The second quarter of 2013 (and the beginning of the third quarter) have essentially been extensions of the first as developed equity markets have continued to provide strong returns. Year-to-date, the S&P 500 is up about 20% (its three year cumulative return is now about 60%) and the rest of the developed world (as measured by MSCI EAFE) is up 13%. Emerging market equities, however, have continued to struggle and are now down about 8% for the year after having been down nearly 2% in the first quarter.
Fixed income returns are slightly negative for the year with the U.S. Treasury index and U.S. corporate bonds each down about 2.5%. Municipal bonds are down slightly over 4%. High Yields Bonds are still in positive territory, however, up a little over 3% year-to-date.
The second quarter saw a significant rise in bond yields (the 10 year U.S. Treasury increased 100 bps (1%) from approximately 1.6% to 2.6%, for example) after Federal Reserve Bank Chairman Ben Bernanke spooked the markets by signaling a possible end to or significant tapering of “quantitative easing” (that is the Fed program of buying approximately $85 billion a month of longer term bonds). Although the Fed Chairman tried to later ameliorate the affects of his comments, the 10 year Treasury yield has continued to rise and is now above 2.76%.
Although quantitative easing may indeed taper down soon (in fact, I think it will), the Fed has not given any indication that its ZIRP (zero interest rate policy) is going to end any time soon. With short rates at effectively zero, causing money market funds and bank deposits to offer very little yield, we think it may be an appropriate time for clients to consider allocating a portion of their cash to short-duration fixed income. Although short-duration fixed income is not cash and does entail some additional investment risk, we believe the risk/reward trade off to be especially favorable in the current environment. If you have an interest in exploring this, please contact me or your individual portfolio manager.
On the equity side, despite the recent strong performance in equities, we continue to believe that for long-term investors, equities offer value. Valuation against traditional metrics like price-to-earnings ratios are still in the reasonable range and equities continue to look favorable compared to bonds. Despite the considerable press coverage of economic slowing in China (to only 7% annual GDP growth!) and some other issues in India and Brazil, we think emerging market equities are becoming more compelling given this recent underperformance as their valuations now look very attractive. Longer-term investors must, however, be willing to endure some short-term volatility that will invariably arise.
All of this short-term discussion of the markets must be placed in the context of a long-term, strategic investment plan. At First Western, we have believed since our founding, and continue to believe, that long-term investment success comes from having, and sticking to, a well-thought through, consistently implemented plan that is developed specifically for individual clients. I think we achieved another quarter of sticking to this discipline, and I very much appreciate your support. If there is anything else we can help with, please let us know.