The domestic stock market managed to post another solid quarterly return despite having its first negative monthly return of the year in June. The S&P 500 returned 2.9% for the second quarter. Unfortunately for diversified investors, the US and Japanese stock markets were the only markets to post positive returns for the quarter. European stocks were down 1.4%, emerging market stocks were down 10%, domestic bonds were down 2.5%, international bond markets were down 3.1%, general commodity prices were down 5.9%, and precious metals were down a whopping 25%. It was a challenging quarter for asset allocators. We think the good news is that investors may finally be focusing on fundamentals and abandoning the “risk on/risk off” mindset.
Most markets were humming along quite nicely through the mid-point of the quarter when Federal Reserve Chairman Ben Bernanke suggested the Federal Open Market Committee was looking into possibly tapering off some of its bond buying activities (quantitative easing) in the coming months. Those comments, and the subsequent statement and press conference following the June FOMC meeting, spooked investors across the globe. Longer-term US Treasury bond yields rose 1% (that represents a price decline of approximately 10% on longer-dated US Treasury securities as bond prices move in the opposite direction of their yields) and global stock markets declined over 6%. Fortunately, bond yields began to stabilize and stock markets recovered some of those losses over the last week of the quarter.
Our clients’ portfolios struggled along with the global stock and bond markets in the second quarter. In fact, the more conservative the allocation the more difficult the quarter as global taxable bond indices returned a negative 2.8% and global stock indices returned a negative 0.25%. On a relative basis clients’ portfolios did benefit from our allocation to non-traditional equities (which actually posted a positive return for the quarter) and to our non-traditional fixed income strategies that, while still negative, did manage to outperform traditional bonds by roughly 1.5%. Our inflation sensitive real asset holdings (natural resources, commercial REITs and infrastructure) were a drag on portfolio returns as inflation expectations continued to decline during the quarter—the Fed’s favorite gauge of inflation, the Personal Consumption Expenditures Index, actually hit a 50-year low during the quarter.
Five weeks of panic selling often leads to many opportunistic pricing dislocations. While we don’t necessarily agree with the magnitude, we understand the rise in Treasury and mortgage yields; but, we are puzzled as to why corporate bond yields rose even more than Treasury yields. The Fed outlined a data-dependent timetable for reducing its bond purchases. Specifically, GDP growth approaching 3%, inflation approaching 2% and unemployment falling below 7%–we think that’s an ideal environment for equity investors; and, if it doesn’t happen the Fed will continue its bond purchases—an environment that heretofore has also been ideal for equity investors. Even with the recent rise in bond yields we would still favor equities and our non-traditional fixed income strategies over traditional bonds.
Not to worry, we remain committed to our mandate to build the least risky portfolios necessary for our clients to achieve their financial goals.