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AAFMAA Blog

AAFMAA Wealth Management & Trust's investment observations from the macro view

2016-09-22

AAFMAA Wealth Management & Trust's team of experts has compiled some observations and considerations for the financial markets in the future.

Here’s what we know with a high degree of probability:

·        The National debt to GDP ratio will continue to exceed 100% for the next five years, based on the fact that we are adding $700 billion of debt each year to current levels. Currently GDP growth averages 2% annually. The national debt yearly estimate may turn out to be low if interest rates return to historically normal levels. At current levels, a 100 basis point increase in rates will increase the deficit nearly $200 billion per year just for debt servicing alone.

·        Global investors will continue to demand US debt for the foreseeable future, as an estimated $13 trillion currently earns a negative yield. This, along with a globally accommodative monetary policy, will keep rates low for an extended period of time.

·        History has shown that in the decade following environments with low inflation (under 3%) and low interest rates (under 3%) equity returns have exceeded historical averages.

·        Also, historically when oil prices have declined more than 50% from peak to trough, equity markets have produced returns in excess of 30% over the following 24 months.

·        Demographic trends are skewing toward a population over age 60. This has major implications for spending (less, thereby reducing tax revenue), savings/investing (searching for higher yield investments, having to save more) and, consequently, economic growth.

 These preceding points lead us to strongly suspect:

·        Worldwide economic growth will remain slow over the next three to five years.

·        Value stocks historically outperform growth stocks in this slow economic environment.

·        Investors’ desire for higher yields will continue to favor dividend paying companies.

·        Expected returns, on both an absolute and risk-adjusted basis, favor equities over fixed income.

·        Stocks that historically perform well in rising or higher interest rate environments (banks, insurance, etc.) will tend to underperform in slow growth, low interest environments.

·        Additional government regulation will make it more difficult to improve corporate earnings.

 What we know but are unclear about as to outcome:

·        International stocks in developed markets appear less expensive than US large caps. But we don’t know yet if this presents a buying opportunity or if unaddressed structural problems combined with continued slow global growth will result in a “value trap,” where the stock/sector stays undervalued for a prolonged period of time.

·        Domestic small cap stocks are undervalued compared to large cap by almost every traditional measure. We don’t know yet if this undervaluation will continue.

·        Asian stocks have outperformed European and emerging market stocks for the past decade. We don’t know yet if this outperformance has run its course or will accelerate.