Our Thoughts

Quarter In Review

Gains, Gains, Gains

U.S. commercial real estate, as measured by the FTSE NAREIT All Equity REIT Index, outperformed every other asset class in both the second quarter (+7.13%) and year-to-date through June 30 (+16.25%).   Improving demand for and limited new supply of apartments, offices, and regional malls as well as the availability of low-cost financing boosted fundamentals, and the markets responded.

Although it is hard to describe the single-digit returns for U.S. large company stocks during the first half of 2014 as a raging bull market, it is also hard to be negative about a six month period when the widely quoted S&P 500 Index recorded 22 record highs.

Virtually everything in your portfolio–including bonds–rose in value.

Fixed Income….Most market participants and pundits expected interest rates to rise and bond prices to fall in the first half of the year.  Instead, interest rates fell and bond prices rose!  30-year Treasuries have seen their yields fall to 3.36% in the past six months, and 10-year Treasuries currently yield 2.53%.  At the low end, three-month T-bills are still yielding a miniscule 0.04%; six-month bills are only slightly more generous, at 0.06%.

Are these low yields sustainable going forward?  From a “demand” perspective, you could be concerned that the appetite for Treasuries will finally dry up, forcing rates higher.  But, ask yourself this:  Would you rather invest in U.S. 10-year Treasuries at 2.53%, or buy comparable Japanese government bonds yielding just 0.563% or 10-year German bunds trading at 1.25% yields?  As little as they are yielding today, Treasuries are still pulling in buyers from around the world, both as a safe haven and as a source of higher yields.

And, from a “supply” perspective, the U.S. government seems to be getting its books back into balance.  You won’t read about this in the newspapers, but the U.S. federal deficit has fallen from $1.4 trillion to around $400 billion in the space of one year.  And the U.S. is now close to energy self-sufficiency which means that the trade deficit, which has largely been driven by the cost of importing Middle Eastern oil, is shrinking dramatically.

Equities….The long bull market in stocks that started in March 2009 and the economic expansion that started at roughly the same time are both among the longest since the Civil War.

The S&P 500 rises for 18 months on average without a correction (a decline of 10% or more).  Nevertheless, on June 30, the Index completed 32 full months without one.  Since the last correction in September of 2011, the S&P 500 has gained 75%!

Can the bull market continue?  Jeremy Siegel, a well-respected professor of finance at the Wharton School of Business and a market bull, offered his take in an early July interview on CNBC. “Investors are looking for yield and want to go to dividend paying stocks, which now are yielding 3-4% and more, well above Treasuries and money market yields.  I think that there’s going to be a steady flow of demand for the next several years from the public.”

Siegel does, however, see some risks in his outlook including the potential for higher inflation from wage gains that aren’t matched by productivity increases, and higher oil prices.  So, this may be a very good time to prepare for that inevitable correction down the road.

Prepare how?  First, it helps to remind ourselves that pullbacks are inevitable, a normal part of stock market behavior.  Since the Great Recession/Financial Crisis lows in March 2009, the S&P 500 has experienced nine declines ranging in magnitude from 6% to more than 21%.

Second, it helps to recognize that these pullbacks are almost totally unpredictable.  Knowing there will be a pullback doesn’t tell us when, or help us maximize returns.  If we take money out of the market today, on the certainty that a pullback is coming, we are just as likely to miss another year or two of upward movements as we are of sidestepping an immediate downturn.  Nor do we know how long the downturn will last.  Add in trading costs and taxes, and a decision to step out of the market, and then back in again, is not likely to add value in the long run.

Third, recognize now that the next unpredictable correction will look blindingly obvious in hindsight.  It will seem like everybody but you knew in advance what was coming and when.  In reality, you will be hearing reporters quoting the same few pundits, people who confidently predicted that a downturn was nigh and turned out to be right.  Look more closely and you will find that this small number of people had been predicting disaster over and over again for years while the markets sailed through scary headlines and economic headwinds.

Finally, realize that inaction is actually taking strong and unusual action.  Investors who simply kept their money in stocks during each of the market downturns since March 2009 ended up seeing small and large U.S. company stock indexes reach new highs once the corrections had run their course.

Looking Ahead….Together we have implemented an investment strategy that is tailored to your long-term goals and your willingness to take on risk.  When the next correction hits, it will put stocks on sale and give the disciplined investor an opportunity to buy in at lower prices.

But, if the prospect of a correction is keeping you up at night, please call us to schedule a conversation about your risk tolerance and your equity allocation.  Maybe you are more averse to market volatility than you used to be.  If that is the case, now is the time to reduce your exposure to equities before a correction does that for you!