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Quarterly Summaries

2013 Quarterly Summaries

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Review of Security Markets, First Quarter, 2013

Following up on the consistent gains of 2012, global stocks continued to march higher in the first three months of 2013. Owners of U.S. stocks enjoyed especially impressive, double‐digit rates of return.

Strength in U.S. stocks reflected perceptions that economic conditions continue to improve gradually, the risks of further crises may be diminishing and corporations may be able to maintain levels of profitability previously regarded as unsustainable. Among other advantages now enjoyed by U.S. corporations, already flush balance sheets can be augmented with low cost borrowing. Just as importantly, since technological developments allow for more work to be done by fewer workers, those with jobs are for the most part unable to demand and obtain higher wages.

The magnitude of first quarter gains surely surprised most observers, including those inclined to make stock market predictions based upon what they learn in the first section of the newspaper. Careful readers of the tax bill passed in the first week of January, for example, were understandably inclined to worry about the prospects of stocks that pay dividends. As of late December 2012, the federal tax rate on dividends was 15% but just a week later the new rate for high earners was 20%. When a tax rises by 33%, we might expect shopping patterns to change. Yet by the end of the first quarter, the differential between stocks that pay above‐average dividends and those that do not was minimal. In fact, the high dividend payers performed slightly better.

Washington observers also worried about the layering effect of the expiration of the payroll tax cut and the reduction of some discretionary federal spending via the mechanism of sequestration. In the case of the payroll tax, the workers’ share of social security had been lowered for the past two years, from 6.2% to 4.2%, but that lower tax rate was not extended. With sequestration in effect, some discretionary federal government spending began to be cut, automatically, by about $1.2 trillion over ten years. While economists understandably argue about the magnitude of the effects of higher taxes and lower spending relative to prior, virtually all agree that it is likely that we will see a somewhat lower rate of economic growth. The link between expectations about rates of economic growth and stock market returns can be tenuous indeed.

Owners of foreign stocks also enjoyed attractive returns in the first quarter. A diversified basket of foreign stocks returned about 3%. Positive returns were most noteworthy in Japan, where stocks rose almost 20% on a yen‐denominated basis.

In contrast to optimism regarding Japan, the most troubling story for global investors centered, in all places, in Cyprus. A member of the European Union, Cyprus needed funds to recapitalize its banks. In turning belatedly to the European Central Bank for a loan package, Cyprus was forced to “bail in” its main banks’ depositors. It appears that large depositors will lose as much as 60% of their money, and capital controls are in place to prevent the movement of what’s left. Giving safety‐minded investors yet another reason to look upon U.S. markets with affection, influential Dutch finance minister Jeroen Dijsselbloem jumped his brief and made known his candid opinion that the rescue program agreed for Cyprus represents a new template for future banking crises across Europe. Whether in Club Med Europe or anywhere else, depositors are surely reminded that converting cash into an uninsured bank deposit is a transaction that involves risk.

For those seeking to mitigate volatility, high quality U.S. bonds were stable in the first quarter, with returns for the most part flat to modestly positive. Hedged foreign bonds enjoyed a good quarter, as the dollar appreciated against most foreign currencies. Bonds denominated in foreign currencies saw some currency‐related losses.

With interest rates low and stock returns high, investors are sure to be tempted to participate in the much‐discussed “great rotation” out of bonds and into stocks. While the concept is flawed on many levels (by definition, investors cannot buy more stocks so much as trade a mostly fixed amount of securities among themselves at higher prices) there is no denying that ever higher stock prices give investors greater confidence that they should buy more stocks. Curiously, while every retailer knows that customers prefer to buy more products during sales, and once again slow spending when prices revert to normal levels, only economists and behavioral psychologists can explain why those who shop for stocks and bonds prefer to buy more only when prices are high.

A Little Inflation, A Little Pregnant?

With the U.S. Federal Reserve, the European Central Bank and now the Bank of Japan all taking aggressive action to lower interest rates and drive down currency values, the annual pageant in which the U.S. Treasury department decides whether to identify China as an official “currency manipulator” has become embarrassing. To be fair, this isn’t because China doesn’t manipulate the value of its currency; of course it does. Rather, it’s because everybody else that matters does, too. In what is commonly called a race to the bottom of “beggar thy neighbor” competitive currency devaluations, central bankers are surely trying to create higher inflation. Quite apart from whether this is a good idea, how might an economy benefit from higher inflation?

Inflation (which we define here as diminished purchasing power) can be helpful in several ways. For those with $400,000 mortgages on houses worth $350,000, defaulting and walking away is a real option, and yet 3 years of 4.5% inflation brings a world in which the value of the house and the size of the loan will be the same. As such, just as inflation erodes real wealth, it erodes real debt, too, and inflation is therefore a means of mitigating differentials between those who lend and those who borrow. In addition, inflation can stimulate investors to buy productive assets, since cash, once thought safe, begins to seem like a sure, long‐term loser. Even those who won’t invest are more inclined to shop, exchanging a perishable, depreciating asset (cash) for useful, tangible goods. And, finally (though by no means exhaustively) a progressively weakening currency can be attractive to those who seek to locate factories and other sources of employment. Workers with declining real wages may become ever less expensive while the cost of the goods they produce can perhaps be passed on to consumers in the countries with appreciating currencies.

A key question going forward is the extent to which central bankers succeed in creating the right balance of incentives to spur prudent economic activity. Japan has long been regarded as the example of doing too little, with persistently falling prices providing little reason for savers to shop or invest. The rub, of course, is that inflation can get out of hand rather quickly. Investors are wise to keep in mind that very low and very high inflation carry their own risks. Portfolios ought not be constructed in confident anticipation of a single predicted outcome.

Written by Jeff Lancaster, CFP®, Principal; [email protected]

Quarterly Summary Returns

IndexMarketLast 3 Months (01/01/2013 – 03/31/13)
Standard & Poor’s 500Large Co. U.S. Stocks10.61%
Russell 1000 ValueLarge Co. Value U.S. Stocks12.31%
Russell 2000Small Co. U.S. Stocks12.39%
Russell 2000 ValueSmall Co. Value U.S. Stocks11.63%
FTSE NAREIT Equity REITReal Estate Investment8.19%
NASDAQ 100Technology Stocks5.93%
MSCI EAFE*Foreign Stocks5.15%
Barclays Capital AggregateU.S. Dollar Bonds‐0.12%
Barclays Capital MunicipalMunicipal Bonds0.29%
Merrill Global Gov’t BondGlobal Bonds‐3.03%

Key Economic Indicators

  • Real Gross Domestic Product (real GDP) in the U.S. increased at an annual rate of 0.4% in the 4th quarter 2012, down from an increase of 3.1% in the 3rd quarter. The deceleration primarily reflected downturns in both private inventory investment and government spending.
  • In its meeting in January, the Federal Reserve agreed to continue holding the target range for the federal funds rate at 0% to 0.25%. The Committee anticipates that this range will be appropriate as long as the unemployment rate remains above 6 1⁄2%, near‐term inflation is projected to be no more than a half percentage point above the 2% longer‐run goal, and longer‐term inflation expectations continue to be well anchored. It has also agreed to continue its purchase of additional agency mortgage‐backed securities at a pace of $40B per month and longer‐term Treasuries at $45B per month.
  • The U.S. unemployment rate was 7.6% in March, down slightly from year‐end numbers. Employment grew in professional and business services and declined in retail trade. The number of long‐term unemployed was little changed, and accounts for 39.6% of the total unemployed.
  • Inflation (CPI‐U) increased by 0.7% in February. Over the past 12 months, the all items index increased 2.0%. The gasoline index rose 9.1%, accounting for three quarters of the total increase.
  • Standard & Poor’s 500 Index fourth quarter operating earnings per share declined 3.5% quarter over quarter. Earnings declined 2.4% from the same quarter last year. Earnings for the 1st quarter 2013 are estimated to increase at 10%.
  • US non‐farm worker productivity decreased at an annual rate of 1.9% during the 4th quarter 2012. The decrease reflects increases of 0.5% in output and 2.5% in hours worked. Labor productivity is calculated by dividing an index of real output by an index of hours worked of all persons, including employees, proprietors and unpaid family workers. Increases in compensation tend to increase costs and increases in output tend to reduce them.
  • The Comex spot rate for gold fell by 4.82% in the 1st quarter 2013, closing at $1,594.80 an ounce. This was gold’s second straight quarterly decline. Despite conditions that would normally support gold’s strength, such as the Fed’s continued quantitative easing, investors are finding better returns in stocks.
  • U.S. crude oil increased by 5.93% in the 1st quarter 2013, closing at $97.23 a barrel. Oil fundamentals looking forward are weak, with demand waning from China and Europe while 20‐year highs in U.S. production are providing a headwind for prices on the supply side.


Key Economic Indicators complied by Barbara 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.

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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.

©2013 Bingham, Osborn & Scarborough, LLC


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