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From New Year to Brexit: Bonds and Gold Lead in First Half of 2016

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July 5, 2016
Nesting dolls: Investor review of 2016 financial market themes for the first half of the year

At the halfway mark through 2016, it can be valuable for investors to assess key themes across a variety of markets. As the old saying goes: You can't know where you are going until you know where you’ve been.

Here's a quick look back.

Stocks Suffer Setback after Brexit

Investors were greeted with a New Year's Eve hangover at the start of 2016. A free-fall on the Shanghai stock exchange in the first days of the year quickly spilled over onto Wall Street and equity markets worldwide.

The key trigger: concerns about a Chinese economic slowdown or a potential "hard landing" for China’s economy. Chinese GDP growth declined to 6.9% in 2015, marking the slowest pace of growth in 25 years, and uncertainty about future growth triggered panic selling in stocks worldwide at the start of 2016. Although the Chinese 6.9% growth is more than double that seen in the U.S., it pales in comparison to the double-digit growth of the Chinese economy before the 2008 financial crisis.

The S&P 500 tumbled from around 2040 in January to a low at 1810 in February, marking out a solid 10% correction in the index. But SPX stabilized and began to recover, reaching a high of 2120 in early June. Then Brexit hit and knocked down the S&P 500 by about 5% in just two trading days, leaving the index close to where it started the year. 

S&P 500 year to date

FIGURE 1: S&P 500 (SPX) YEAR TO DATE.

The SPX saw some wild swings in the first half of the year, but ended close to where it began 2016. Data source: S&P. Image source: the TD Ameritrade thinkorswim® platform. For illustrative purposes only. Past performance does not guarantee future results.

Crude Oil Comes Back in Q2

The crude oil market also played a starring role in global market action in early 2016 with an extremely high correlation with the S&P 500. Stocks and crude oil formed bottoms at roughly the same time in February, and as crude oil climbed, U.S. stocks gained as well.

The price of West Texas Intermediate (WTI) crude oil hit its lowest level in 13 years in February. Nearby New York crude futures touched the $26 per barrel area, as seen in figure 2. That marked the continuation of the multi-year slide in oil prices from over $100 per barrel back in 2013.

Crude oil futures recover

FIGURE 2: CRUDE OIL (/CL) REVERSES WEAKNESS AND RECOVERS DURING Q2.

Crude oil formed a bottom in early 2016 before climbing into June. Data source: S&P. Image source: the TD Ameritrade thinkorswim® platform. For illustrative purposes only. Past performance does not guarantee future results.

Massive global overproduction—stemming in large part from the U.S. shale industry along with overproduction from OPEC nations—and slowing demand for crude contributed to the price slide.

The low level of crude oil prices decreased profitability for U.S. oil drillers and ultimately triggered a slowdown in U.S. production. That, along with weakness in the U.S. dollar and expectations that OPEC could freeze production, helped support a rising trend in crude oil. Crude oil futures climbed from a low at $26.05 per barrel in February to a high in early June above $50 per barrel.

Bonds March Higher into History

Yields on the 10-year Treasury note remain historically low. A key theme driving the direction of bond prices and interest rates (which move inversely) this year, of course, has been the U.S. Federal Reserve and monetary policy expectations. Since the start of 2016, expectations on when the Fed could pull the trigger on another rate hike have fluctuated wildly.

The Fed ended its zero interest rate policy in December 2015 with a small rate hike of 0.25%, the first hike in nearly 10 years. That brought the Federal funds rate to its current 0.25% to 0.5% level.

Shifting views on the strength of the U.S. economy and whether inflation is picking up enough to hit the Fed's 2% target have knocked expectations of Fed policy back and forth throughout the year.

Global investors have continued to favor the safe-haven appeal of U.S. Treasuries in light of early-year concerns about Chinese growth and, most recently, fears about what Brexit could mean for the global economy. The yield on the 10-year Treasury fell to 1.45% immediately following the Brexit vote as investors piled into bonds pursuing safety.

All That Glitters

Gold has been a big gainer throughout 2016, posting a 24% gain year to date through late June. Gold, like Treasury bonds, has been viewed as a safe-haven asset and received a fresh jolt of buying interest post-Brexit.

Throughout 2016, gold also gained support from investors worldwide amid concerns about the move to negative interest rate policies by a number of global central banks, including the European Central Bank and the Bank of Japan. Gold futures spiked to a high at $1,355 per ounce immediately after the Brexit vote, hitting its highest level since March 2014.

Return of King Dollar?

Last but not least, the U.S. Dollar Index (/DX) has been buffeted back and forth by conflicting themes in 2016. Early in the year, the dollar came under pressure as traders began to lower expectations for the number of Fed rate hikes in 2016. At the start of the year, many economists expected as many as three or four rate increases. Now, some question whether the central bank will be able to hike at all this year.

The U.S. dollar index slid from a high around 100 at the start of the year into a low near 92 in early May, as seen in figure 3. Bargain hunting emerged around that zone, and shifting expectations about future Fed monetary policy boosted a rebound. In late June, the dollar soared higher, boosted by global safe-haven demand in the wake of the Brexit vote. 

U.S. dollar index

FIGURE 3: U.S. DOLLAR INDEX (/DX) IS SLIGHTLY LOWER ON THE YEAR.

The dollar traded lower in the first half of 2016, but rebounded sharply off its low in May and following the Brexit vote. Data source: CME. Image source: the TD Ameritrade thinkorswim® platform. For illustrative purposes only. Past performance does not guarantee future results.

Looking to the second half of 2016, Brexit and its repercussions for the U.K. and eurozone economy—and the spillover impact onto the global economy—might remain in the spotlight for investors and markets. Continuing uncertainty over when and if the Federal Reserve will hike interest rates in 2016 and the pace of growth in the U.S. economy will of course be key market drivers, too.

Stay tuned. It’s already been a fascinating year in the financial markets, and it’s only half over! 

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