The threat of a government shutdown virtually guaranteed that the investment markets would close out the third quarter with a whimper rather than a bang. The S&P 500 Index lost 1.1% of its value in the final week of the quarter as the U.S. Congress lurched toward a political standstill that would shut down the U.S. government. All the uncertainty has tended to obscure the fact that most U.S. stock market investors have experienced significant gains so far this year.
The recent quarter was no exception. The S&P 500 Index of large U.S. company stocks gained 5.24% for the quarter and is up 19.79% for the year. The Russell 2000 small-cap index was up 10.21% in the third quarter, while posting a 27.69% gain in the year’s first nine months.
As we have mentioned in previous commentary, in the first half of the year, diversification into investments other than U.S. stocks was dragging down returns. No longer is that the case. The broad-based EAFE index of larger foreign companies in developed economies rose 10.94% in dollar terms during the third quarter of the year, and is up 13.36% so far this year. Real estate, as measured by the FTSE NAREIT index, fell 2.61% for the quarter, but is still standing at a 3.03% gain for the year. Even Commodities, as measured by the Dow Jones UBS Commodity index, reversed their recent slide and rose 2.13% this past quarter.
Bonds have continued to provide disappointing returns both in terms of yield and total return. The U.S. Aggregate index has lost 1.89% of its value this year. In the Treasury markets, the year has seen a bifurcated market; declining yields in bonds with 12 month or lower maturities, while longer-term bonds have experienced rising yields and a corresponding decline in the value of the bonds held by investors.
Perhaps the most interesting thing to notice about the United States’ 20+% stock market returns so far this year – extraordinary by any measure – is that they were accomplished at a time when investors seemed to be constantly skittish. Just a short time ago, everybody seemed to be worried that the Federal Reserve would end its QE3 program and let interest rates find their natural level in the economy. One might wonder why this would be such a scary event, since it is the Fed’s way of telling us that the U.S. economy is finally getting back on its feet.
All eyes are still on Washington, but now they have moved from the Fed to the Capitol building. The question everybody was asking in the final days of the quarter was: what would be the investment and economic impact of a government shutdown? Maybe more important, what will another debt ceiling fight do to the U.S. and global economies? These questions might be ones to continue to consider going forward, since the two parties seem to have many fundamental disagreements over spending priorities, and budget battles could become quarterly events.
Interestingly, Congress has quietly moved away from the issue that has triggered the last few budget stalemates. In the past, the issue was budget deficits, but it turns out that the budget deficit has come down dramatically over the past 12 months. The U.S. government posted a $117 billion surplus in June, and the Congressional Budget Office expects to run a surplus again in September – the result of revenue gains as a result of tax hikes plus the growing economy, coupled with a 10% reduction in spending.
What does all this mean for your investments in the final quarter? Who knows!? Nobody could have predicted, at the start of the year, with all the hand-wringing over the fiscal cliff and new tax legislation, that we would be standing nine months into 2013 with significant investment gains in the U.S. markets and a resurgence in global investments led by, of all places, Europe.
This much we can predict: the recent uncertainties – paralysis in Congress, worries about the direction of interest rates, and whether the Fed is going to continue intervening in the markets – will give way to new worries and new uncertainties.
But the headlines obscure the fact that investment returns are created the hard way, by millions of people getting up in the morning, going to work, and spending their days finding ways to improve American businesses, generate profits, create new products and new markets, day after day after day.
Whatever ups and downs you will experience – and you WILL experience them, perhaps in the next quarter or the next year – the underlying driver of investment returns is a globally diversified portfolio of high quality stocks and bonds. Nobody enjoys the investment ride the way children enjoy the thrills of a roller coaster, but both seem to ultimately deliver their riders to a semblance of safety in the end.