David B. Smith, CFASenior Vice PresidentInvestment Management Group
July, 2013 "There are no environments where you're only going to win, because life just isn't like that." - Bobby Orr, Bruins #4 While Orr's words probably seem painfully obvious to Bruins fans, they will also make sense to fixed income investors this quarter. Bonds declined 1.7%, as measured by the Barclays US Government/Credit index, its first decline since the fourth quarter of 2010. Comments made by Fed Chairman Ben Bernanke on June 19, after a regular meeting with Federal Reserve Presidents drove the sell-off. Bernanke painted a more optimistic economic outlook than many market watchers expected and said the Fed's program of bond buying (quantitative easing or QE) may end by mid-2014 if unemployment drops to 7%. The absence of QE could mean that interest rates will rise, introducing a headwind for fixed income investors. Bernanke's comments suggest confidence in the Fed's GDP forecast of 2-3% growth over the next few years and an improving labor outlook. This would seem to be supported by corporate earnings. Almost 70% of companies in the S&P500 reported better than expected earnings in the first quarter. In addition, as discussed below, U.S. consumers appear to be in good shape. Outside the U.S., markets generally struggled as Europe continued to suffer under European Union austerity measures and China experienced moderating growth as China's central bank attempted to rein in lending. Notable exceptions in each market were Germany, which is proving to have a very resilient economy and Japan, which is benefiting from "Abenomics", the stimulative economic policies of Shinzo Abe, Japan's new Prime Minister. Traditional Asset Class Returns Q2: 2013
Domestic equity classes ended the quarter with a positive gain, led by small cap stocks, as did Master Limited Partnerships (MLPs). However, all fixed income, except floating rate debt, posted losses along with commodities and foreign stocks. Emerging markets stocks and commodities fared the worst losing 8.1% and 9.4%, respectively. With the exception of MLPs, all diversifying assets sold off after the June 19th statement although, as noted, domestic equities still finished the quarter in the green.
Conclusion It may take some time before markets adequately discount the possibility of higher interest rates. Fortunately, our emphasis on portfolio diversification ensures that, while some asset classes will inevitably be hurt in the short run by rising rates, others will compensate and perform well in the same environment. The pathway to higher returns is never a perfect line upward, but as this concluding quote reminds us, through patience and a disciplined investment approach, we can get the results our clients expect. "Forget about style; worry about results." - Bobby Orr, Bruins #4 We greatly appreciate your business.