While fears over Federal Reserve (the Fed) tapering and some uneven economic data hurt stocks earlier in the quarter, September was a surprisingly strong month for equities. The Fed’s decision to keep its quantitative easing program going, combined with moderating tensions in Syria, helped stocks to easily outperform bonds for the third quarter. Three other market themes emerged during 3rd Quarter 2013: cyclical stocks outperformed defensive stocks, the equity market rally widened its focus to include international stocks and emerging markets, and corporate and municipal bonds outperformed Treasuries. Despite a mediocre jobs market, retailers and other consumer discretionary stocks continued to outperform.
US Economic Outlook
As we enter the fourth quarter, the debate over funding for the federal government and the need to increase the debt ceiling are leading to risks in US credibility on the fiscal front. Just two years after Congress led America to a fiscal cliff that prompted Standard & Poor to downgrade the United States’ long-term credit rating; we now appear poised to repeat the same fiasco.
Despite the political dysfunction in Washington, the private sector continued down the path to recovery. Markets more than shrugged off the political noise and focused instead on the US economy’s leadership role within the global recovery, as well as the decreasing probability of negative tail-risk events outside of the United States. We continue to expect that the US economy will grow at a relatively moderate pace as a result of the long-term overhang of deleveraging and re-regulation. However, with increasing signs that the Eurozone economy is bottoming and Chinese GDP growth may be stabilizing, we are looking forward to improved revenue growth for US companies both domestically and outside of the United States moving into 2014. The biggest question hanging over investors’ heads now is when the Fed will begin normalizing monetary policy and at what pace it will proceed.
The economy continued to heal during the 3rd Quarter of 2013. Housing prices continued to recover and have now increased over 21% since the end of 2011 based on Case-Shiller 20-City Price Index. Household net worth has hit another all-time high, and while housing was the key driver of improvement, financial assets and moderating consumer debt also added to consumers’ wealth.
Looking ahead to the 4th quarter, the Fed and politicians are likely to remain in the headlines. Janet Yellen has received the nod for the next Fed Chairwoman. Assuming she weathers the process and is ultimately awarded the position, tapering may be less imminent looking ahead. The Fed’s quantitative easing program will be under the microscope for the remainder of the year as speculation abounds over when tapering of asset purchases will begin. It remains unclear how long stocks can continue to rise on what has been a Fed-inspired rally.
The situation in Washington is fluid and something we continue to monitor closely. While it is difficult to speculate on the outcome surrounding the US debt ceiling debate, it appears the lines of communication between Republicans and Democrats are beginning to open. US Government uncertainty is likely to remain elevated given the “kick-the-can” nature of the budget deal into early next year. It will take some time to gauge the full impact of the government shutdown and data is likely to be somewhat skewed over the next couple of months. However, sitting on the sidelines is not a great option and stocks still appear to be the best place to invest money for the longer term.
Global Developed Economic Outlook
The Eurozone emerged from recession in the second quarter and leading economic indicators point to continued recovery. Relative to a year ago, the reduced threat of financial contagion due to The European Central Bank (ECB)’s conditional bond purchase program has resulted in a reversal of business and consumer sentiment. Additionally, fiscal drags are shrinking due to economic progress and an eased stance on austerity. That said, growth is likely to be modest as continued bank deleveraging pressures lending. The good news is European stocks have likely priced in a lot of bad news. If concerns rise again, the resulting volatility could present a good buying opportunity.
In the coming quarter there are a number of reasons for optimism as Europe begins to stabilize and growth from elsewhere in the world continues to display steady progress. Given the structural reforms taking place across the continent, European economies and companies are well placed for the long term. This is important, as European companies still have compelling valuations and could soon benefit from a cyclical recovery in share prices.
While there remains a healthy degree of skepticism surrounding structural reform, Japan’s Prime Minister, Shinzo Abe’s plan to alter Japan’s growth trajectory has begun to bear fruit. The consumer price index (CPI) has crept above the zero line and done so without meaningfully disrupting the bond market. Finally, if there is a need for any other evidence that Japan has entered a “goldilocks” phase, Tokyo handily won the bidding for the 2020 Olympics and, in so doing, set off celebrations on the streets of that metropolis.
Global Emerging Economic Outlook
Emerging markets (EM) finished higher at the end of the third quarter, though country and sector-specific performance was mixed. The quarter opened well with emerging market equities higher in the beginning of July following very weak performance in June. However, the emerging market asset class declined steeply later in July amid concern of potential tapering of US Federal Reserve’s bond purchasing program. The Fed’s resolution to postpone tightening after the September 18 Federal Open Market Committee meeting bolstered markets.
Despite volatile EM movements in the past quarter, we believe emerging market fundamentals remain strong. The recent correction following the Fed announcements illustrates the degree to which sentiment has driven share price movement over the last several months. We believe it is important to take a long-term perspective when investing in the emerging markets. EM companies have continued to generate higher return on equity than their developed-market peers and persistently trade below their long-term average.
As we look to year-end and beyond, we are encouraged by a number of factors. The US recovery remains intact despite political concerns and uncertainty over monetary policy. We increasingly believe the evidence emanating from Europe attests to a bottoming out of its economic cycle. Likewise, we see signs of near-term stabilization in Chinese GDP figures as a positive sign as it reduces the risk of a hard landing. We recognize neither the Eurozone nor the China story is particularly positive. Rather, we point them out as examples of market drivers whose negative impacts seem to be dissipating. US companies have been challenged by a lack of revenue growth in recent quarters. Our hope is the ongoing US recovery will be augmented by stabilization and improved economic conditions in Europe and China, leading to revenue growth for American exporters. Given the lack of domestic labor pricing pressure and generally lower commodity prices, we believe US companies can sustain their elevated profit margins even with a marginal pickup in demand.
Surprises come at any moment in the investing world, reinforcing the need to have both a long-term view and a balanced/diversified portfolio. We believe signs are pointing to better US and European growth, a near-term rebound in China, and some possible positive momentum building in Japan. As your trusted advisor, Clearview Wealth Management works diligently to assess the changing U.S. and global economic landscape for opportunities as well as risks that permeate the financial world.
Portions of information for this newsletter were sourced from Schwab Market Perspective: You Never Knowby Liz Ann Sonders, Senior Vice President, Chief Investment Strategist, Charles Schwab & Co, Inc.; Brad Sorensen, CFA, Director of Market and Sector Analysis; Michelle Gibley, CFA, Director of International Research, Schwab Center for Financial Research September 27, 2013, and Lazard Asset Management LLC, Ronald Temple, CFA, Managing Director, Portfolio Manager/Analyst.