Market Insight - July 2014

Financial investments have performed quite well during the first half of 2014 and for some good reasons. The Fed is slowly unwinding QE3 in an organized and predictable way, earnings growth is anticipated to be nearly 7% for the second quarter, and the economy added some 288,000 jobs in June (recall January 2009, when we lost 818,000 jobs in a single month!) Still, investors aren’t feeling very happy about it…for some good reasons. The revised first quarter GDP shrunk by 2.9%, the worst showing ever in an economic expansion, although poor weather may have been a contributing factor.

The Numbers

The bond market made a surprisingly strong showing so far this year. The almost unanimous consensus calling for yields to move higher through the first half of 2014 proved inaccurate, as rates fell from nearly 3% to 2.51%, and prices rallied. The Barclays Aggregate US bond index added nearly 2% for the quarter.  The Dow posted a 2.2% gain in the three months ending June 30th, putting it ahead a modest 1.5% for 2014, and 12.9% for the trailing 12 months. The top Dow gainer was Caterpillar, up 19% in 2014; the worst performer, Boeing, lost 6.8%.  The S&P 500 added 4.7% (its 6th consecutive quarterly gain) up 6.1% for 2014 and  22% for the trailing

 12 months.  Mid-sized companies posted respectable numbers as well, with the S&P Midcap 400 up 6.7% for the year, and 22% for the trailing 12 months.  Our focus sector, biotech, got off to a rough start in the beginning of 2014, but came back strongly; the Biotech index IBB, gained 13.2% ytd. Surprisingly, real estate was the best performing asset class; Cohen & Steers Realty Fund (CSRSX) advanced 17.31%. Smaller stocks, measured by the Russell 2000 rose 1.7% for the quarter; emerging markets, measured by MSCI Emerging Market Ishare (EEM) added 3.4%, while the MSCI Developed Market Ishare (EFA) added 1.9%.

It’s very easy, following the lead of the media, to get too narrowly focused on what could go wrong in the short term. Here are some old chestnuts that keep getting rewarmed and served up: 

“Global instability” 

Always with a potential to disrupt markets, but when has the geopolitical landscape ever been free from turmoil?  Most of the crises of the previous few years that were supposed to upend markets never did, and are already forgotten. Those that impacted markets were unanticipated.

"Interest rates are rising…”

This is a real concern but not the way it’s being portrayed. There is a universe of misinformation about bond prices and interest rates; a mathematical relationship has morphed into a catch all for fixed income fearfulness.  Bonds have done very well so far in 2014, and interest rates are considerably lower than they were a year ago.

“Markets hitting new highs”

Totally irrelevant and meaningless, and clearly has become a time-filler for lazy financial reporters. Usually goes together with “the market has gone up so far, it must go down” (lean years following on good years is biblically accurate; not so for capital markets.)

“Markets are so volatile now…"

Not really. The Dow has had 51 consecutive sessions without a 1% move up or down, the longest since 1995.


“Valuations are high”

Well, P/E ratios on the Dow, a decent measure of stock market value, rose from 16.3 times trailing earnings mid-year 2013 to 16.5 times trailing earnings as of the end of June 2014. Stocks are not on sale, but hardly overvalued.

Real wage-driven inflation, until now a secondary issue, is becoming more worrisome. New jobs may soon begin to absorb excess capacity; the core CPI rate was up 2% year-over year in May 2014. Problems here could pose real headwinds for both stock and bond investors, and is something we are watching closely. 

When the market has a correction…

The above chart shows us the surprising frequency of 5% and 10 % corrections, and the relatively brief time it takes for markets to regain their previous highs.  It’s important though, to overlay the numbers with the emotions involved.  Every time the markets slip, it seems to investors the beginning of a more serious decline, or even a long bear market (and every 3-4 years, on average, it is.) Sentiment turns extremely negative and expectations become dire when there is even a small downturn, as media, pundits, and investors build a wall of worry, (which we know from experience markets are most likely to climb.)

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