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Issue # 6
In This Issue
- Economic And Market Update
- Equity Market Update
- Fixed Income Market Update
Market Point
An Economic & Market commentary from Trust Point
w ww.trus tpoin tin c.com
S e c ond Q ua rt e r 2 0 1 4
An Economic and Market Update from Trust Point
Since the 2008-2009 financial crisis, global growth
has been “not too hot and not too cold, but just right.”
The accompanying low inflationary environment
has allowed major central banks to keep rates low,
and asset markets have benefited strongly from this
“goldilocks” environment, but can the trend continue?
As of
Actual
3 Mths Ago
1 Year Ago
Dollar Index Level
June
79.8
80.1
83.1
U.S. Economic AcƟvity
ISM Manufacturing (>50=Expansion)
ISM Non-Manufacturing (>50=Expansion)
Non-Farm Payrolls
Unemployment Rate
CPI Ex-Food & Energy (yoy)
June
June
June
June
May
55.3
56.0
288K
6.2%
2.0%
53.7
53.1
203K
6.7%
1.6%
52.5
53.4
201k
7.5%
1.7%
June
52.7
52.4
50.4
June
55.8
53.5
52.8
Global Economic AcƟvity
JP Morgan Global Manufacturing Index
(>50=Expansion)
JP Morgan Global Non-Manufacturing Index
(>50=Expansion)
Source : Bloomberg
Signs Of A Maturing Market
On many occasions over the past several years, we have emphasized the positive
impact that loose monetary policies have had on markets. By taking and maintaining
the yield on cash at nearly zero, (Chart 1) the Federal Reserve has incentivized
investors to take on risks, both in equity and fixed income markets. As a result, risk
premia across asset classes has compressed. In other words, value has been taken
out of the markets as asset prices reach new highs. Coincidentally, volatility has
been falling to levels last seen in the summer of 2007, creating a false sense of
security among investors. The macro-economic environment is certainly different
than it was 5-6 years ago, but we also recognize that complacency and higher
valuations have never been a recipe for investment success. The Federal Reserve has
helped dampen market volatilities, but only a sustained “goldilocks” environment
will allow the Fed to stay the course. At this point in the cycle, we have become
slightly more cautious as we see growing signs of maturing markets developing,
especially in the U.S. As we always look to follow opportunities and not trends, we
currently see more value in international and emerging markets, both in equities
and fixed income, and have started making portfolio changes accordingly.
Chart 1 : Federal Funds Target Rate
5.000
4.000
3.000
2.000
1.000
0.250
0.000
2006
2007
Source : Bloomber
Bloomberg
rg
2008
2009
2010
2011
2012
2013
2014
Just a few weeks ago, the Bureau of Economic Analysis announced the third
and final revision to the 1st Quarter U.S. Gross Domestic Product (GDP), the
broadest measure of goods and services produced across the economy. From
an initial estimate of +0.1%, the final number came in at -2.9%, (Chart 2) the
greatest decline in economic activity since the recovery began in mid-2009. The
unusually harsh winter paralyzed economic activity in several ways in the first
quarter and was largely blamed for the poor performance of the economy. As
temperatures warm, many economists are expecting a strong weather rebound
in 2nd Quarter activity (first estimate due on July 30th). We do not disagree
with this assessment but question the vigor of the U.S. economy as economic
data in recent months have been a mixed bag, with manufacturing, housing and
employment improving, but durable goods orders and retail sales disappointing.
The economic and financial conditions for a continued expansion are still in place,
but the average growth rate for the first half of 2014 will be far below the 2%+
growth trend we have been accustomed to since the 2008-2009 financial crisis.
Chart 2 : U.S. Economy Slows to A Crawl In The 1st Quarter
Quarter-to-Quarter Growth in Real GDP
6
4
Percent
U.S. Q1 GDP: The Worst Quarter Since The Great Recession
2
0
-2
-4
II
III
IV
I
2010
II
III
IV
I
II
2011
III
IV
I
2012
II
III
IV
2013
Source : U.S. Bureau of Economic Analysis
Have Emerging Markets Turned The Corner?
Both emerging market equities and debt had a difficult year in 2013, down
-2.6% and -6.6% respectively, while developed nations’ stock and bond markets
performed substantially better. The bear case for emerging markets suggests
that declining revenue and earnings growth will continue due to excess credit
growth and malinvestment leading to excess capacity and declining productivity.
Concerns over slowing growth in China and the implications for commodity
producers (many large emerging nations are net producers of commodities)
have also weighed on sentiment. Finally, increased political and social instability
(Ex: Turkey, Ukraine, Thailand, etc) has highlighted the continuous need for
reforms to improve governance, supervision and equality. The bear case certainly
has merits, but there is always a price for everything, and in emerging markets, a
lot of bad news has already been priced in. (Chart 3) Although emerging market
equities and bonds still remain a small portion of our clients’ portfolios, we are
increasingly allocating to these asset classes as market-friendly reforms have
started to emerge in key countries like India and China. We believe that these
reforms are the right things to do long-term and will eventually benefit investors.
Alignin
ng your goaals with vision
n for the future
Chart 3 : Forward Price to Earnings
P/E raƟos for next 12-month consensus EPS
MSCI EM
S&P 500
MSCI EUROPE
18x
AVERAGE
11.0x
13.8x
11.7x
CURRENT
10.9x
15.6x
14.3x
16x
14x
12x
10x
8x
6x
‘04
‘05
‘06
‘07
‘08
Source : MSCI
MSCI, FFactSet,
actSet JP Morgan Asset Management
‘09
‘10
‘11
‘12
I
2014
‘13
An Equity Market Update from Trust Point
With U.S. stocks at record high levels, it is important to
remain diversified. Attractive investment opportunities
still exist but selectivity is becoming increasingly
important. The recent relative underperformance of nonU.S. stocks provides an opportunity for a catch up rally.
Major U.S. Equity Index Level
Quarter-End
3 Mths Ago
1 Year Ago
S&P 500
Dow Jones Industrial Average
Nasdaq
1,960
16,827
4,408
1,872
16,458
4,199
1,606
14,910
3,404
3 Month
YTD
1 Year
U.S. Large Cap Growth
U.S. Large Cap Value
U.S. Mid Cap Growth
U.S. Mid Cap Value
U.S. Small Cap Growth
U.S. Small Cap Value
5.1%
5.1%
4.4%
5.6%
1.7%
2.4%
6.3%
8.3%
6.5%
11.1%
2.2%
4.2%
26.9%
23.8%
26.0%
27.8%
24.7%
22.5%
16.3%
16.9%
14.5%
17.6%
14.5%
14.6%
19.2%
19.2%
21.2%
23.0%
20.5%
19.9%
Interna onal Large Cap Developed
(U.S. Dollar)
Interna onal Small/Mid Cap Developed
(U.S. Dollar)
Emerging Market (U.S. Dollar)
4.1%
4.8%
23.6%
8.1%
11.8%
2.1%
5.5%
29.1%
9.8%
15.2%
6.6%
6.1%
14.3%
-0.4%
9.2%
Equity Returns (%)
3 Years Ago 5 Years Ago
1,321
12,414
2,774
919
8,447
1,835
3 Year (Ann) 5 Year (Ann)
Source : Bloomberg, Morningstar
When Will The Stock Rally End?
It has now been over five years since the U.S. came out of the last recession, and it
has been almost two years since the last market selloff of over 10%. (Chart 4) Two of
the most common questions clients are asking today are “Do you see a stock selloff
coming?” and “What is keeping stock prices elevated?” The main reason equities
remain elevated is the lack of a good alternative. Interest rates are surprisingly lower
than they were at the start of the year, leaving bonds still relatively unattractive.
Inflation has been depressed for many years, limiting the attractiveness of gold,
commodities and real estate. As for stocks, they are currently offering income of
2% or more (dividend) plus potential for long-term capital appreciation as earnings
have maintained an upward path. Halfway through the year, global equity markets
are up about 6%, still positive in spite of 2013’s stellar performance. Typically, major
corrections only happen leading up to or during economic recessions, and the
probability for that is currently low. Short-term corrections of 3% to 7%, however,
can occur at any time, for any reason and without warning. We would anticipate one
of those short-term corrections in the second half, just like we have experienced a
few of them over the last two years. This would be normal and healthy for the market.
Chart 4 : Major Stock Market Selloffs Typically Only Happen During Economic Recessions
S&P 500 Index - Last Price
50% Max Selloff
2000
1960.23
50% Max Selloff
1800
1600
1400
1200
1000
18% Max Selloff
8% Max Selloff
18% Max
Selloff
8% Max
Selloff
800
600
400
'94 '95 '96
'97 '98
Source : Bloomberg
'99 '00
'01
'02 '03
'04
'05
'06 '07
'08 '09 '10
‘11 ‘12 ‘13 ‘14
Thinking Globally
In 2012, over 45% of S&P 500 revenues came from outside of the U.S. (Chart 5)
In today’s globalized economy, investors must understand what is happening
around the world, not just in their home country. The health of the European or
Chinese economies has real effects on U.S. corporations. However, just because
U.S. companies generate sales in other countries does not mean that one should
only invest in the S&P 500. Having direct investments in foreign companies
can provide diversification benefits and potential opportunities. Since January
1, 2013, the MSCI U.S. index is up 42% while the MSCI All Country World Ex.
U.S Index is up 23%. The underperformance of non-U.S. stocks provides an
opportunity. Better global growth prospects and market-friendly reforms in key
foreign countries are reasonable catalysts for a change in investors’ sentiment. To
take advantage of this, we recently took some profits in U.S. equities and added
exposure to funds that maintain large exposure to non-U.S. stocks, positioning
our portfolios for a catch up rally in international and emerging market stocks.
Chart 5 : S&P 500 Percentage of Foreign Sales by Region
50%
45%
18.65%
17.25%
19.66%
30%
2.65%
25%
4.59%
2.62%
4.37%
2.14%
1.94%
9.69%
11.08%
13.48%
7.49%
7.16%
6.07%
3.55%
3.67%
3.00%
40%
16.61%
18.31%
2.65%
3.49%
2.58%
35%
20%
4.53%
11.91%
13.33%
15%
10%
5%
0%
2012
Africa
2011
Asia
Europe
8.22%
6.36%
3.70%
2010
2.81%
2009
North America (ex-U.S.)
South America
2008
Other Foreign Countries
SSource : S&P C
Capital
pit l IQ
IQ, S&P D
Dow JJones IIndices
di
The Difficulties Of Predicting Stock Markets
Heading into 2014 the consensus was that interest rates would continue
to rise, putting pressure on traditionally high dividend paying sectors like
utilities. Many of the equity managers utilized in our portfolios had little
to no weight in these sectors. In late 2013, these equity managers told us
that the already rich valuations and limited growth prospects made most
utility stocks unattractive. Little did they know that this winter would be
one of the coldest and snowiest ever. The bad weather led to energy and
utility usage skyrocketing and was a catalyst for weak economic growth
and declining interest rates. As a result, utility and energy stocks were the
best performers during the first half of the year. (Chart 6) These types
of market surprises occur from time to time, and the limited exposure
to utility stocks contributed to the underperformance of some of our
managers relative to their benchmark in the first six months of 2014.
Chart 6 : S&P 1500 Year-To-Date Sector Returns
Consumer Discre onary
Consumer Staples
5.7%
Energy
13.0%
5.2%
Financials
Health Care
10.2%
Industrials
4.1%
Informa on Technology
8.5%
Materials
8.6%
4.5%
Telecom Services
18.1%
U li es
0%
Source : Morning
Morningstar
gstar
Alignin
ng your goaals with vision
n for the future
2%
4%
6%
8%
10%
12%
14%
16%
18%
20%
A Fixed Income Market Update from Trust Point
U.S. Yields (%)
Fixed-Income markets continued to defy economist
expectations in the 2nd Quarter. Interest rates have
yet to move higher; in fact, rates have fallen, led by
the decline of the 10-year U.S. Treasury yield from
2.71% on March 31st to 2.53% on June 30th. In
the U.S., the difficult and stormy winter caused weaker
economic numbers to extend into the 2nd Quarter, and
the bond market showed concerns that the economy
may not be growing as fast as most anticipated.
Quarter-End
3 Mths Ago
1 Year Ago
0.0%
0.5%
2.5%
0.0%
0.4%
2.7%
0.0%
0.4%
2.5%
3 Month
YTD
1 Year
U.S. TIPS
U.S. Treasury
U.S. Mortgage
U.S. Municipal
U.S. Corporate
U.S. Floa ng Rate
U.S. Conver ble
U.S. High Yield
3.8%
1.7%
2.4%
1.3%
1.8%
1.4%
4.8%
2.4%
5.8%
2.8%
4.0%
2.4%
3.6%
2.6%
9.3%
5.5%
4.4%
2.2%
4.7%
4.1%
5.6%
5.6%
25.8%
11.7%
3.6%
3.1%
2.8%
3.2%
4.9%
5.4%
13.2%
9.5%
5.6%
4.5%
4.0%
4.1%
7.0%
8.7%
16.4%
14.0%
Global Bond (Unhedged)
Global Bond (Hedged)
2.4%
1.9%
4.9%
4.1%
7.2%
4.7%
2.7%
1.3%
4.7%
3.9%
Emerging Market Debt (U.S. Dollar)
5.4%
9.1%
11.0%
7.6%
10.4%
2010
2012
3 Month T-Bill
2 Yr U.S. Treasury
10 Yr U.S. Treasury
Fixed Income Returns (%)
3 Years Ago 5 Years Ago
0.0%
0.5%
3.2%
0.2%
1.1%
3.5%
3 Year (Ann) 5 Year (Ann)
Source : Bloomberg, Morningstar
ECB Takes Action
The European Central Bank (ECB) joined the club of very accommodative central banks this past quarter as it cut the rate it pays on deposits by banks to below zero. It also became the first central bank to move the deposit rate into negative territory, essentially forcing banking institutions to pay to park funds at the
ECB. With low inflation becoming rooted in Europe, expectations of more easing policy in the future is becoming likely. In anticipation of the rate cut, yields
in Europe and surrounding countries have moved lower this year. The situation
has created a divergence between U.S. Treasuries and many rival sovereign bond
markets. Global bond investors are seeing that U.S. Treasuries are cheap relative to Japan, Germany and other core Eurozone members. In addition, if central banks in Japan and Europe succeed in weakening their currencies, the value
of U.S. dollar bonds held by foreigners will rise. This acts as a hedge against the
decline in their local currency. At a time when the U.S. Fed has reduced bond
purchases, foreign investment has dramatically picked up the slack. (Chart 7)
Chart 7 : Foreign Demand Strong For U.S. Bonds
Foreign purchases of U.S. Treasuries Quarterly totals ($tn)
6
4
2
0
2000
2002
2004
2006
Source : U.S. Tre
Treasury,
easury, Bloomberg, Deutsche Bank
2008
2014
“Hunt For Yield” Still Going Strong
Interest rates moved lower in all fixed income sub-asset classes since the
beginning of the year, and with the exception of Treasuries and TIPS, fixed
income has recovered all of 2013’s losses. This recovery and subsequent move
lower in yields has also made it more difficult to find investments with a decent
yield. This has resulted in an increase in demand for higher yielding instruments
such as high-yield bonds, global corporate bonds and emerging market debt,
investments which assume more risk in exchange for higher yields. Volatility
in these markets has been low, and with solid fundamentals such as low default
rates, ample liquidity, sustained global growth and contained inflation, these
credit markets have rewarded investors. The high yield index has moved below
5%, (Chart 8) a historical low, but investors’ demand remains strong and relative
to Treasuries, and after adjusting for default rates, some value still remains.
Chart 8 : High Yield Yield-To-Worst Below Historical And Pre-Crisis Levels
Bid Price
High on 12/12/08
Average
Low on 6/20/14
4.91
22.97
8.60
4.83
Barclays U.S. Corporate High Yield
Yield To Worst - Last Price 4.91
20
15
10
Below
pre-crisis levels
5
4.91
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
Source : Bloomberg
Global Diversification
We continue to closely monitor our fixed income allocations and optimize portfolios
through a diversified approach. Diversifying domestically is not enough in this low
yielding environment. We have been thinking globally and allocating in developed,
international and emerging countries around the globe. Just a few years ago, the
foreign bond market was dominated by high quality government bonds, also known
as “sovereigns.” The global market has expanded to include many sectors, regions
and currencies and covers all credit qualities. Investors now have better access to
these markets and the potential for new avenues of return and diversification. As
global yields continue to move lower, (Chart 9) however, strategists and economists
have started to rethink their outlooks and assumptions for bond returns in
the years to come. Going forward, high single digit returns from bonds will be
extremely difficult to replicate. On the positive side though, 2014 is set to be a
much better year than initially anticipated. Our fixed income allocations reflect
an environment which is supported by central banks around the globe, and our
portfolios are structured to provide some protection against rising interest rates.
Alignin
ng your goaals with vision
n for the future
Chart 9 : Sovereign Debt Yields
10 Year Rates
U.S
Germany
United kingdom
Japan
China on 6/27/14
2.5648
1.2210
2.6523
0.5520
4.0503
7.0000
6.0000
5.0000
4.0503
4.0000
3.0000
2.6523
2.5648
2.0000
1.2210
1.0000
0.5520
0.0000
2007
2008
Source : Bloombe
Bloomberg
erg
2009
2010
2011
2012
2013
2014
Pictured: Left to right;
Randy Van Rooyen, Yan Arsenault, Brandon Hellenbrand, Steve Brudos, Joseph Zeck.
230 Front Street North I PO Box 489
La Crosse, WI 54602-0489
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The opinions expressed here reflect our judgment at this date and are subject to change. Trust Point uses its best efforts to compile its data from reliable sources,
however, it does not warrant the accuracy, completeness or timeliness of any of the information provided. This publication is prepared for general information
only. This material does not constitute investment advice and is not intended as an endorsement of any specific investment. Investors should seek advice regarding
the appropriateness of investing in any securities or investment strategies discussed or recommended in this report and should understand that statements regarding future prospects may not be realized. Investment involves risk, Market conditions and trends will fluctuate. Past performance is no guarantee of future returns.
FX 608.784.3880 I www.trustpointinc.com
PH 608.782.1148 I 800.658.9474
230 Front Street North I PO Box 489 I La Crosse, WI 54602-0489
This commentary is offered by the Investment management team. The individuals contributing to Market Point are Randy Van
Rooyen, CFA®, Yan Arsenault, CFA®, CAIASM, Brandon Hellenbrand, Steve Brudos, and Joseph Zeck, CFA®. Please feel free to contact
any team member with questions.
Market Point is a quarterly market commentary designed to provide you with an overview of economic conditions, as well as equity
and fixed income market summaries for the quarter. Market Point
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