A quick look at a timely topic of interest – with a brief review of why it could matter to investors.

Chart of the Week

February 10, 2014

Winter chill for US stocks
2014 YTD: S&P 500 price and 10yr UST yield

chart

Source: Bloomberg, as of 2/6/14. Past performance is no guarantee of future results. An investor cannot invest directly in an index. Unmanaged index returns do not reflect any fees, expenses or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.

The Bottom Line:

  • Six weeks ago, optimism for US stocks ran high and pessimism clouded the bond market.
  • After all, the S&P 500 returned over 32% in 2013; and interest rates were expected to continue their rise in the improving economic landscape.
  • But the consensus turned abruptly in the face of weaker-than-expected economic data in the US and China, a currency devaluation in Argentina and uncertainty about the impact of Fed tapering on global financial markets, especially in the developing world.
  • That rapid reversal in mood is a good reminder of eternal verities of investing:
  • Diversification is wise – no matter how sure you are about an outcome
  • After big market moves, pullbacks (and rebounds) are common
  • Broad consensus views are usually already reflected in prices: the unexpected is what may have the biggest impact on markets
  • Sentiment can trump fundamentals  in the short-run
  • Short-term volatility hurts – especially if haven’t planned for it

The chart:

  • The chart shows daily S&P 500 price action (blue line) and the daily change in the 10-year US Treasury yield (red line) for 2014 through February 6th.
  • The lows during the period were reached on February 3rd; the S&P 500 declined nearly 5.76% since year-end, and the 10-year Treasury yield was down 45 basis points (0.45%).

Context & Perspective:

  • Investors were much cautious about stocks at the start of 2013: a year ago, flows into equity funds were still negative, and bond fund inflows were overwhelming positive.  
  • But the tide had turned by the end of the year; flows into equity funds had turned strongly positive, as investors were encouraged by already-rising stock prices and some visible improvement in the economic outlook.
  • While the market’s strong gain in 2013 was indeed encouraging, it also raised the probability of a pullback— a common outcome after a sustained period of strong returns.
  • In fact, since the current bull market started there have three instances of notable pullbacks (based on closing prices) in the S&P 500 after big runs:
  • After the index rebounded 79.9% off the March 9, 2009 low, it corrected 16% between April 23, 2010 and July 2, 2010.
  • From that point it gained another 33.4% before correcting 19.4% between April 29, 2011 and October 3, 2011.
  • The S&P 500 then gained another 29.1% before pulling back 9.9% between April 2, 2012 and June 1, 2012. From June 1, 2012 until the most recent peak on January 15, 2014, the S&P 500 gained 44.6%.
  • So far, the depth of the most recent pullback is just 5.8% from January 15, 2014 through February 3, 2014
  • Of course, there are often catalysts for these kinds of pullbacks—and investors had a fair share to choose from early in 2014:
  • After a string of mostly stronger-than-expected US economic reports late in 2013, investors were faced with some mixed data in early 2014 that included disappointing December and January jobs reports, a drop in durable goods orders, a weaker-than-expected manufacturing PMI for January and some soft data from the housing sector. While harsh weather likely impacted these reports, the weaker tone called into question the growing ebullience about the economy.
  • Meanwhile, some weaker than expected data from China, including the first reported contraction in its manufacturing sector since last summer, clouded prospects for emerging market economies, many of whose markets were already under pressure in 2013.
  • Adding to that uncertainty was a sharp drop in Argentina’s Peso last month, a reflection of the dire economic circumstances in that country.
  • But over and above these issues, the US Federal Reserve has begun tapering its asset purchases, popularly known as QE. Although tapering is not tightening—the Fed is continuing to increase liquidity through the purchase of assets, just at a slower pace—global investors are nonetheless reevaluating future expectations for liquidity conditions and relative growth prospects, which has likely contributed to some of the present volatility and pullback.

Definitions:

The S&P 500 Index is an unmanaged index of common stock performance.  Please note an investor cannot invest directly in an index, and unmanaged index returns do not reflect any fees, expenses or sales charges.

The Federal Reserve Board (“Fed”) is responsible for the formulation of policies designed to promote economic growth, full employment, stable prices, and a sustainable pattern of international trade and payments.

Tapering refers to the Fed’s announced approach to reduce the pace of its current $85 billion in monthly asset purchases gradually instead of ending the purchases all at once.

Quantitative Easing (QE) refers to a monetary policy implemented by the Federal Reserve in which it increases the excess reserves of the banking system (supply of money) through the direct purchase of U.S. Treasury securities.


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Poll

Go for growth: Where will a global recovery be strongest this year?








Poll

Go for growth: Where will a global recovery be strongest this year?

Europe, as countries emerge from bailouts
(39%)
US, as consumers regain optimism
(41%)
Japan, as stimulus programs begin to bear fruit
(9%)
China, as reform and pro-growth policies continue
(11%)



Previous month Poll

Expect the unexpected:
Which of these outcomes
do you think is the most likely
in the coming year?

US: economic surge spurs Fed to begin raising interest rates
(27%)
Japan: return to recession despite Abe's continued aggressive stimulus policies
(12%)
China: negotiate with neighbors over its territorial claims in the South China Sea
(5%)
Europe: Italy forms a government that lasts the entire year
(14%)
None of the above; business as usual worldwide
(42%)