Market Comment Q3 2013
The investment environment is clouded by uncertainty about what will happen when massive monetary stimulus is removed. One manifestation of this uncertainty was the recent sharp increase in bond yields. This appears to have been the result of signals that the Fed was preparing to reduce its $85 billion of monthly purchases of Treasury and mortgage-backed securities.
“THE VALUES OF LONGER-MATURITY BONDS ARE
LIKELY TO REMAIN UNDER PRESSURE FROM
RISING RATES IN THE YEARS AHEAD.”
The Fed subsequently took pains to emphasize that its decision would be “data-driven,” signifying that it has little intention of undoing the good it has done thus far by contributing to premature increases in rates. This week, the Fed announced that it will maintain its current rate of purchases for the time being.
WHO WILL PAY THE PIPER?
Since May, interest rates have risen sharply. The yield on the 10-year U.S. Treasury bond has risen from 1.6% to nearly 3.0%, though this level is still below historical averages. In consequence, many popular bond funds have dropped by 10% or more from their peak. For some time, HeadInvest has limited the interest rate exposure of its bond portfolios by keeping maturities short. Short-maturity bond portfolios have suffered only modest price declines—1-2% or less—in response to the increase in rates. The values of longer-maturity bonds are likely to remain under pressure from rising interest rates in the years ahead. We continue to recommend bond portfolios of short average maturity.
Emerging country markets have also suffered a sharp reversal in fortune in apparent response to the talk of Fed “tapering.” Taken as a whole, emerging market stocks have fallen 10% so far this year and their bond markets by a similar amount. When U.S. interest rates rose, at least some of the money that had sought opportunity in these markets returned to the U.S., or suddenly seemed more likely to. In addition to the direct damage to their markets, most emerging market currencies fell as well. Some countries have raised rates to stem further currency declines. These rate rises threaten further damage in some markets, including India, Indonesia and Brazil. This sequence of events is a dramatic illustration of just how difficult it is to predict the consequences of exiting from conditions of exceptional monetary ease.
“THE ECONOMIC RECOVERY, WHILE MUTED, HAS BEEN
SUFFICIENT TO DRIVE CONTINUED GAINS IN BOTH
EMPLOYMENT AND HOUSING ACTIVITY.”
In developed markets, stocks have maintained their upward momentum despite the sharp rise in interest rates. The economic recovery, while muted, has been sufficient to drive continued gains in both employment and housing activity. These gains have given a lift to consumer and business confidence, as well as to investor confidence. Perhaps more important, central banks around the world continue—at least for the time being—to pursue investor-friendly policies.
In the United States, the estimate of second quarter GDP growth was recently revised upward from 1.7% to 2.5%. Auto production surged in August and consumer confidence remains high, despite a slight downtick in August. Employment continued to gain in August, though employment growth in the last three months has slowed from the pace of previous quarters. Housing activity, too, has slowed a bit, though prices nationally posted a 10% year-over-year gain in June. In Europe, economic activity strengthened in the second quarter for the first time in over a year and a half.
In the month ahead, the market may also face headwinds from renewed fiscal policy debates and the threat of war in the Mideast. A prudent exposure to equities remains desirable, but the risks are not to be discounted lightly.
We are pleased to announce the completion of our purchase of HeadInvest from Androscoggin Bank. Our new principals, and all of us at HeadInvest, are energized by the support we have received from our clients for this transaction. We extend our gratitude to our clients and to Androscoggin Bank.
Our new ownership structure provides us with a key ingredient to our continued success. Direct ownership of our firm, and the prospect thereof, will help us to retain and attract the talented and experienced professional staff to serve our clients well. Next year, HeadInvest will celebrate the 25th anniversary of its founding in 1989. Now, we are even better-positioned for the next 25 years than ever before.
Our portfolio managers will continue to work with our clients as they have in the past. Carl Gercke will remain our Managing Director and Chief Investment Officer.
Gerry Ross has been promoted to Senior Portfolio Administrator helping our professionals meet the needs of our clients. We welcome Patrick Flaherty and Linda O’Malley, both of whom have recently joined our staff. Patrick will assume operational and client service responsibilities and Linda will provide administrative support.
HEADINVEST IS MOVING
HeadInvest will be relocating its offices at the end of the month to new quarters nearby in the Old Port. Our new address will be as follows:
7 Custom House Street
Portland, ME 04101