Mid quarter stock market update

Strong Start to 2013

Global stock markets charged hard out of the gate in the first quarter with U.S. and Japanese markets leading the way.  The S&P 500 Index climbed 10% and finished the quarter notching a new all time high, narrowly surpassing the previous record of 1565, which was set 5 ½ years ago.  This was the best start to a year for U.S. equities in fifteen years.  High-grade bonds suffered a bit during the quarter as investors shifted money into stocks.  The 10-year U.S. Treasury note gave up some ground as its yield rose 0.2% to 1.85% . . . which of course is still a very low level, historically speaking.

Why, many investors are asking, has the market been able to make new highs despite high unemployment, weak economic growth and a challenging fiscal situation across most of the developed world (e.g. the U.S., Europe and Japan)?

The first and most obvious reason—that the vigorous monetary easing of central banks around the world has pushed markets higher—is likely the single strongest reason, but it is also difficult to measure.  In the past six years, central banks around the world have cut rates more than 500 times and injected more than $10 trillion into the global economy.  Short-term interest rates (which central banks control) and long-term rates (which central banks influence but do not control directly) have consequently remained at very low levels for the last several years, thus encouraging investors to look to financial assets other than fixed income instruments to earn them a satisfactory rate of return.  The big test for both bonds and stocks will come when the Fed and its brethren central banks signal to markets that the global economy has recovered sufficiently for them to begin withdrawing their monetary support.

Bernanke & Co. have put their stamp on markets, but a second potential source of vitality for U.S. stocks is the U.S. residential real estate market, which appears to have bottomed in most of the country and is now beginning to reverse its six-year price collapse.  According to Zillow, a real estate firm, the total increase in the value of all U.S. residential real estate in 2012 was $1.35 trillion—the first annual increase in value since 2006.  (The total value of all U.S. residential real estate is a little over $20 trillion.) While home prices broadly remain down 20%-30% from their very frothy 2006 levels, the fact that consumers’ largest and most prized asset is rebounding in value cannot fail to bolster confidence. There is also a positive knock-on effect of rising real estate prices, including higher spending on things such as home goods and furnishings, renovations and landscaping.  Consumer sentiment towards the economy remains somewhat sour, but real estate is gradually turning from a hinderer to a helper in this regard.

A third possible reason for stocks’ strong recent performance is that they still exhibit significant value relative to bonds, their main rival for investors’ affections.  As many blue-chip companies now sport dividend yields quite a bit higher than the 10-year U.S. Treasury note, investors needing income have taken notice.

Given the strong move the equity markets have already had already in 2013, investors would be prudent to expect a period of consolidation as we move through the year.

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Picture of Peter Thoms, CFA, MBA

Peter Thoms, CFA, MBA

Peter Thoms, CFA, founded Orion Capital Management LLC in April 2002. Peter has extensive experience managing investment portfolios for clients pursuing a wide range of financial goals.

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