, and growth in wages over the past 12 months is 2.6%. US GDP growth is likely to continue at least at a 2% clip. US stock valuations, as measured by Morningstar, are fairly valued. On the other hand, trailing stock price to company earnings ratios (P/E ratios are another gauge of stock value) indicate that US stocks are richly valued compared to average historical P/E ratios. According to Scott Crawshaw, Co-Manager of the Harding Loevner Emerging Markets Portfolio Fund, emerging market stocks look cheap relative to their history.

Regardless of what the future holds in terms of returns, stocks will continue to be the investor’s best bet as a hedge against inflation in the long run. Moreover, a disciplined strategy of continued portfolio diversification over time will provide the best returns.

By Barry Jamieson

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