The term “Goldilocks Economy” was coined by Dr. David Shulman in the early 1990’s. It describes an economy with sustainable moderate growth, low inflation, a market friendly monetary policy, low interest rates and increasing asset prices. This term has recently resurfaced in the media as it accurately describes our current economic situation. This complacent state will not last indefinitely, but let’s take a moment to enjoy it.
The economy’s best friend the past six years has been an accommodative central bank. The Federal Reserve implemented a zero interest rate policy over five years ago and Janet Yellen’s recent comments suggest there is no predetermined end in sight. The Fed Fund Rate remains targeted between zero and twenty-five basis points for the foreseeable future. The Federal Reserve’s three plus trillion dollar bond buying spree aimed at stabilizing the banks and adding liquidity is coming to an orderly conclusion as they complete their tapering program. The current dovish Fed will likely remain market friendly through 2014 despite recent the inflation and employment numbers.
Inflation ticked up to a 2.1 percent annual rate, slightly above the Fed’s target, but the Fed assured investors all is well. Also, the unemployment rate is falling faster than the Fed’s expectations, but the Fed removed their self-imposed 6.5 percent unemployment rate line in the sand. The revision of U.S, Gross Domestic Product (GDP) 2014 first quarter number showed the output of goods and services decreased at an annual rate of 2.9 percent. While this was the first negative GDP quarter since the first quarter of 2011, the market shrugged off the news as a weather related decline. Positive GDP growth should return in the second quarter.
The market, in its Goldilocks state, gave both bond and stock investors cause for celebration. For bond investors it was lower long-term interest rates and tighter credit spreads. Performance across all bond sectors was positive and the six month numbers would make great annual returns. For the six months ended June 30, 2014 the U.S. Aggregate Bond Market returned 3.93 percent, high yield 5.46 percent and municipal bonds 6.00 percent. Long-term U.S. Treasuries led the way with equity like 12.14 percent return over the past six months. For bond investors 2013 is now a distant memory, but let’s be reasonable and lower future return expectations into the low single digit area.
The stock market rolls along setting new highs with regularity. We have been consistently bullish on stocks recognizing the power of the Federal Reserve, the strength of corporate earnings and the concept of reasonable valuations. As we sit atop the mid-year mountain it would be prudent to caution investor expectations. Our 2014 stock outlook was for high single digit returns. This was based on corporate earnings growing at seven percent, dividends providing a two percent return, and valuations remaining constant. Year to date the S&P 500 is up 7.14 percent, NASDAQ gained 6.18% and emerging markets rose 6.14 percent. Looking forward, the Federal Reserve will likely be less of a market tailwind as they complete their taper program and begin to tackle current inflation and employment trends. Corporate earnings will need to accelerate to achieve the seven percent annual growth and valuations have been stretched to bring the market to its mid-year summit.
At the end of the day, we are long-term investors who believe in properly allocating among diversified portfolios. Our best advice is to set realistic expectations and stay invested for the long haul. Every year the market will experience some form of a pull back or correction. If we get one in the second half of 2014 don’t be surprised, just be confident in your long-term investment plan and stay on course.