Mid quarter stock market update

Bernanke Giveth. Bernanke Taketh.

After a strong first quarter, the second quarter got off to a solid start for U.S. stocks as they rose steadily to close at a record level on May 21st.  As is well-known, the U.S. Federal Reserve and other central banks around the world have been very accommodative to financial assets in recent years.  Though the amount cannot be quantified precisely, both stocks and bonds worldwide have benefited significantly from the Fed’s zero interest rate and quantitative easing (money printing) policies.  However, it seemed to come as a shock to many market participants that these easy-money policies may be curtailed in the relatively near future.  On May 22nd, Federal Reserve Chairman Ben Bernanke remarked that, given the improving outlook for the U.S. economy, the Federal Reserve could begin tapering its $85 billion per month bond buying program in “the next few” Federal Open Market Committee meetings.  Markets, to put it mildly, did not react well to this notion.  U.S. stocks held their ground better than almost all other asset classes in the last six weeks of the quarter, but there were significant declines in international stocks and in all flavors of bonds, both U.S. and international.

Given the continued improvement in the U.S. economy (housing, labor market, stock market) Mr. Bernanke & Co. have fewer and fewer justifications for their bond buying program.  To review, the program works like this:  first, the Fed creates $85 billion with a few strokes of the keyboard.  Then it uses this newly created money to buy government and mortgage-backed bonds in the open market.  This buying pressure is intended to keep prices high and therefore yields low, which in theory should bolster the housing market and any other markets that do better when rates are low.

After Mr. Bernanke’s pronouncement, the assets that were aided the most by the Fed’s low interest rate policies declined the most.  In June, U.S. bond mutual funds, which had enjoyed a streak of monthly inflows nearly two years long, saw many of their investors head for the exits.  By the end of June, investors had pulled a record $60 billion from bond funds, eclipsing the previous monthly record (of $41 billion in October 2008) by nearly half.  In overseas markets, emerging markets suffered the most, with the MSCI Emerging Markets Index losing 9.1% in the quarter.  Gold was also particularly hard-hit as prices dropped 23% in the quarter, the largest quarterly decline for the metal since 1974.  Finally, within the U.S. stock universe, those stocks with high dividend yields—those that had been perceived to be “bond substitutes”—notched the largest declines.  The S&P Utilities Index, for example, was down 3.7% in the quarter.

While the signs of economic progress are unmistakable, the current environment (with stocks fairly-valued and bonds richly-valued) is a difficult one for conservative investors.  For many years, conservative investors with long-term bond holdings have enjoyed a bull market that got its start more than 30 years ago.  But now, with interest rates on the rise and bonds declining, these investors have few low-volatility options available except for cash—which pays essentially nothing.

If recent economic progress can be built upon, the U.S. economy is heading back to a more normal state.  And when we arrive at that state –whether it takes 2 or 3 or 5 years—we will probably be looking at interest rates that are higher than today’s and closer to their historic averages.  For both equity and bond markets, this transition to a normal economy will surely include lots of hand wringing, but the time is coming for the Fed to dump out the easy-money punch bowl.  Our economy will need to stand on its own feet and drive itself home.

Share This!

Join Our list!

Join our email newsletter list to receive more market updates and financial articles like this one.

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.

Wondering if we can help you reach your financial goals?

Let's Talk!

Schedule a quick introductory call with you and see if we would be a good fit for you.