Returns among asset classes were mixed this past quarter. The Barclays Aggregate Bond Index was barely positive, up 0.17% and municipal bonds rose 1.49%. TIPS dropped 2.04% while foreign bonds took a nosedive, down 5.34%. Large cap stocks were the lone bright spot in equities, up 1.13%. Small and mid caps fell 2.80%. Developed international stocks were down 5.88%. Emerging markets stocks lost 3.49%. Real estate was down 3.05%, ending a hot streak. Commodities continued to struggle, dropping 11.83%.
Inflation-protected securities struggled due to weak commodity prices, a downside surprise in reported inflation, perception of a more hawkish Federal Reserve, and the stronger US dollar. Foreign currencies (especially the Euro and Yen) got hit hard this quarter, driving down returns for foreign securities. US dollar-hedged foreign bond funds actually posted solid gains as the dollar strengthened. Commodities plummeted as energy, gold, and agriculture prices fell.
When Janet Yellen took over as Chair of the Federal Reserve, she emphasized a commitment to a data-driven decision making process. Now that the unemployment rate took a surprising turn for the better, dropping to 5.9%, it looks like the data will force the Fed to wind down its policy of Quantitative Easing and start raising rates sooner than expected. This plays into half of the Fed’s dual mandate of keeping unemployment low and holding inflation between 2-3%. The second part of that mandate may be the excuse that the dovish Dr. Yellen needs to delay a rate hike. Inflation has been low and the strengthening dollar will likely continue that trend.
Just in time for Halloween, there are plenty of stories being told to scare investors out of their financial plans. From Ukraine to ISIS to Ebola, pundits paint the most frightening scenario they can in order to spur some action from the others gathered around the campfire. The talking heads on TV would likely advise the babysitter in a horror movie to run upstairs rather than out the front door. There is always a temptation to react emotionally to news or financial entertainment, but one of the few things investors can control is their own investing behavior. Investors who are frightened out of their investments by short-term events have a difficult time getting back in because there is always some bad news out there. Just like someone in a horror movie who says, “I’ll be right back” they get caught up in the bogeymen of the world and miss out on the happy ending.
It may be timely to remember that in an average year the S&P 500 drops 14% at some point. The last drop of that magnitude was in September of 2011. There was a drop of almost 10% in 2012, but the biggest drop in the last two years has been 6%. At some point we will see that average 14% drop again and all the media panic that will accompany it. In the mean time, it’s best to be prepared by having a diversified portfolio to take advantage of dislocations in the markets without becoming emotionally involved.