The 2nd quarter was marked by very low equity market volatility and steady, positive performance across all major indices. Our diversified approach to managing investments continued to focus on limiting downside equity risk through a bias for value-oriented, high quality, dividend paying domestic and international equities. In the short term, volatility and potential for loss has been further mitigated by allocating fewer investment dollars to US Small Cap stocks. They have experienced significant gains over the past several years and in our opinion, have been richly valued for quite some time. This is why we reduced our positions in the latter half of 2013, well in advance of Fed Chair Janet Yellen’s remark about the category valuations being stretched.
Hybrid investments, led by preferred stock, global bonds and energy infrastructure, had a strong quarter validating our belief the asset class can perform well during strong equity markets. Our consumer-focused emerging market investments slightly under-performed during the quarter but exceeded our expectation on a risk-adjusted basis. Despite headwinds created by the Federal Reserve’s plan to stop tapering and end quantitative easing in October, fixed income posted attractive gains (again) for the quarter and reinforced our commitment to this asset class as an effective anchor. Performance returns for some of the major market indices follow.
2nd Quarter Index Returns
|2 Yr. US Treasury||+0.3%|
|Barclays US Aggregate Bond Index||+2.0%|
|Morningstar Broad Hedge Fund Index||+3.1%|
|S&P 500 U.S. Equity Index||+5.2%|
|MSCI EAFE International Equity Index;||+4.1%|
|MSCI Emerging Markets Equity Index||+6.6%|
Market and Economic Backdrop
Economic and geopolitical highlights in the quarter included uneven economic performance, continued reductions (tapering) in quantitative easing by the Federal Reserve, tensions between Ukraine and Russia and escalating violence in Iraq, Israel and Palestinian held Gaza. Despite these factors, the SPX Volatility Index, better known as the VIX, finished the quarter at 11.6 which is its lowest reading since December 2006. When volatility is low, equities tend to trend higher and the past quarter was no different.
The US employment outlook remains favorable amid stable economic growth and improving business confidence. US consumers remain on firm ground, supported by improving employment, healthier balance sheets and greater access to credit. Housing activity will likely remain positive but tepid in the near term but slow improvements in employment and mortgage credit should help housing sector to provide modest boost to economy in medium term. US corporations remain well positioned with sentiment pointing to a potential increase in capital expenditures.
Despite an increasingly mixed outlook amongst countries and regions, the global economy remains on a trend of slow but steady growth. Developed markets are showing solid (albeit slow) underlying economic growth with low inflation. Europe’s expansion remains sluggish and deflationary pressures persist. These conditions drove the recent ECB monetary easing to try and boost conditions in that region. Many emerging markets (EM) continue to face headwinds such as slowing growth, inflationary fears and currency revaluations, but the tone of recent data was less negative in EM during the 2nd quarter of 2014. Rate hikes (currency support) implemented by many EM countries early in 2014 have helped to stabilize their financial situation and moderate inflation pressures while China continued to try and balance the need to rein in excess credit and still meet targets for economic growth.
The negative 1st quarter 2014 GDP data (-2.9%) notwithstanding, the economy seems poised to bounce back in the coming months to a more steady rate of growth. Despite the slow employment gains during this “recovery”, payrolls now exceed the peak reached prior to the financial crisis in 2008-2009. The economy has replaced all of the 8.7M jobs lost in the ensuing “great recession”. Businesses are in a strong financial position to hire more aggressively and may do so with less political infighting in Washington and greater clarity on the impact of healthcare reform. Corporate profits as a percentage of GDP appear to have peaked, as evidenced by the chart below. Historically, cycle peaks for profit margin have been a preamble to stock market peaks that tend to follow an average of 1-2 years later. Relying on a historical trend like profit margins is certainly not infallible, however it’s something to be mindful of as we approach 2015-2016.
Chart Sourced from Strategas Research Partners, LLC June 2014©
 Quarterly index returns sourced from Morningstar, Inc. Clearview Wealth Management uses a blend of selected indices that are specific to a clients’ risk profile to gauge performance. Historical performance is not a predictor of future returns.
Portions of this newsletter were sourced from Charles Schwab, Fidelity Investments and JPMorgan & Chase