By Scott Smith, CFA

Note: This post is an excerpt from Gould Asset Management’s Economic and Market Review for the Second Quarter of 2016. The excerpt is posted here for the benefit of our blog subscribers.

US Stocks Shake Off Brexit Worries to Finish Higher

Despite initial selling pressure after a surprise “leave” vote, US stocks moved higher on the quarter, thanks in part to a strong post-Brexit rally at quarter-end. The S&P 500 stock index finished the period up 2.5%, and has gained 3.8% for the year. While far from spectacular, US stock market returns continue to show resilience amidst a variety of economic pressures both at home and abroad.

Mid and small cap US stocks outpaced large caps, with the Wilshire 4500 stock index gaining 4.1% in the second quarter and 4.0% for the year. Generally speaking, smaller US companies were less exposed to the strong US dollar and the postBrexit international weakness, compared to the large cap global conglomerates that derive much of their revenues abroad.

Market volatility was mostly subdued in the second quarter. The VIX volatility index started the quarter around 14 in early April and maintained a modest range between 13 and 16 into June, before briefly jumping as high as 26 the morning after the surprise “leave” vote. Despite the initial shock, markets quickly digested the news and within less than a week, the VIX index was back below 16 to finish the quarter.

International Stocks Fail to Keep Pace with US

International developed stocks succumbed to Brexit pressures, with the MSCI EAFE index dropping 1.2% in the second quarter. The index now stands 4.0% lower than it did at the start of the year. Markets have priced in the low expectations for global growth, however, so even a small improvement in the international outlook could have a big impact.

Despite some volatility, emerging markets stocks finished modestly higher on the quarter, rising 0.8% for the period. For the year, emerging markets have risen 6.6% as they continue to rebound from a dismal 2015 in which they declined 14.6%. The stabilization of oil prices is helping the outlook, but a variety of issues continue to present challenges for many of the BRIC countries (Brazil, Russia, India and China). Bonds Post Strong Gains as Interest Rates Fall Lower Still

Nearly all bond investments rose on the quarter as yields finished at new lows for the year. The benchmark 10-Year US Treasury yield started the quarter at 1.78%, but quickly retreated to 1.49% by quarter-end as Brexit-weary global investors looked to the safety and stability of US dollar denominated debt.

US taxable bonds performed well in this environment, rising 2.2% as measured by the Barclays US Aggregate Bond Index, which has now gained 5.3% year-to-date, a rather remarkable result considering the modest expectations many had for bonds at the outset of 2016. Municipal and foreign bonds were also strong performers, rising 2.6% and 4.0%, respectively, in the second quarter. For the year, munis are up 4.3% and foreign bonds an astounding 13.5%, with the latter a reflection of yields pushing toward zero (and in many cases into negative territory) throughout the world. Alternatives Impress

Major alternative asset classes posted strong gains in the second quarter. Commodities (up 12.8%) and energy stocks (up 11.6%) led the charge, while REITs and gold both posted gains of 6.8%. The figures are even better when looked at year-todate, with energy stocks up 16.1%, commodities up 13.3%, REITs up 13.6%, and gold up 24.6%. While we generally only recommend small allocations to these rather volatile asset classes, their performance thus far in 2016 illustrates some of the diversification benefits of their inclusion in portfolios.

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