After surging higher through most of the year, investment assets turned in a mixed performance in the third quarter. As usual, there were plenty of events to generate drama. The U.S. Treasury announced that it would be ending bond purchases by October. Ukraine’s increasing tensions with Russia fueled both fear and a new round of international sanctions. As the militant Islamic State forces grew more aggressive, President Obama ordered airstrikes in Iraq.
These matters, however, were similar to what we have seen over the past few years. Many will remember the downgrade of the United States, the “fiscal cliff” and the Greek crisis. Another related item was the sovereign debt crisis. Sometimes these have lasting effects and sometimes they don’t. It is interesting that in July, after an extended battle with creditors, Argentina finally defaulted on its bonds. It hardly made the newspapers. Through all of this, the S&P; 500 experienced one of the greatest bull markets of all time.
One of the greatest challenges to investing many saw was an impending collapse of the dollar. The argument had it that the easy money policies of the Fed would lead to a collapse of the dollar. Actually, it went the other way. As the U.S. economy strengthened, assets actually flowed toward dollar assets, not away from them. During the third quarter, the dollar rose more than eight percent against the yen and the euro.
In our last letter, we noted that markets have been remarkably calm. While results were good, the gut-wrenching large moves had faded away. As we predicted, that can’t last forever. Markets are rarely so predictable. That changed a bit toward the last of the quarter. The Dow had triple-digit moves, up or down, for five straight days. This isn’t the dire new world. It is likely just a return to more normal volatility.
Being a disciplined investor is pretty straightforward. One examines risk carefully and prudently, and develops a thoughtful, outcome-based solution. Then, one repeatedly adjusts for personal circumstances, market conditions and valuations. Unfortunately, it seems an impending crisis, real or imagined, comes along every few months to tempt us away. Don’t give in. In the words of 1970s Saturday Night Live character, Roseanne Roseanadanna, “it’s always something.”
Domestic Equities: Stocks benefited from the strength of U.S. currency. As other currencies weakened, money flowed to the perceived safety of the dollar. As market participants worried about growth and stability, large capitalization stocks were the dominant beneficiaries of that flow. The S&P; 500 managed a gain of 1.1% for the quarter. For the calendar year the index is up a solid 8.3%. Smaller stocks were the flip-side of the action in large stocks. As the turbulence in the currency markets caused investors to seek safety, smaller company shares lost favor. The Russell 2500, a popular gauge of small company shares, dropped 5.3% for the quarter. The index is still barely positive for the calendar year, eking out a gain of 0.3%.
International Equities: Foreign stocks also felt the shift in risk and currency volatility. As the dollar soared against the yen and the euro, foreign stock prices came under pressure. The MSCI EAFE index sank 5.9% for the quarter, wiping out the previous gain for the year. The index is now down 1.4% for 2014.
It should be noted that the currency markets have something of a self-balancing effect over time. A more expensive dollar makes foreign goods cheaper in dollar terms. This can cause money to flow toward foreign currencies and away from the dollar.
Fixed-Income: Over the past few years, analysts have made it clear interest rates, given they are near 30 year lows, have to go up. While this may be true, the real question is: when? As we have seen over the past year, the answer is: not right now. As with large stocks, the risk and currency fears benefitted bonds. The Barclays Aggregate Index rose 0.2% for the quarter and is up 4.1% in 2014. Municipal bonds turned in a similar performance. That index was up 1.5% for the quarter and is up 7.6% for the year.
Just because in the investing world, “it’s always something,” doesn’t mean we just resign ourselves to whatever may come along. Taking into account the uncertainties of our world is at the core of our process. Wall Street predictions often fail miserably; preparation has a much better record. We know that our job is to listen carefully to your goals. Then, we prepare your portfolio for the frightening “always something” that is sure to appear. Simply put, it is our job to help get you all the way home.
We will be talking soon. In the meantime, if there is anything you need, please let us know.