July 2014 Newsletter
We are pleased to provide you with a quarterly perspective on recent data, our outlook for the future, the status of our investment class weightings and watch items for the coming months. If you have any questions about any topic, we hope you will not hesitate to contact us.
Data – On June 25th we learned that the US economy contracted a disappointing 2.9% during the first quarter of 2014. The depth of the contraction caught many analysts by surprise. Economic data during the second quarter has improved, suggesting that much of the winter slowdown was weather related. Strong data was reported last week for May in both the sales of existing homes and of new homes. In May, new home sales rose 18.6%, which followed an increase of 6.4% in April. It is now clear that a rebounding housing sector is the last missing piece of the recovery puzzle. Job growth has been strong for four consecutive months, adding an average of 227,000 jobs per month. The national unemployment rate now stands at 6.3%, which compares favorably to past readings in May of 2013 (7.6%), 2012 (8.2%) and 2011 (9.1%). Weekly jobless claims averaged 315,000 during the quarter, lower than the 329,000 of the previous quarter. Durable goods posted a decrease of 1.0% for the month of May, after an increase of 0.8% in April. The June Business Outlook survey by the Federal Reserve Bank of Philadelphia showed optimism in the manufacturing sector, with both current and future (looking forward 6 months) expectations hitting high marks not seen since October of last year. Consumer confidence readings by the Conference Board have continued to show strong sentiment, rising to a six-year high mark of 85.2 in May. Even though auto sales have powered higher, retail sales overall rose just slightly during the quarter. During the quarter we saw the yield on the 10 year US Treasury stay more range bound falling from 2.72% (March 31st) to 2.52% (June 30th). Volatility (as measured by VIX) remained low ending the quarter at 11.60; this reading is much closer to the 2014 low (10.61 on June 18th) than the 2014 high (21.44 on February 3rd). Year-to-date we see the following equity benchmark price return performance data: S&P 500 (+6.05%), Dow Jones Industrial Average (+1.50%), Russell 2000 (+2.51%), International (+2.89%) and Emerging Markets (+3.42%). For fixed income, the benchmark Barclay’s US Aggregate Bond Index is +2.76% year-to-date.
Outlook – In a statement released after the conclusion of the June 17-18 FOMC Meeting we learned the following: (1) The US economy has rebounded from a poor 1st quarter of 2014. (2) Tapering will continue. For the fifth consecutive month, the FOMC reduced monthly bond purchases by $10 billion, which purchases are now set at $35 billion. Most investors view the Fed’s decision to continue on this tapering path as affirmation of their confidence in the economy and its ability to withstand potential headwinds. (3) After a difficult winter, residential construction appears to be stabilizing. (4) Fed officials expect the unemployment rate to fall to 6.0% in 2014 with further declines in 2015 (5.5%) and 2016 (5.0%). (5) Low market volatility, as measured by the VIX, is a concern shared by some committee members. (6) The most important issue confirmed by the Fed was a commitment to keep short term interest rates low for an extended period of time. With this commitment came upward revised projections to the benchmark Fed funds target rates for 2015 (from 1.125% to 1.2%) and 2016 (from 2.4% to 2.5%). Looking further into the future, the long run rate could settle at 3.75%, lower than earlier forecasts of 4.0%.
Status of our Investment Class Weightings
US Large Cap Sectors – No changes for this quarter
No Weighting - Utilities
Underweight – None
Neutral – Consumer Staples, Energy, Financials and Healthcare
Overweight – Consumer Discretionary, Industrials, Technology and Materials
US Mid and Small Cap – Maintain mid and small cap weightings.
International Developed Markets – Maintain all weightings.
Emerging Markets – Maintain all weightings.
Alternative Strategies – Maintain weightings in multi-asset funds and add to REIT positions.
Multi-sector Bond Funds – We will maintain a target average duration of about 5 years.
US Treasuries – No weighting.
Investment Grade Corporate Bonds – Neutral, with an outlook to add to positions.
High Yield US Corporate Bonds – Maintain positions.
Floating Rate Bank Loans and Convertible Bonds –Reduce Floating Rate Bank Loans and maintain Convertible Bond positions.
Investment Grade Municipal Bonds – Underweight.
Watch Items – Lingering tension over the annexation of Crimea by Russia is just one of several geopolitical hot spots that could, at any time, worsen and become disruptive to financial markets. The growing list of hot spots now includes Iraq, Syria, Iran, Korea and China, the latter which continues to make aggressive claims in its territorial waters. Deepening conflict within any of the aforementioned has the potential to disrupt, at least in the short term, economic growth on a regional basis.
In the summer of 2012, ECB President Mario Draghi pledged “to do whatever it takes” to preserve the Euro. Any extraordinary action implied by that statement was finally delivered on June 5th as the ECB took aggressive action to reduce the threat of dangerously low inflation in Europe. This action included cutting its main lending rate to a record low of 0.15% and reducing the overnight rate, for funds deposited at the central bank, to a -0.1%. The worry here is that low inflation, if left unchecked, could become deflation or, even worse, long term price stagnation like that experienced in Japan over the past two decades.
Inflation in the US rose to 2.1% in May, just above the Fed target of 2.0%. Some inflation can actually be good for the economy as it suggests that the economy is growing nicely, creating jobs, lifting wages and increasing consumers’ ability to spend. As a driver of consumption, inflation makes us ask the question “should I buy something today, rather than delaying the purchase to next year and risk paying more for the same item?” As our economy has recovered from the recent recession, inflation brought on by accommodative monetary policy has always been a fear. It looks like the Fed must now work a bit harder and smarter to manage that balancing act between full employment and price stability.
