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Quarterly Summaries

2012 Quarterly Summaries

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Review of Securities Markets, Third Quarter, 2012

Stocks surged in the third quarter due in large part to the accommodating monetary policies of central banks around the world. European Central Bank President Mario Draghi set the tone in late July, stating that the ECB “is ready to do whatever it takes to preserve the euro, and believe me, it will be enough“. Investors took this as their cue to begin piling into risk assets, pushing global equity prices higher. Just as the initial euphoria started to wear off, the ECB announced the details of its latest bond buying program entitled Outright Monetary Transactions (OMT). The OMT allows the ECB to purchase unlimited amounts of sovereign debt in the secondary markets in order to restore investor confidence in the euro.

Not to be outdone by his European counterpart, Federal Reserve Chairman Ben Bernanke unveiled the Fed’s latest bond buying program (QE3) that will focus on purchasing mortgage-backed securities until the U.S. jobs market significantly improves. In response, U.S. stocks rose. Contrary to what we might expect in a risk-driven environment, large company stocks continued to outperform small companies so far this year. The S&P 500 gained 6.4% in the third quarter, posting year-to-date returns of over 16%.

After a weak second quarter, foreign stocks rallied in the third quarter, with the MSCI EAFE index of developed-market stocks returning 6.9%. While the European debt crisis is far from being resolved, the ECB’s actions have helped to reduce the “tail risk” of a break-up of the Eurozone.

The yield on 10-year US Treasuries reached an all-time low of 1.38% in late July and ended the quarter just above 1.6%. Bonds of lower credit quality, often referred to as “junk” bonds, outperformed for the quarter as investors stretched for yield. Municipal bonds also benefited with the Barclays Capital Municipal Bond index up over 6% for the year.

Of Politics and Policy

Four years have passed since the worst of the financial crisis unfolded in September 2008. Since then, central bankers from around the world have played a pivotal role in managing the post-crisis and recovery period. Not only have the central banks used creative monetary policy tools to provide stimulus, but policy makers have also more openly discussed the use of monetary policy. In spite of, or maybe because of, this improved transparency, we have experienced increased speculation and anticipation of future policy decisions, one of a number of sources of uncertainty for investors.

The third quarter was no exception to investors’ waiting and wondering as central banks signaled the willingness to use more policy tools. Through its OMT mechanism, the ECB will continue its efforts to buy sovereign debt on the secondary market, but this program is very different from past efforts. The participating countries must ask for the ECB’s backing and in return, are expected to meet strict fiscal standards. If the criteria are not met on an ongoing basis, the ECB intends to discontinue the bond purchases for that country. Unlike past programs, the ECB will give up its position as a senior creditor, sharing in potential losses with all other investors in sovereign debt. By indicating the willingness to buy unlimited amounts of bonds, the ECB intends to reassure investors that the central bank will do whatever it takes to safeguard access to affordable credit for even the weakest sovereign borrowers.

Federal Reserve Chairman Ben Bernanke cited the high unemployment rate as justification for QE3; however, with the election nearing, the additional stimulus is controversial. The Fed has two mandates – full employment and price stability. While these mandates are simple, the evidence used to judge the current condition of the economy is complex and subject to interpretation. And while the Fed is expected to operate without political bias, the central bank’s interpretation of the current environment often leads to a politically-charged debate, especially in an election year.

At times, these debates stem from the complexity of the data used to guide the Fed in policy setting. For example, over the past year the U.S. has experienced a declining unemployment rate. At face value, this seems like a positive for the U.S. economy; however, in some cases, the calculation of the unemployed includes fewer people because some have become so discouraged by the lack of job openings that they have stop searching for work altogether. In this case, a lower unemployment rate is not a signal of an improving economy. Price stability is also very complex in that the Federal Reserve excludes the volatile food and energy components, preferring to focus on core inflation. As consumers, we know that food and energy price increases are not only meaningful but sometimes painful, especially as gasoline approaches $5 per gallon.

At other times, these debates stem from the differences in the philosophical beliefs of those analyzing the data. There is general agreement that the joint efforts of central bankers around the world prevented an even deeper financial crisis in late 2008. But many, including Paul Krugman, the Nobel Prize winning economist, believe the Fed can and should do more to stimulate the economy. He contends that central banks have the tools to stimulate and ultimately to improve the economy. Without Fed intervention, millions will struggle with long-term joblessness, a price that should be unacceptable for wealthy economies such as the United States and Europe.

Others, including Mohamed El-Erian at PIMCO, the world’s largest bond investor, are concerned that the Federal Reserve is creating dependence on easy money by keeping interest rates low, forcing savers to take on risk to obtain return. His analogy is that this “sugar high” is likely to end with a crash that will ultimately leave economies around the world in worse shape. These analysts are credible and intelligent, and yet have very different beliefs about the role of central bankers and the ultimate results of policy decisions.

The ECB and the Federal Reserve are not the only central banks using monetary policy to restore their local economies to vibrancy. In an increasingly globalized world, the actions of central bankers around the world create a complex environment. When reducing interest rates, central bankers can have a meaningful impact on currency valuations. As interest rates fall, the local currency becomes less attractive for savers. This leads to a decline in value relative to other currencies that may offer higher rates of interest. As the value of a currency declines, the goods and services produced by that country become less expensive to trading partners. A robust export trade creates domestic jobs, ultimately leading to national wealth and prosperity. It is no wonder that analysts call the cuts in interest rates around the world “a race to the bottom”, referring to the push to become the cheapest currency in the exporting world.

We start the fourth quarter of this year with many unknowns ahead. Needless to say, central bank activities are only one part of our national debate prior to this election. It is often said that monetary policy is a blunt instrument, meaning the full effect of central bank decisions, both intended and unintended, will not be known for many years to come. In the face of this ongoing uncertainty, it is important to consider and review your risk tolerance regularly. Please contact your BOS team to discuss these issues, and others, pertaining to your long-term financial security.

Written by Colleen S. Supran, CFA, Principal; [email protected] and Joel R. DeMaria, CFP; [email protected]

Quarterly Review of Securities Markets: Total Returns

IndexMarketLast 3 Months (07/01/2012 – 09/30/12)Year-to-Date as of 09/30/2012
Standard & Poor’s 500Large Co. U.S. Stocks6.35%16.43%
Russell 1000 ValueLarge Co. Value U.S. Stocks6.51%15.75%
Russell 2000Small Co. U.S. Stocks5.25%14.23%
Russell 2000 ValueSmall Co. Value U.S. Stocks5.67%14.37%
FTSE NAREIT Equity REITReal Estate Investment0.16%15.10%
NASDAQ 100Technology Stocks7.01%22.89%
MSCI EAFE*Foreign Stocks6.92%10.08%
Barclays Capital AggregateU.S. Dollar Bonds1.59%4.00%
Barclays Capital MunicipalMunicipal Bonds2.31%6.05%
Merrill Global Gov’t BondGlobal Bonds2.35%2.53%

Source: Thomson Financial’s Investment View;

Key Economic Indicators

  • Real Gross Domestic Product (real GDP) in the U.S. increased at an annual rate of 1.3% in the second quarter of 2012, a slowdown from the first quarter pace of 2.0%.
  • The U.S. unemployment rate decreased to 7.8% in September. This rate had stayed within a narrow range of 8.1% to 8.3% for the first 8 months of the year. The number of long-term unemployed was little changed.
  • Inflation (CPI) increased 0.6% in August. Over the past 12 months, the all-items index increased 1.7%.
  • Standard & Poor’s 500 Index operating earnings per share increased 2.3% in the second quarter of 2012 from the same quarter a year ago. Analysts expect a slowdown in earnings in the third quarter.
  • US non-farm worker productivity increased at an annual rate of 2.2% during the second quarter of 2012.
  • The Comex spot rate for gold increased by 10.45% in the third quarter of 2012, closing at $1,771 an ounce. Demand for gold as an alternative investment is on the rise as investors attempt to protect against the risk that monetary easing will erode the value of paper currencies. The value of gold has risen 13.11% from the beginning of the year.
  • Crude oil rebounded 8.5% in the third quarter, closing at $92.19 a barrel. Crude oil is down 6.72% year-to-date.

    Key economic indicators compiled by Barbara A. Ziontz, CFP, Portfolio Manager; [email protected]

    Data Sources: The Wall Street Journal; US Dept. of Commerce – Bureau of Economic Analysis; US Dept. of Labor;;;;;;; ; Dimensional Fund Advisors

    Disclosures and Footnotes:

    This information is not intended to be used as a general guide to investing, or as a source of any specific investment recommendations, and makes no implied or express recommendations concerning the manner in which any client’s account should or would be handled, as appropriate investment strategies depend upon the client’s investment objectives. It is the responsibility of any person or persons in possession of this material to inform themselves of and to take appropriate advice regarding any applicable legal requirements and any applicable taxation regulations which might be relevant to the subscription, purchase, holding, exchange, redemption or disposal of any investments.

    This information does not constitute a solicitation in any jurisdiction in which such a solicitation is unlawful or to any person to whom it is unlawful. Moreover, this information neither constitutes an offer to enter into an investment agreement with the recipient of this document nor an invitation to respond to the document by making an offer to enter into an investment agreement.

    The portfolio risk management process includes an effort to monitor and manage risk, but does not imply low risk. Past performance is not indicative of future results, which may vary. The value of investments and the income derived from investments can go down as well as up. Future returns are not guaranteed, and a loss of principal may occur.

    Opinions expressed are current opinions as of the date appearing in this material only. No part of this material may, without Bingham, Osborn & Scarborough, LLC’s prior written consent, be (i) copied, photocopied or duplicated in any form, by any means, or (ii) distributed to any person that is not an employee, officer, director, or authorized agent of the recipient.

    (1) Source: MSCI. Neither MSCI nor any other party involved in or related to compiling, computing or creating the MSCI data makes any express or implied warranties or representations with respect to such data (or the results to be obtained by the use thereof), and all such parties hereby expressly disclaim all warranties or originality, accuracy, completeness, merchantability or fitness for a particular purpose with respect to any of such data. Without limiting any of the foregoing, in no event shall MSCI, any of its affiliates or any third party involved in or related to compiling, computing or creating the data have any liability for any direct, indirect, special, punitive, consequential or any other damages (including lost profits) even if notified of the possibility of such damages. No further distribution or dissemination of the MSCI data is permitted without MSCI’s express written consent.

    ©2012 Bingham, Osborn & Scarborough, LLC


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