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Market Insight July 2013

“Volatile” just doesn’t begin to describe the final weeks of the second quarter.  Fed chairman Bernanke’s comments on June 19th regarding the tapering of the QE3 program triggered a sell-off in both stocks and bonds; interest rates spiked; investors turned jittery and unsettled, and market swings of 200 points or more followed. Then, in the closing sessions of June, after some clarification (and perhaps backpedaling) by several members of the Fed’s Open Market Committee, some semblance of order returned, and prices began to recover.

Bonds and Precious Metals                                                                                  

Yields on the benchmark 10 year U.S. Treasury shot up from 1.60% at the beginning of May to 2.65% by the latter part of June, finally settling at 2.5% at the end of the month. This was the largest move, in the shortest interval, in recent memory.  IEF, the IShare that tracks the Barclays 7-10 year bond index, fell 7.8% from its high in the sell-off, while the IShares iBoxx $ High Yield Corporate Bond index, (HYG) lost 8.3%, before regaining some ground at month’s end. Gold prices collapsed; the precious metal ended the quarter at $1,217/oz., off more than 32% from its 52 week high.

Equities

Despite the turmoil, most averages remain higher year-to-date, and most of our globally balanced portfolios held onto respectable gains through the first half of the year. Real estate, measured by Cohen & Steers Realty shares, added 3.8%. Smaller stocks, measured by the S&P Small Cap 600, were up 15.4% year-to-date.  The Dow and the S&P 500, representing core US large cap stocks, posted gains of 15% and 13% respectively from their January 2013 levels.  Even the MSCI Developed Markets index held a small gain for 2013, despite a steep decline from its highs; emerging markets, however, tumbled, suffering from continued turmoil in the Chinese banking system and interest rate concerns, and fell 13.5% for the year.

We wrote in our April letter that a 5-10 % correction was likely, and probably desirable, to consolidate the market for further growth. The events of May and June seemed to confirm this. Those investors who believed the strength of our equity markets rested solely on low interest rates sold quickly; the Dow fell rapidly from its May 28th high of 15,409 to 14,659 on June 24th, a loss of nearly 5%. Then, both stock and bond markets rallied strongly in the final days of June, as downward revision of 1st quarter economic growth to a tepid 1.8%, (following 4th quarter growth of just .4%), gave investors cause to reconsider whether Fed minutes on the timing of the taper of QE3 really justified the sell-off, considering an economic expansion and job recovery that still seems tentative and somewhat fragile.

We try to keep in mind that, on average, markets tend to experience pullbacks of 5% or so three times a year, and that declines of 10% occur about once a year. (The last time was October 2011, prior to that, July 2010.)  Astute investors know that most of these moves signify very little about the future direction of the markets.

Frequency of market corrections 1900-2012

Bonds and rising rates

Most of the dire predictions of a bond market collapse  seem to come from those with little real experience in navigating a rising interest rate environment; with bombast and hyperbole standing in for common sense.  The fact is, rising interest rates, while a challenge for fixed income investors, can also present great opportunities. Experience tells us that an effective  strategy can include using high quality corporate bonds, laddering bonds to spread out due dates, avoiding longer terms, diversifying across various classes of fixed income, controlling average maturity and duration, and most important, keeping funds available to buy new bonds as rates increase.  And of course, an appropriate allocation of assets among equity/growth investments and fixed income, determined by each client’s  tolerance for risk, requirement for income, and growth objectives.

 

Steven Weber                                    Gloria Harris                           Frank  Weber

Registered Investment Advisor          Director, Client Services         Director, Operations
The Bedminster Group

TAGGED: Market Insights
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