Download Last quarter, we cautioned that conditions were right for a

MARKET REVIEW & OUTLOOK | JUNE 30, 2013
Market Review
GLOBALT Summary Investment Outlook
L
ast quarter, we cautioned that conditions were The Federal Reserve’s June announcement of plans to taper Quantitative Easing (QE) later this
year has led to higher interest rates and market volatility. This trend may continue as investors
right for a market pullback after earlier strong
gains and overly optimistic investor sentiment were grapple with what the plans means for stocks. However, the QE exit strategy remains dependant
on continued improvement in employment and GDP growth.
fueled by Federal Reserve policy. Investors had
been driven out of cash in search of higher yields
and capital gains. Consequently, the higher yield- Equities - U.S. equities remain the most relatively attractive asset class in our models. Developed markets in the MSCI World ex-U.S. Index also look attractive. Though emerging markets in
ing consumer staples and utilities were the most
the long term have great potential, in near term, their economies particularly those with export
susceptible to profit taking. Counter to the stance
of many global investors who bet that quantitative driven economies are growing at a slower rate. We are monitoring these economies closely.
easing was indeed forever, improving U.S. economic
data provided the catalyst for Chairman Bernanke Fixed Income – Interest rates, as feared, have increased significantly in the 2nd quarter. In the
short run, rates have likely increased more than they should. However, if the economy continues
to jolt the markets out of complacency when he
to improve, rates may lift again.
announced that the Easy Money policies and asset
purchases will start winding down. This news sent
REITs – have suffered because of rising rates and are not in as much demand as earlier in
both bond and stock prices lower, driven by fear
the year.
that bond yields might head much higher. The
Barclays Aggregate Bond Index fell -2.3% for the 2nd
Alternative Investments – Commodity prices continue to weaken in light of the emerging marquarter bringing year-to-date returns to -2.4%, the
ket slow down. Despite its recent performance, we continue to believe gold is a hedge against
worst start since 1994. The S&P 500 Index corrected unexpected shocks to world economies.
after reaching its all time high on May 22, but still
ended the quarter with a respectable +2.9% total
return, maintaining a healthy advantage over bonds. Over the last Two of the most important data points in recent weeks were U.S.
12 months the return differential of stocks over bonds was 21.3%
consumer confidence, which rose yet again in the month of June,
– the largest since 1987.
and the Chinese HSBC PMI, which declined for a second month as
Japanese stocks continued their relative winning ways while
European markets posted losses. Emerging markets fared worse.
High real rates in these emerging markets have long contributed
to a global carry trade by borrowing cheap U.S. dollars to invest in
high yielding emerging economies. The unwinding of this trade
drove emerging equity markets down nearly -8% in the quarter,
creating more than an 18% disparity year-to-date versus the broad
MSCI World Index. Faring even worse, gold plunged -22.9% for the
period bringing the year-to-date decline to -26.5% as the enemies
of gold, rising interest rates and falling inflation, took hold.
output fell into contraction mode along with export orders. It is our
opinion that this decoupling is a function of the progress global
economies are making towards resolving structural issues. While the
U.S. sees a declining deficit, energy resurgence and a manufacturing
renaissance, China’s economic headwinds are just beginning to surface, as a big area of investor concern is the view on China’s growth
prospects. Many investors believe that a slowdown in China could
bring slower growth across the world and in the U.S. In our opinion,
this fear over a slowdown in foreign earnings of U.S. companies is
exaggerated.
Market Outlook & Portfolio Positioning
Inflation outlook has improved. We regard the inflation outlook as
a key area to monitor for investors. The “Bears” see falling inflation
expectations as a signal that the economy and markets will fall;
we suspect they have it wrong. During the past decade, corporate
earnings almost doubled, but the market barely made gains as those
earnings were weighed down by inflation. Higher inflation generally
depresses the multiple that investors are willing to pay for earnings.
Today, China is slowing and so is U.S. inflation. As China’s economic
growth slows, we expect that commodity prices will fall, which translates to lower inflation in the U.S. As inflation falls, the U.S. consumer
who accounts for 70% of U.S. GDP, generally spends less on food
and energy and more on discretionary items. Indeed, investors are
paying a higher multiple for corporate earnings today, even though
the pace of growth has slowed overseas. Although structural issues
abound, cyclical tailwinds are poised to act in Europe’s favor as inflation trends have been in a steep decline since last September.
I
n our opinion, a global decoupling appears to be unfolding
across global financial markets with a wide disparity of returns.
The U.S. markets are leading the charge propelled by higher home
prices, strong auto sales and growing energy production with
the developed international markets following close behind. In
contrast, emerging markets have fallen on high real interest rates,
fears of slowing growth, political unrest, liquidity issues and the
need for structural economic reforms.
Index
2Q 2013
YTD
One Year
Russell 3000 (U.S. stocks)
2.7%
14.1%
21.5%
MSCI World ex-US (Int’l stocks)
-1.6%
3.0%
17.1%
Barclays Gov/Credit Index (bonds)
-2.5%
-2.7%
-0.6%
DJ Real Estate Index (REITS)
-3.7%
4.9%
8.8%
Gold ETF
-25.5%
-28.5%
-25.7%
0.0%
0.1%
0.3%
90-Day Treasury Bills (Cash)
Was Sell in May right again? Each year since 2010, the economy and
financial markets have started strong only to suffer a summer swoon.
Page 2
The classic adage, “sell in May and go away,” often proves to be
good advice. We remain on alert for signs of weakening, but in the
U.S., growth appears to be on firm footing. In particular, housing
continues to strengthen although a significant rise in interest rates
could put this improvement at risk. As rates rise, the earning potential of banks is increased as the willingness to make loans normally
lifts employment, home equity values, and consumer confidence.
Finally, the ongoing energy boom in the U.S. shale oil regions are
creating a manufacturing renaissance as companies relocate production facilities back home to capitalize on cheaper energy costs.
This could provide an important, sustained boost to the economy.
Fed starts to taper its bond purchases later in the year because it
is making progress toward achieving its economic objectives, that
should be good for credit, not bad. Spreads should narrow, not
widen. The economy must validate the Fed and investors’ expectations or yields and stocks will likely fall.
Putting it all together – The first quarter of 2013 kicked off to a
strong start with high investor optimism, lower interest rates, tighter
credit spreads and falling volatility. The second quarter saw many
of these positives reverse and stall the upward momentum of the
equity markets. We anticipate further gains by year-end along with
volatility in stock prices as investors debate the implications of the
One of our biggest concerns is Japan’s economic situation. Because Fed slowing its QE program. Our overall bullish stance on U.S. equiof its huge debt burden, Japan must be careful to balance strong
ties has remained steadfast and has led us to increase our weightgrowth with rising yields in order to ensure adequate revenue to
ings in large cap value and small cap value to overweight positions.
pay off the growing debt service that comes with higher rates.
However, we believe stock prices have begun the transition from
Higher yields generally come with stronger growth, but Japan
their reliance on monetary policy to fundamentals.
cannot afford higher yields! At yields of 3.6%, debt service would
Portfolio Positioning − For now our broad, balanced positioning reconsume 100% of tax revenues, so with the current rate at 0.8%,
mains with a small increase to U.S. equities during the second quarthere is little room for error.
ter and also in July. Longer term, we strongly believe that some of
In the short run, Japanese stocks are up over 30% year-to-date in
the most attractive investment opportunities for equity investors will
response to an improving economic environment in Japan, combe found overseas, especially in the emerging markets. During the
bined with the quantitative easing program initiated this spring
quarter we initiated a small position in the emerging markets ETF
by Prime Minister Abe’s government. These events have recently
after having zero broad emerging market exposure since the fall of
led us to remove a long held underweight position in the iShares
2011. We also eliminated a long held position in the Australia ETF in
MSCI Japan ETF vs. Japan’s weight in the MSCI World ex-U.S. Index.
July due to deteriorating domestic economic conditions in Australia
We will be watching the Yen and Japanese rates very closely and
compounded by slowing economic growth in China (a major market
are prepared to return to our underweight position should their
for Australian commodity exports). Overall, our international equity
economy and markets falter.
exposure is lower than other similar asset allocation strategies and is
biased towards developed economies.
Interest rates are a key to global recovery but it is important that
they don’t rise too quickly. Uncharacteristic bond losses on quarWe remain underweight fixed income with a shorter weighted duraterly statements may unsettle investors and could hasten the “great tion in government bonds than the Barclays U.S. Aggregate Bond
rotation” out of bonds and into stocks, pushing rates even higher.
Index. Though not on the horizon at this time, if we see signs of a
While normalization of rates from crisis to recovery levels is desirstrengthening U.S. economy that may impact stated Fed policy, we
able, a move above 3% on the 10 year Treasury without signifiwill act to minimize the effect of rising interest rates on the fixed
cantly stronger economic growth could scare equity markets. If the income portion of the strategy.
For additional information please contact Greg Leftwich or Cheryl Lavette at 404-364-2188 or toll-free at 1-877-428-6956 or e-mail [email protected]
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