Volatility Increases
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Both stocks and bonds experienced increased volatility during the third quarter. Both markets were negative in July, positive in August, and negative again in September, ending very nearly even for the quarter. Conflicting economic data, much of which points to a U.S. economy running out of steam, was the primary culprit. Also causing concern among investors were geopolitical threats in the form of ISIS, renewed military action in the Middle East, and questions about the health of Europe’s economy. It was, needless to say, an eventful three months.
Steady As She Goes
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The second quarter ended with solid gains in both stocks and bonds, even as economic data showed mixed results. Stocks continue to add to their gains of last year, and bonds have rebounded nicely from a difficult 2013. While not all economic data support market gains, the economy continues to show slow, steady improvement, which the markets like to see. A recent headline on the market asked the question, “Why is the stock market so boring?” We will take today’s boring market over the excitement of 2008 anytime.
Off and Running
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Stocks are off to a volatile start in the New Year, as a weak January was followed by a strong February. March saw lots of ups and downs as the events unfolding in Ukraine surpassed economic news in the U.S. in importance. When it was all said and done, stocks were able to end the first quarter with a small gain. The bond market also experienced small gains during the quarter as inflation remained a nonfactor.
2013 Year End Review
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2013 was a good year for stock investors and a bad year for bond investors. Stocks had their best year since 1997, while bonds had their worst year since 1994. Improving economic data pushed stocks higher while at the same time causing bonds to sell off as long term interest rates moved higher from their historic lows.
Stock Bulls, Bond Bears
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The stock market continued its climb during the third quarter, rising in July and September while declining slightly in August. Through September, stocks, as measured by the S&P 500, are up nearly 20% for the year. Bonds rallied during the quarter, reversing course after a big selloff during May and June. Even with this rally, most bond indices remain negative on a year to date basis. Stocks have probably gotten a little over extended at this point and a pullback would not be a surprise during the fourth quarter. Longer term, however, stocks continue to look good, especially relative to bonds.
What Happened to Bonds?
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Many investors are concerned about seeing negative returns in their bond portfolios. While we never like to see negative numbers on our performance reports, bonds fluctuate in value just like all other financial assets. We have gotten very accustomed to seeing nothing but gains from the bond market over the years as interest rates have dropped to near zero. As interest rates move back to a more normal level, bond prices will drop. When prices drop by more than the bond’s interest rate, you get negative returns.
2012 Year End Review
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The Running of the Bulls
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Winding Down The Year
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Since June 4th of this year the stock market has risen almost 16% as the rally from the end of the second quarter has continued throughout the third quarter. This has occurred even as we have seen mixed economic data. Consumer sentiment has improved, as has the housing market. The employment situation has continued to be very uneven although the new jobs trend is upward. We are also seeing a spike in the negative to positive corporate earnings ratio which usually alerts us to a market selloff, at least in the short term. Bonds have held their gains for the year as interest rates have stayed at very low levels.
Summer Slow Down
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Like the past two years, this year started out with the promise of stronger economic growth only to see the economy begin to sputter as the summer months arrive. After a very strong first quarter for the equity markets, stocks sold off early in the second quarter as evidence of a weaker than expected economy began to emerge, then rallied late in the quarter. As we said in our last letter to you, the stock market was due for a pull back, so we were not been surprised by that. More alarming to us is the fact that the economy can’t sustain any momentum and is affected by several problems that have difficult solutions.
Since the last economic recession ended three years ago, the recovery has been very uneven and inconsistent. Of the twelve recessions we have had since 1940, this recovery has been ninth of the twelve in terms of new jobs created, adding 2.5 million. While all of us yearn for a return of the economic growth of the 1990’s, it is important to remember where we were in 2008 and how far we have come since then. Three years ago we were embroiled in the worst recession since the Great Depression. To expect a complete recovery this quickly is unrealistic. Our economy has been growing in the 2 - 2 1/2% range the past three years and that is expected to continue over the next year. The Fed would like to see that number closer to 3 - 3 1/2%.
