Summary of this Quarter’s Newsletter:
- The U.S. stock markets end the quarter on a mixed note after increased volatility early in the year.
- Our portfolios fared well for the quarter relative to risk and we remain cautious on the stock market.
- Uncertainty over Russian/Ukraine tensions watched closely.
- Federal Reserve keeps rates unchanged (for now), and continues to “taper”.
- Economic data continues to give mixed signals.
- Be sure to schedule your personal quarterly review now.
The Markets:
There were three major themes that dominated the headlines in the first quarter, and two of the three could be placed in one bucket: winter weather, emerging market jitters early in the quarter, and geopolitical instability brought on by Russia’s incursion into Ukraine. The latter are international and could probably be lumped into the same category.
Despite the worries and a January hiccup, most of the major stock indices climbed a wall of worry as the quarter wore on. There was a modest amount of volatility, especially near the end of January, when jitters in emerging markets created an excellent excuse for some to book profits following 2013’s run-up in stocks. The Dow Jones Industrial Average declined by 119 points or .72% for the quarter. (Google Finance)
Problems in countries like Turkey and Argentina generated eerie reminders of the 1997-98 currency crisis that rocked emerging markets. But those taking a more sanguine approach, including the International Monetary Fund, argued that most emerging markets are far less vulnerable than they were back then.
In the meantime, China, which could safely be called the 800-pound gorilla of developing economies, has been hit by a raft of soft economic data (Bloomberg, Reuters). Some of it may simply be seasonal swings tied to the Chinese New Year (Evergreen Gavekal, Citi Surprise Economic Index), but cracks in its financial system bear watching.
Our Outlook:
Our portfolios fared well relative to risk in the first quarter, with a turnaround in performance of fixed income and “alternative” investments from last year. Interest rates fell during the quarter, while commodity prices rose in general. Stock indices saw small losses to small gains, depending on the particular sector of the stock markets overall. We saw the largest percentage gains on our more conservative portfolios that hold a greater percentage of assets in fixed income. We still remain underweighted at this time in stocks/equities for all portfolio risk categories and continue to take a cautious approach as we move forward.
The Russian Bear Growls:
Understandably, investors may grow concerned when unexpected geopolitical stability creates unwanted volatility. Around the clock cable news networks that gladly feed us a steady diet of disturbing photos only serve to fuel the angst.
Markets hate any unusual amounts of uncertainty, and Russia’s incursion into Ukraine neatly fit that description. Traders took a shoot first and ask questions later mentality when the situation first developed. However, Russian President Vladimir Putin appeared to flinch following a rout in Russia’s currency (the ruble) and its stock market (Bloomberg).
Unless there is a significant escalation of tensions, or a harsh round of sanctions against Russia prompts an in-kind response that impacts the global economy, it seems unlikely we’ll experience any long-lasting turmoil in financial markets.
The Federal Reserve and Winter:
Much of the country has just experienced a very rough winter, erecting a temporary speed bump to economic growth. See Figure 1 – transportation delays and power outages can’t be good for manufacturing.
Retailers didn’t escape Mother Nature’s wrath either – see Figure 2. Both December and January came under pressure, but pent-up demand and the continuation in the economic recovery helped put sales in the win column for February, even if gains were modest at best.
In the Federal Reserve’s March 19th statement that followed its meeting (the Fed normally holds eight meetings each year); the central bank acknowledged that economic activity slowed at the beginning of the year, “in part reflecting adverse weather conditions.”
But what briefly caught the attention of traders was a comment at Fed Chief Janet Yellen’s quarterly press conference. Yellen briefly rattled the market when she acknowledged the fed funds rate (the overnight interest rate banks lend funds to each other) may start rising about six months after the Fed’s bond buying program ceases.
Recall over the last year that the Fed has been purchasing $85 billion in longer-term Treasury and mortgaged-backed securities each month in order to boost bond prices and lower yields. In December, the Fed began reducing its monthly purchases and has trimmed outlays to $55 billion as of the latest meeting.
Her candid remarks, even if unintended, shouldn’t have created a stir in our view, as the individual projections from 10 of 16 Fed officials revealed they currently believe a fed funds rate of at least 1% is appropriate by the end of 2015 (Fed website). The fed funds rate currently sits near zero.
What seemed to fly under the radar was a sentence in the Fed’s press release that signaled interest rates could remain low for quite some time:
The Federal Reserve “currently anticipates that, even after employment and inflation are near mandate-consistent levels (Fed jargon for price stability and full employment), economic conditions may, for some time, warrant keeping the fed funds rate below levels the Committee views as normal in the longer run (about 4%).”
Translating into everyday language, it simply means that even when the economy nears full employment, we could still see a fed funds rate that is roughly around 2%, according to the Economic Projections of Federal Reserve Board Members. On the last day of the quarter, Yellen seemed to downplay the “six month” comment by hammering the point home that heavy slack in the labor market (slack = too many qualified job applicants for the positions available) will likely mean that rock bottom rates will “still be needed for some time (March 31, 2014 speech: What the Federal Reserve is doing to promote a strong job market).”
Bottom Line on Interest Rates:
Simply put, the Fed can set the fed funds rate, giving it an enormous amount of influence over short-term interest rates. Yet, it can only hope to create an environment that will hold down longer-term rates, which it believes will encourage economic activity and hiring.
We hope you all are having a great start to Spring! Please be sure to call us now to schedule your personal review for this quarter, either in person or by phone, if you have not already done so.
God Bless,
Your TEAM at F.I.G. Financial Advisory Services, Inc.
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