The classic novel by Charles Dickens A Tale of Two Cities was written in 1859 and currently provides a theme for my thoughts on the stock and bond markets. The opening paragraph reads:
“It was the best of times, it was the worst of times, it was the age of wisdom, it was the age of foolishness, it was the epoch of belief, it was the epoch of incredulity, it was the season of Light, it was the season of Darkness, it was the spring of hope, it was the winter of despair, we had everything before us, we had nothing before us, we were all going direct to Heaven, we were all going direct the other way – in short, the period was so far like the present period, that some of its noisiest authorities insisted on its being received, for good or for evil, in the superlative degree of comparison only.”
“It was the Best of Times, It was the Worst of Times” – is an apt description of the first half of 2013! The overwhelmingly good news is that major U.S. stock indexes recorded double-digit returns for the first half of 2013. The S&P 500, which consists of large companies, was up just shy of 14 percent, while midsize and smaller stocks surged over 14 percent. The S&P 500 racked up its strongest first half in 15 years as the bull market that began in the depths of the Great Recession is now over four years old. How did the other sectors one typically owns in a well diversified portfolio perform since the start of the year?
While it was among the “best of times” for U.S. stocks, it was “not so good times” for developed international stocks, as the EAFE¹ return was over four percent. Likewise, after over 30 years of positive return trends (falling yields), virtually every fixed income (bond) index had “not so good times” returns that were slightly negative. Bond yields are at historic lows. They are very close to zero and real rates (adjusted for inflation) have been negative and at historic lows for the longer maturities for much of that time frame. A shorter duration typically reduces the losses in a period of rising interest rates.
In the “worst of times” category, emerging markets lost over nine percent and trailed U.S. stocks by a margin of over 20 percentage points. To complete the “worst” picture, the Barclays 20+ Year U.S. Treasury Bonds returned -8.5 percent year-to-date and after a decade-long bull market for commodities and precious metals, both suffered sharp reversals so far this year. “Gold is a haven, because it’s universally recognized as currency” has gone the same way as “you can’t go wrong with real estate, because they aren’t making any more of it.
“The price of an ounce of gold tumbled about 30 percent in the first half of 2013, turning in the worst six-month performance since 1968. Not surprisingly, funds that invest in physical gold, such as the $45 billion SPDR Gold Shares, fell an average 27 percent. It was not long ago that people would ask me if they should invest everything they own into gold. Warren Buffet, known as the greatest investor of our times has a quote that nicely summarizes my thoughts: “Be fearful when others are greedy, and be greedy when others are fearful.”
Of course, many observers attribute this year’s stock market gains to the Federal Reserve’s programs that have been very successful at suppressing interest rates and bond yields. The current round is the Fed’s third QE program since 2009 and it is also the largest at $85 billion per month of U.S. Treasury and mortgage-backed-security (MBS) purchases.
Here are some thoughts to ponder:
• If the Fed reduces its MBS purchases, mortgage rates will increase which might impact the housing market and housing has been one of the strongest sectors of the economy.
• Higher rates could cause the economy to slow further. This scenario has caused many short term speculators to trim their financial asset exposure. This particularly concerns me here in Central Oregon as our current market frenzy reminds me of 2006.
• Interest rates and bond values have an inverse relationship. As interest rates rise the price of bonds decreases. How will this affect your fixed income exposure? Will is cause inflation to spike?
• Are U.S. equity markets artificially high as investors have fled out of cash, money markets and CD’s that have been offering negligible returns for equities which offer upside?
Watching emerging markets decline, while U.S. stocks rise, does create the temptation to shift allocations from “the worst” to “the best” opportunistically. For long-term success I believe having a disciplined process is imperative. Returning to Mr. Dickens’ opening paragraph, different strategists might label this time as either the “spring of hope” or the “winter of despair.” However, I feel it is very important not to forecast the short term direction of stocks or bonds based on opinions about future Fed actions. In a prudent strategic process, an attempt should be made to understand the relative attractiveness of different asset classes based on valuations and growth potentials. Further, it is important to understand the correlation of price movements with the goal of lower volatility (risk) in your portfolio, designed to perform in all of Dickens’ scenarios.
As U.S. stocks have had a nearly unprecedented start to the year, most other top managers are in a short term “worst of times” situation in equities. It is mathematically impossible for a diversified portfolio to outperform its best performing component. The job of successfully navigating portfolios through a daily web of variables requires constant attention. Peter Lynch of Fidelity Investments states: “Which way the next 1,000 to 2,000 points in the market will go is anybody’s guess, but I believe strongly that the next 10,000, 20,000 and 40,000 points will be up.” An ancient Chinese proverb states: “May you live in interesting times.” I think you will agree with me that we most certainly do.
1An index created by Morgan Stanley Capital International (MSCI) that serves as a benchmark of the performance in major international equity markets as represented by 21 major MSCI indexes from Europe, Australia and Southeast Asia. This international index has been in existence for more than 30 years.
David is President of the Rosell Wealth Management in Bend. He is the Past President of the City Club of Central Oregon and a Past Chairman of the Bend Chamber of Commerce. David can be reached at 541-385-8831. Check out his latest financial videos: www.RosellWealthManagement.com.
Investment advisory services offered through Rosell Wealth Management, a State Registered Investment Advisor. Securities offered through ValMark Securities, Inc. Member FINRA, SIPC 130 Springside Drive, Ste 300 Akron, Ohio 44333-2431. 800 765-5201. Rosell Wealth Management is a separate entity from ValMark Securities.
