Interest rates and fixed income investments stole the spotlight during the second quarter. Federal Reserve Chairman Ben Bernanke gave preliminary indications that the Fed could begin “tapering” or reducing its $85 billion monthly bond purchases later in the year, with the possibility of ending the program by mid‐2014. While this should be good news – the Fed believes that the U.S. economy is closer to being able to stand on its own without ongoing quantitative easing – investors reacted by abruptly selling fixed income and other interest‐rate sensitive investments, including real‐estate investment trusts (REITs). The interest rate on the bellwether 10‐year U.S. Treasury increased nearly two‐thirds of a percentage point during the quarter, settling at 2.52% at the end of June. Foreign bonds also declined. Yield‐starved investors from around the world purchased U.S. dollar‐denominated investments, hopeful that they would earn a higher interest rate than those available in other currencies. This demand caused the value of the dollar to increase relative to many foreign currencies.
U.S. stocks registered gains during the quarter with the S&P 500 up 2.92%. Gains during April and May were followed by declines in June in response to concerns that the Fed could end quantitative easing sooner than expected. Foreign developed‐market stocks were mixed, with Japan’s continuing market ascent (and accompanying volatility) particularly notable. Investors remain hopeful that the newly‐ elected Japanese administration will be able to implement its pro‐growth policies. Emerging market stocks did not fare so well, with most major markets, including China, India, Brazil and Russia, coming up with losses in U.S. dollar terms during the quarter. Slowing global growth and Japan’s competitive posturing threaten emerging market exports to the developed world. Turkey’s political unrest and market declines also highlighted the fragility of emerging nations.
To help us better understand the significance of the Fed’s tapering announcement, it is helpful to reflect on the central bank’s remarkable involvement in stimulating the U.S. economy over the past few years. Prior to the financial crisis, the Federal Reserve’s balance sheet totaled $870 billion, comprised mostly of U.S. Treasuries. During these more “normal” times, the Federal Reserve used these accumulated balances as part of its primary monetary policy tool to influence the general level of short‐term interest rates in the economy. Monetary policy is used by the Fed to achieve its key mandates of full employment and moderate inflation.
In December of 2008, with its standard monetary policy tools fully implemented and short‐term interest rates near zero, the Fed found itself with limited firepower to stimulate an economy that was in recession with high unemployment and the risk of deflation. As a next step, the Fed implemented a series of quantitative easing programs, non‐standard tools through which money is printed to purchase longer‐ term Treasuries and mortgage‐backed securities.
In its third and most recent quantitative easing program that began in September 2012, the Fed committed to buying $40 billion of mortgage‐backed securities and $45 billion of longer‐term bonds each month. The Fed hoped that these actions would be especially beneficial for the mortgage market since housing affordability and borrowing are more dependent on longer‐term rates. These monthly purchases of $85 billion are the focus of Ben Bernanke’s “tapering” announcement during the quarter.
As a result of these standard and creative policy tools, the Federal Reserve has accumulated a balance sheet totaling nearly $3.5 trillion, mostly in Treasuries and mortgage‐backed securities. Despite fears of runaway inflation that can be a result of easy money policies, prices remain low, hovering at or near the lower bound of the Fed’s preferred target. Unemployment, while still higher than normal, is improving. After years of struggling to recover in the aftermath of the financial crisis, housing activity is no longer a drag on the economy.
What do we know about the Fed’s plans for tapering?
Is the tapering announcement bad news? Perhaps this quarter’s bond returns tell us that it is unwelcome news in the short‐run, as talk of tapering creates volatility for stock and bond investors alike. In the long‐ term, an economy without such Fed tinkering is both healthy and necessary. Our clients’ portfolios, while not immune to the losses incurred with this sudden jump in interest rates, are better protected from the worst of the volatility by holding short‐ to intermediate‐term duration bond portfolios of high credit quality. The value of these types of bonds can fluctuate; however, the variation in value is small compared to the potential volatility of stock investments. We will be following the recent trends closely and will have more to say about this in upcoming quarters. Meanwhile, your Bingham, Osborn & Scarborough client service team is always available to discuss your investment portfolios.
Written by Colleen S. Supran, CFA, Principal; [email protected]
Quarterly Review of Securities Markets: Total Returns
|Index||Market||Last 3 Months (04/01/2013 – 06/30/13)||Year-to-Date as of 06/30/2013|
|Standard & Poor’s 500||Large Co. U.S. Stocks||2.92%||13.84%|
|Russell 1000 Value||Large Co. Value U.S. Stocks||3.20%||15.90%|
|Russell 2000||Small Co. U.S. Stocks||3.09%||15.86%|
|Russell 2000 Value||Small Co. Value U.S. Stocks||2.47%||14.39%|
|FTSE NAREIT Equity REIT||Real Estate Investment||‐2.13%||5.80%|
|NASDAQ 100||Technology Stocks||3.23%||9.35%|
|MSCI EAFE1||Foreign Stocks||‐0.99%||4.10%|
|Barclays Capital Aggregate||U.S. Dollar Bonds||‐2.32%||‐2.44%|
|Barclays Capital Municipal||Municipal Bonds||‐2.97%||‐2.69%|
|Merrill Global Gov’t Bond||Global Bonds||‐3.81%||‐6.72%|
U.S. non‐farm worker productivity increased at an annual rate of 0.5% during the first quarter of 2013. Unit labor costs fell 4.3%, the deepest decline in hourly compensation since 1947, when records were first maintained.
The Comex spot rate for gold fell by 21.4% in the second quarter of 2013, its biggest quarterly loss ever, closing at $1,252.80 an ounce. Gold is down more than 25% this year.
U.S. crude was little changed in the second quarter of 2013, closing at $97.24 a barrel. While oil fundamentals in the U.S. are looking strong, Chinese PMI data for the second quarter were disappointing, putting downward pressure on oil prices.
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; Bloomberg.com; Live.Lehman.com; MSCI.com; REIT.com; NYTimes.com; StandardandPoors.com; Vanguard.com.; Dimensional Fund Advisors
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