The year's first half for equities can be summed up in simple
terms: confusing and unpredictable markets produced gains. As of June 30, the S&P 500 had already
logged 22 record highs this year alone, ending the first half up 6% while the
Dow Jones Industrial Average (DJIA) increased by 1.5%. Both of these indexes hit new highs in the 2nd
quarter while the NASDAQ Composite index rose by 5.5%, reaching a 14-year
highpoint. Interestingly, 2014 has produced the biggest halftime lead by the
S&P 500 over the DJIA since 2009 and the seventh-biggest since 1929,
according to Bespoke Investment Group.
Investors started 2014 with several serious concerns. How would
the S&P 500 Index follow up 2013’s 30%+ gain (including dividends)? Would the market correct, or would there be
profit-taking? Would the slow economic improvement send bond prices lower, or
would we see the Federal Reserve shift to higher interest rates?
So far in 2014, the bond market has
also fared well—in fact, better than most had expected. The yield on the U.S. Treasury ten-year
note, which moves inversely to its price, fell to 2.51% from 2.76% at the end
of the first quarter.
Unfortunately,
many investors are having a hard time enjoying these increases, as concerns
about lofty prices make it difficult to decide whether to keep funds in cash or
stay invested. The forces driving the
stock market to new highs and helping parts of the bond market to remain near
record low yields don’t show immediate signs of changing.
What are these
driving forces? Many credit the aggressive efforts by the world’s major central
banks to flood financial markets with new money in order to keep sluggish
economies moving forward.
U.S. stocks
have been supported by expectations that the still-sluggish U.S. economy will
grow fast enough to keep corporate profits expanding. But many investors no longer feel comfortable
with that outlook, and have begun focusing more on what can go wrong with their
portfolios than on where they can make money.
The current
stock market rally has outlasted the historical average of other bull markets
with higher returns, but there is “still a bit of a fear-factor” among
investors, said Thomas Huber, Manager of the T. Rowe Price Dividend Growth
Fund. “Everyone is looking for what’s
going to be the big crack in the markets.”
(Source: Wall Street Journal, July 1, 2014)
While many investors are concerned about
how markets will respond when the Fed raises interest rates in the future,
there are also concerns building in the opposite direction regarding the
estimate in the growth of our economy. The Commerce Department’s third and
final estimate of the Gross Domestic Product (GDP) for the first quarter of
2014 continued the downward spiral of the first two estimates—from +0.1% to
-1.0%, and now down to -2.9%. Many
economists believe that the extent of the first quarter decline is so
substantial that we’re unlikely to reach a 2% increase, even if the next three
quarters are significant. (Source: Bob LeClair’s
Finance, June 28, 2014)
A recent GDP
report offered some positive data:
- Existing-home sales climbed 4.9%, the strongest
gain in three years.
- New-home sales jumped 18.6% in May (the largest
gain in more than 20 years), a six-year high.
- The Conference Board’s confidence index improved
to 85.2 in June, its highest reading since 2008. (Source:
Bob LeClair’s Finance, June 2014)
Will we be able to hold onto these gains and add enough through the end
of the year to at least have a positive GDP for 2014? Let’s hope so. Slow growth could reduce corporate profits,
which would be bad news for stocks and could lead to higher-than-expected
default rates on junk bonds.
PRICE–TO–EARNINGS RATIO
Price-to-earnings
(P/E) ratios have risen over the last two years, as improving investor
confidence helped drive market gains.
Some investors are focused on the current valuations, which are slightly
above the long-term average (17.1 versus 15.1). The higher the P/E, the more
likely the stock market is overpriced.
Although most stock indices are at an all-time high, the market
valuation is nowhere near its 2001 peak. (Source: Fidelity.com)
Even with a gain in the first half of 2014, bears exist. Nobel Prize-winning professor Robert Shiller
notes that currently the market looks more expensive on a cyclically adjusted
basis. Still, he’s not telling investors to sell all of their holdings and
retreat, just to be cautious and lighten up.
STOCK BUYBACKS
Companies
buying back their own shares represent the single biggest category of stock
buyers today, according to a study by Jeffery Kleintop, Chief Market Strategist
at LPL Financial. (Source:
Wall Street Journal, June 30)
Some
economists say buybacks allow companies to provide artificial support for stock
prices by increasing demand for shares.
Also, reducing the number of shares increases the earnings per
share. Most professional money managers
look primarily at earnings per share, so buybacks can improve a company’s
apparent earnings performance, even if overall earnings aren’t rising at all.
GLOBAL
Financial
markets worldwide are getting a boost from recent upbeat economic data out of
China. China has increased its
manufacturing activity and many economists believe that its appetite for raw
materials will continue. While many markets were rattled earlier this year by
worries that China’s slowing growth would lead to a hard landing, the Chinese
government took steps to build investor confidence, including credit easing,
more spending on highways, and business tax breaks.
The
U.K. and Germany remain the primary drivers of the European Economic Expansion,
but now other European economies have also improved significantly, suggesting
that Europe’s cyclical upturn continues to become more broad-based.
INTEREST RATES
Central bankers around the world debate
whether very low interest rates, adopted in many economies since the 2008
financial crisis to spur stronger recoveries, are actually feeding market bubbles
that could burst and potentially cause new financial turmoil.
As the
Fed is winding down its bond-buying program, Janet Yellen, Chairperson of The
Federal Reserve, assured investors that the Fed won’t raise interest rates
abruptly simply because some markets may look a bit volatile. (Source: Wall Street Journal, July 3, 2014)
Most
Fed officials have indicated they expect to start raising interest rates
gradually in 2015, but the final decision will depend on whether the economy
continues to strengthen as they forecast.
However, many investors think that the rise in interest rates could
happen sooner and the pace of increases could be more rapid than expected.
INFLATION
Inflation finally
nudged above the 2% level that the Fed says is its
long-term target. Compared with a year
ago, the Consumer Price Index (CPI) is up 2.1% (not including food or
energy). Although that might make the
Fed happy, it sent a tremor of worry through analysts, investors, and
economists.
UNEMPLOYMENT
On
Wednesday, July 2, a report on the U.S. labor market was better than expected
in that 281,000 private-sector jobs were created in June compared with an
estimated increase of 210,000. Although this is certainly good news, many
investors say that stocks will need continued evidence of an improving economy
to sustain the move higher. (Source: Wall Street Journal, July 3
2014)
CONCLUSION
What
should an investor do? Some believe that
stocks will benefit from robust earnings and low interest rates, while many
other financial professionals are spending sleepless nights focusing on whether
the five-year-plus bull market is getting long in the tooth. Those money
managers who sided with caution so far in 2014 have underperformed the indexes;
however, as Confucius once said “the cautious
seldom err.”
Although
U.S. stock indexes are pushing through fresh records and valuations have passed
pre-financial crisis levels, some analysts believe markets aren't overvalued
yet. Still, an examination of historical valuations points to proceeding with
caution in the stock market. Normally during these times bonds would provide a
safe harbor, but with interest rates still near historic lows, bonds might not
provide the same portfolio protection as in years past and, potentially even
worse, bond prices will decline when interest rates rise.
It’s not easy to structure a portfolio in the face of these risks, but
perhaps the best advice is to continue to focus on your personal situation and
timelines. Consider these important questions:
- What is a realistic time horizon?
- What is a realistic return expectation for my
portfolio?
- What is my risk tolerance?
Your
answers to these questions will help us recommend what type of investment
vehicles you should consider, which investments to avoid and how long to hold
each of your investment categories before making major adjustments.
We are
continually reviewing economic, tax and investment issues and drawing on that
knowledge to offer direction and strategies to our clients.
We pride
ourselves in offering:
- consistent and strong communication,
- a schedule of regular client meetings, and
- continuing education for every member of our team on the issues
that affect our clients.
A good financial advisor can
help make your journey easier. Our
goal is to understand our clients’ needs and then try to create a plan to
address those needs. We continually
monitor your portfolio, keep a watchful eye on the markets and interest rates,
and keep the lines of communication open.
We can discuss your specific situation at your next review meeting or
you can call to schedule an appointment. As always, we appreciate the opportunity
to assist you in addressing your financial matters.
P.S.
During this year’s big Treasury rally, the question’s been, “Who’s buying all
those bonds?” The answer is the Federal Reserve. During the six months ended in May, the Fed
bought 73% of all new Treasurys, notes Strategas Research Partners’ Daniel
Clifton. That’s the largest percentage
since the start of quantitative easing.
The
reason isn’t greater demand, but reduced supply. With the budget deficit falling, the amount
of bonds issued has declined faster than the Fed’s taper, or reduction in bond
buying. That leaves a limited supply of
bonds for others to buy,
according to Clifton. Perhaps that’s why
bonds have held up in the first half of 2014
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Financial Literacy Facts
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61% of adults admit to not having a
budget, the highest percentage in six years.
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35 million people admit to rolling over credit
card debt of more than $2,500 a month.
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29% are spending less this year than the
previous year.
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41% gave themselves a grade of C, D, or
F on personal finance knowledge.
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Source:
National Foundation
for Credit Counseling Survey |
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Michael L. Schwartz, RFC®, CWS®, CFS, a
registered principal offering securities and advisory services through
Independent Financial Group, LLC., A Registered Broker/Dealer and Registered
Investment Advisor, Member FINRA-SIPC Schwartz Financial and Independent Financial
Group are unaffiliated entities
Note: The views stated in this letter are not necessarily the opinion of Independent Financial Group, LLC, and should not be construed, directly or indirectly, as an offer to buy or sell any securities mentioned herein. Investors should be aware that there are risks inherent in all investments, such as fluctuations in investment principal. With any investment vehicle, past performance is not a guarantee of future results. Material discussed herewith is meant for general illustration and/or informational purposes only, please note that individual situations can vary. Therefore, the information should be relied upon when coordinated with individual professional advice. This material contains forward looking statements and projections. There are no guarantees that these results will be achieved. There is no guarantee that a diversified portfolio will outperform a non-diversified portfolio in any given market environment.
Due to volatility within the markets mentioned, opinions
are subject to change without notice. Information is based on sources believed
to be reliable; however, their accuracy or completeness cannot be guaranteed.
In
general, the bond market is volatile, bond prices rise when interest rates fall
and vice versa. This effect is usually pronounced for longer-term securities.
Any fixed income security sold or redeemed prior to maturity may be subject to
a substantial gain or loss. The investor should note that investments in
lower-rated debt securities (commonly referred to as junk bonds) involve
additional risks because of the lower credit quality of the securities in the
portfolio. The investor should be aware of the possible higher level of
volatility, and increased risk of default.
The
payment of dividends is not guaranteed. Companies may reduce or eliminate the
payment of dividends at any given time.
Sources:
CNN Money; Shiller PE Ratio; Barron’s,
June 2014; Bob LeClair’s Finance, June 2014; Fidelity; Bob LeClair’s
Finance, June 28, 2014; Wall Street Journal; CNBC.com 7/2014 Contents © 2014
