A successful third quarter in the financial markets has ended and the hype from Washington is once again the number one story in the land. We have heard these stories before: a government shutdown, debt default and raising the debt ceiling. The debt ceiling in the United States has been raised fourteen times in this thirteen year old 21st century. A fifteenth increase is a safe bet. As the media spotlight shines on Washington’s fiscal issues, investors will become more concerned and market volatility will increase in the weeks ahead.
The political nature of the debt ceiling debate and a potential government default will receive full coverage by all the media outlets, but there are other key stories occupying the front page that will impact the fourth quarter financial markets. Uncertainty regarding the next chairperson of the Federal Reserve, questions about Fed policy and future tapering plans, geopolitical instability, economic growth, unemployment rates, and a new corporate earnings season will influence future of stock and bond prices. Before we look ahead, let’s review what happened.
International stocks had a huge month taking the lead role after many months of weaker performance. The MSCI EAFE Index jumped 7.39% and the MSCI Emerging Market Index gained 6.50% for September. U.S. equity markets posted attractive gains for the month ranging from up 2.27% on the Dow Jones Industrial average to up 5.14% on the NASDAQ Index. For the trailing twelve months, if you invested in stocks you should be gratified with returns near twenty percent. For the doom and gloom investors who moved into gold and commodities a year ago it was a different story. Gold is down 25.0% over the past year and commodities in general have fallen by 14.35%.
The bond market crashed in May and June as the Federal Reserve hinted at ending their accommodative policies. Yields on the 10-year U.S. Note moved from 1.70% to 3.00% very quickly. The “taper” is now priced into the bond market and September marks the third consecutive month where bond investors are getting accustomed to a new trading range. It appears a 2.50%-3.00% range on the 10-year Treasury has replaced the unsustainable 1.50%-2.00% range of the past few years. While the twelve month returns from investment grade bonds are in negative territory, the higher current interest rates give bonds a more compelling relative value moving forward. High yield bonds continue to shine reflecting strength in the both the equity markets and lower quality corporate credit.
If you own bonds in your portfolio, remember why. Bonds provide for capital preservation, income, stability and low correlations to equity returns; important components for successful long-term portfolio strategies.
The fourth quarter and particularly October tends to be a stern test of investor resolve. Our long-term view is stocks can still move higher in 2014 as fundamentals like corporate earnings, consumer confidence and global economic growth will move prices upward. Even though stock prices are near all-time highs, they are still reasonably priced relative to other asset classes. Stock gains in the fourth quarter though will likely remain muted as volatility increases and investors digest the stories of the moment.
Our best advice to all investors is to not let yourselves get trapped into thinking today’s breaking news is tomorrow’s end of the world. Years matter – days, weeks and months are irrelevant in the bigger picture. We may experience some headline induced turbulence in the fourth quarter; fasten your seatbelt, sit back and enjoy the ride to your financial destination.