After a strong year for global equity markets in 2013, the first quarter of 2014 proved to be a period of digestion.  Here in the U.S. the markets were broadly flat.  The S&P 500 Index rose 1.3% but the Dow Jones Industrial Average declined 0.7%.  In Europe, where in the past few years stocks have lagged the recent advances in the U.S., equities managed to advance 1.8% in the quarter despite the crisis in Ukraine.  U.S. bonds, which had their worst year in over a decade in 2013 (posting a return of negative 2.1%), recovered a bit in the first quarter.  Yields on the 10-year Treasury declined to 2.73% on March 31^st from 3.03% at the end of 2013, driving bond prices modestly higher.

Even though equities ended the first quarter very close to where they started it, there was some excitement in the interim.  The two main events that impacted the markets were the start of Janet Yellen’s term as the new Federal Reserve chief and the Russian invasion and subsequent annexation of the Crimea in Ukraine.

On January 6^th the U.S. Senate confirmed Janet Yellen to lead the Federal Reserve.  After the Bernanke era, investors were very attentive to see what, if any, major changes might be in store for a Yellen-led Fed.  The early answer seemed to be “not too much.”  Ms. Yellen has a reputation for being very concerned about the level of unemployment in the U.S.  She has stressed repeatedly that she thinks the labor market continues to undershoot its potential and is still in need of help from the Fed.

Mr. Bernanke moved to keep things afloat with aggressive monetary action during his tenure.  But now, with the economy continuing to improve, Ms. Yellen now has a more delicate task ahead.  In the last several years the Fed has engaged in an open-market bond-buying program to keep interest rates low—thereby lowering the borrowing costs for consumers and businesses alike.  Last year, with the economy on the mend, the Fed began to scale back that support and is now on track to end the bond-buying program entirely later this year.  While this removal of the Fed’s crutch is a vote of confidence in the continuing recovery of the U.S. economy from the 2008-09 recession, it certainly brings with it the risk of unintended consequences.  For example, the progress of the recovery could be put at risk if the absence of the Fed’s buying-power in the bond market leads to higher interest rates sooner than the Fed would like.

Now that Ms. Yellen has taken the helm at the Fed, she will need to weigh her public remarks carefully.  Her offhand comment on March 19th that the Fed could begin to raise interest rates “around six months” after the bond-buying program ended had investors concerned that rate hikes could come too early for the still wobbly recovery.  Stocks gyrated on this news, but as the quarter came to a close, Ms. Yellen had reassured markets that the Fed would be careful not to back away from its accommodative stance on rates too soon.  All in all, it seems to have been a smooth transition of Fed leadership.

Overseas, the big event of the quarter was the Russian invasion and annexation of Crimea.  Global markets did not seem overly concerned by Russia’s actions, however, apparently believing that this incident would not lead to a wider and more damaging confrontation between the West and Russia.  That, of course, still remains to be seen and as I write this the crisis appears to be worsening, particularly in eastern Ukraine.  European markets in particular do not seem concerned, despite the fact that Europe is in a much more economically precarious situation with regard to Russia should there be fallout regarding cross-border trade.

In my opinion, markets did quite well in the quarter despite not posting a healthy gain.  Going sideways for a while after a period of good performance is fine, as it allows corporate earnings to catch up with stock valuations.  Investors are now broadly constructive about the economy and earnings in the coming years, as evidenced by the 15.2 price-to-earnings ratio at which the market now trades.  (The average P/E ratio for the past decade is 13.8 times earnings.)  If the economy can stay on its present course through the year, corporate earnings should come through nicely as well.