Quarterly Summaries

2014 Quarterly Summaries

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Review of Securities Markets, Third Quarter, 2014

The Standard & Poor’s 500 finished the quarter with a modestly positive return of 1.1%, ending just 39 points below its all-time high set on September 18. This is the seventh straight quarterly gain for the index, the longest since the 14-quarter bull run that ended in 1998. Even though the S&P 500 managed to post another quarterly gain, investors were reminded of the volatility inherent in owning stocks. We experienced a sell-off in July, a recovery in August, and more selling later in September. Small company stocks, measured by the Russell 2000, tend to be more volatile than large stocks and this quarter was no exception. Small stocks did not fare as well as large stocks, declining 8.8% from the index’s record high reached on July 3. Both small and small value stocks ended the quarter with negative year-to-date returns.

Developed-economy foreign stocks, measured by the MSCI EAFE, also declined during the quarter due to slowing economic growth and a surging U.S. dollar. Most notably, the Eurozone continues to struggle. German gross domestic product (GDP) is all but flat, the French economy is stagnant, and Italy entered its third recession in six years. August Eurozone inflation was measured at a meager 0.4%, largely due to declines in energy and food prices. While most of us would cheer declining prices for everyday staples, this is a less-than-encouraging sign of fragile economic conditions and lackluster demand in Europe and many other parts of the world. The European Central Bank has promised to keep interest rates low until inflation nears its target of 2%. With a long way to go, accommodative monetary policy is expected for the foreseeable future. The slow growth conundrum lingers in Japan, as well.

Emerging markets provided a mixed bag of worries, from pro-democracy protests in Hong Kong to a continuing crisis between Russia and Ukraine. Even though foreign stocks have more attractive valuations when compared to the U.S. markets, investors fled to the relative safety of U.S. assets.

Bonds rose modestly during the quarter as the yield curve flattened. Investors paid careful attention to the Federal Reserve’s messaging about tapering and upcoming rate increases. Municipal bonds did better than taxable bonds as fewer tax-exempt issues came to market, constraining supply. Bond markets also made headlines late in the quarter as Bill Gross, the founder of PIMCO, left the firm to manage a bond fund at Janus. Bond market dislocations were predicted as a result of his unexpected departure.

A Stronger Dollar is a Mixed Blessing

The U.S. dollar was among the world’s best performing currencies during the third quarter, gaining 7% against the euro and 8% against the Japanese yen. In the past, a strong currency was a sign of economic might and global leadership. Ironically, it has been many years since any political leader spoke about achieving and maintaining a strong local currency. Since the financial crisis, governments have been more interested in pursuing a policy of relative currency devaluation.

In the third quarter, economic and political turmoil worsened around the globe. Even though the U.S. has had an uneven recovery since the financial crisis, we have been somewhat insulated – both economically and geographically – from many of these conflicts. There are reasons to be cautiously optimistic about the U.S. economy. Employment is steadily improving, even though we have many long- term unemployed and a low labor participation rate. Corporate operating earnings continue to rise. On average, GDP has continued on a path of slow but steady growth.

A rising dollar has implications. Relative currency valuations are a mechanism that can shift fortunes among economies over time. On the plus side, U.S. consumers can buy imported goods that are less expensive because of the relative strength of the dollar. We can travel overseas on the cheap because the dollar buys more goods abroad. At the same time, U.S. goods become more expensive to consumers overseas, who may decide to buy a new cell phone from Samsung instead of Apple. Some may forego a trip to the U.S. because it is just too expensive. This type of consumer behavior reduces the competitiveness of U.S. corporations on a global scale and, in theory, earnings decline as a result. To complete the cycle, as corporate earnings decline, stock prices would be expected to follow and the vibrancy of the U.S. economy could also slow. Eventually, a new currency appreciates relative to the dollar.

Relative currency valuations can also impact rates of inflation. Even though U.S. consumers enjoy inexpensive foreign-produced goods, declining prices on imports can contribute to disinflation. At the same time, European consumers who buy U.S. goods import inflation as they pay more euros to buy dollar-denominated goods. With a recent inflation measure of 0.4%, this is not a current worry for the European Central Bank; however, for a country like India that has struggled to contain inflation, importing goods denominated in highly-valued U.S dollars contributes to rising prices.

A strong U.S. dollar has implications for investing, too. Most directly, foreign bonds provide exposure to a large group of foreign issuers and are a tool to diversify among currencies, protecting an investor from a declining U.S. dollar. For our clients who own foreign bonds, we have hedged most of the foreign currency exposure while still diversifying among the foreign issuers. The foreign stocks our clients own are always denominated in the companies’ local currencies. For example, if investors own Samsung stock, they have exposure to the profitability of the company’s operations and the Korean won. If the dollar appreciates relative to the won, the currency component of return from the investment is negative. Because of this extra volatility, we carefully consider and control the foreign stock exposure in our clients’ portfolios.

While a rising dollar can be considered a vote of confidence in the U.S. economy, it can act as a headwind to U.S. economic growth if it appreciates too much. To date, U.S. policymakers have had little to say about the appreciating dollar. Expect this to change if the dollar continues its recent ascent.

Written by Colleen S. Supran, CFA, Principal; colleen.supran@bosinvest.com

Quarterly Review of Securities Markets: Total Return

IndexMarketLast 3 Months (7/1/2014 – 6/30/14)Year-to-Date as of 09/30/14
Standard & Poor’s 500Large Co. U.S. Stocks1.13%8.34%
Russell 1000 ValueLarge Co. Value U.S. Stocks-0.19%8.07%
Russell 2000Small Co. U.S. Stocks-7.36%-4.41%
Russell 2000 ValueSmall Co. Value U.S. Stocks-8.57%-4.74%
FTSE NAREIT EquityReal Estate Investment Trusts-2.48%13.37%
NASDAQ 100Technology Stocks5.19%12.74%
MSCI EAFE1Foreign Stocks-5.87%-1.38%
Barclays AggregateU.S. Dollar Bonds0.17%4.10%
Barclays MunicipalMunicipal Bonds1.49%7.58%
BofA Merrill GlobalGlobal Bonds-3.26%1.15%

Key Economic Indicators

  • Real Gross Domestic Product (real GDP) in the U.S. increased at an annual rate of 4.6% in the second quarter of 2014 after declining 2.1% in the first quarter.
  • In its meeting in July, the Federal Reserve Open Market Committee agreed to hold the target range for the federal funds rate at 0% to 0.25%. The Committee has again agreed to reduce the pace of its purchase of Treasury and mortgage-backed securities by a total of $10 billion per month. The Committee will closely monitor incoming information on economic and financial developments. If this information supports the Committee’s expectation of ongoing improvements in labor market conditions and inflation moving back toward its longer-run objective of 2%, the Committee is planning to end its current program of asset purchases at its next meeting.
  • The U.S. unemployment rate was 5.9% in September, down from 6.1% at the end of June. The civilian labor force participation rate of 62.7% has changed little in the past year.
  • Inflation (CPI-U) decreased 0.2% in August. This was the first decline since April 2013. Over the past 12 months, the all-items index increased 1.7%. While the indexes for food and shelter rose, they were offset by declines in the energy indexes, particularly gasoline.
  • Standard & Poor’s 500 Index second quarter 2014 operating earnings per share increased 7.8% from the first quarter. Earnings increased 11.7% from the same quarter last year.
  • U.S. non-farm worker productivity increased at an annual rate of 2.3% during the second quarter of 2014.
  • The Comex spot rate for gold decreased by 7.5% in the third quarter of 2014, closing at $1,216 an ounce. Inflation expectations in the U.S., Europe and Japan are falling, while the U.S. dollar is strengthening. These factors, along with better-than-expected U.S. jobs data, have dampened the appeal of the precious metal. Gold is up 1.14% since the beginning of the year.
  • U.S. crude oil prices dropped 13.5% in the third quarter of 2014, closing at $91.16. This is the largest quarterly drop since the second quarter of 2012. Caught between slack demand and plentiful supplies, oil futures have touched multi-year lows, and are down 7.6% so far this year.

Key economic indicators compiled by Barbara A. Ziontz, CFP®, Portfolio Manager; barbara.ziontz@bosinvest.com Data Sources: The Wall Street Journal; U.S. Dept. of Commerce – Bureau of Economic Analysis; U.S. Dept. of Labor; Bloomberg.com;

Live.Lehman.com; MSCI.com; REIT.com; NYTimes.com; StandardandPoors.com; Vanguard.com; 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 agreem ent.

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.

©2014 Bingham, Osborn & Scarborough, LLC

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