Returns were mixed this quarter, mostly positive for equities and negative for income-producing securities. The Barclays Aggregate Bond Index was down 1.7%. Municipal bonds lost 0.9% and TIPS dropped 1.1%. Foreign bonds declined by 1.5%. US Large Cap stocks as measured by the S&P 500 returned 0.3% while Small and Mid Caps dropped 0.7%. Developed Markets rose 0.6%, but Emerging Markets were up 0.7%. Real Estate reversed course, losing 3.9%. Commodities gained 4.7%.
The Federal Reserve held rates at 0-0.25% again at their latest meeting, but are expected to raise rates by the end of 2015. Rates are still at emergency levels even though the data that drives Janet Yellen’s Fed indicates recovery. GDP should get a boost after the government corrects a seasonality error that was incorrectly depressing first quarter data. Unemployment is 5.5% (long-term “normal” unemployment is 5.4%, according to the Congressional Budget Office) and inflation is under control, particularly with the ceiling on energy prices due to the American shale revolution. The Fed is running out of reasons to delay a rate hike. We expect to see a short term bump up in volatility after the first increase as traders overreact to the news. Instead of viewing a raise in rates as a negative, investors should recognize it for what it truly is: a return to normal. Zero percent interest rates hinder a healthy economy.
The father of value investing, Benjamin Graham, said that in the short term the market is a voting machine, but in the long term it is a weighing machine (short term movements are due to the whims of buyers/sellers, but long term movements are due to a company’s actual value). Since the financial crisis, the world’s central banks have had their thumbs on the market weighing machine by means of significant monetary policy. Currently, the Federal Reserve has stopped pushing on the scale and is on the brink of taking some pressure off. The European Central Bank (ECB) is adding weight while Japan’s central bank (BOJ) has thrown out all pretenses and is jumping up and down on the scale. Just as the financial crisis hit the United States first and then rippled out to Europe, the recovery started in the US first and Europe is 2-3 years behind. The US is providing a roadmap to Europe on how to navigate from crisis to recovery through monetary policy. If Europe continues to follow that playbook, the stage is set for continued US dollar strength.
If there has been one constant over the last few years, it has been that Greece has been about to default/Grexit/Graccident. Margaret Thatcher might have said that they ran out of other people’s money. The June 30th deadline for Greece’s loan payment passed without a deal. Eventually something will happen with Greece, whether it’s “just” default or if it is accompanied by an exit from the Eurozone. This may actually be a good thing, providing a case study for the rest of Europe. Greece is big enough to matter, but not big enough to pose systemic risk. Until the reckoning, we can look forward to headlines about Greece on the brink of default or nearly reaching a deal every Monday morning.
Our investment committee continues to suggest the following guidance:
- Allow Bonds weighting to drift as much as 5% lower than policy and add foreign exposure if needed
- Allow Stocks weighting to drift as much as 5% higher than policy, favoring international equities