In August, the S&P 500 topped 2,000, the NASDAQ hit a 14-year high, the Dow Jones Industrial Average crossed 17,000 and interest rates remain low so the question everyone is asking: Where do we go from here?
The three to seven year answer is likely higher stock prices and marginally higher short term interest rates. What happens in the financial markets over the next month or the remainder of the year is a more difficult question to answer. The elusive stock market correction has yet to surface and the prediction of higher interest rates still remains a prediction. The financial markets have an uncanny ability to inflict the most pain on the largest number of investors. While the vast majority of investors are positioned for a stock market correction and/or higher interest rates, it should not be a surprise that stocks are moving defiantly higher and interest rates are grinding lower.
August was another solid total return month across many asset classes despite heightened concerns over geopolitical fires that continue to burn. Second quarter corporate earnings were strong and the economy snapped back proving the first quarter results were hindered by an exceptionally harsh winter. The consumer, the main driver of our economy, is more confident than ever and continues to spend at a steady rate. This trend, if maintained, bodes well for future stock prices.
The U.S. stock market set the pace in August. The NASDAQ Composite gained 4.99 percent, the S&P 500 added 4.00 percent and the Dow Jones Industrial Average was up 3.60 percent for the month. International stocks took a back seat to the U.S. this month. Emerging Markets led the international segment gaining 2.25 percent while the MSCI EAFE Index posted a small decline of 0.15 percent.
The fixed income market was running on both cylinders: lower interest rates and tighter credit spreads. Each of these factors equate to higher bond prices, thus bond investors enjoyed some modest capital appreciation to enhance the earned interest income. For the month, the Barclays Aggregate Bond Index was up 1.10 percent. Long term US Treasuries lead the way with an equity-like 4.06 percent monthly return. High yield, investment grade corporate bonds and municipal bonds all had monthly returns greater than one percent.
The bond market has found its happy place. Economic growth is not too hot and not too cold. Inflation is well under control and energy costs are on the decline. The Federal Reserve has telegraphed their intentions of ending the bond purchase program in 2014 and will very gradually begin moving the Fed Funds Rate higher sometime in 2015. U.S bond investors often overlook the global yield landscape. The chart below show 10-year government bond yields from some other developed countries and one can easily argue the 10-year U.S. Treasury at a 2.39 percent yield is a great relative value at these yields. Don’t be surprised if we see a 2.00 percent U.S. 10-year yield before we see a 3.00 percent yield.
We do not see current market bubbles in either the bond or stock markets. In the stock market, we remain cautious at these valuations but are still constructive over the long term. While a five to ten percent price correction is overdue, we would view it as a buying opportunity if it comes. Bond performance has been a positive surprise this year and when viewed in the global light, the U.S. bond market still looks attractive. At the end of the day bonds will be bonds. Set your return expectations accordingly. Earning the coupon with general price stability will be the likely path into 2015.
Our recommended approach for investors is to take a long term view, set your financial course and stay the course. Review Mike Binger’s August 25th Market Reflection piece posted on the Gradient Investment website. He discusses the pros and cons of long-term investing versus market timing. Market timing is difficult proposition in normal market cycles and can be exasperating when the market consistently defies consensus thinking. The cure to this emotional struggle is to become a long term investor armed with a long term financial plan. Add focus, patience, put time on your side and you are well on your way to achieving your financial goals.