September was a rough month for investors. After stocks pushed to new highs in the early days of the month, disappointing economic numbers, mixed signals from central banks, and political uncertainties gave investors several excuses to reduce the risk in their portfolios or increase their cash positions. As we enter the fourth quarter, many investors are reevaluating their portfolios and starting to plot changes for the coming year.
US jobs data was disappointing. This really concerned US investors. Ever since January, investors have been hoping that the economic indicators were just lagging behind, but the US economy was growing. The summer’s data was lackluster and the preliminary September data was discouraging. While the jobs data released last week revised those figures upward for September and the preliminary October data was better than analysts hoped, investors remain cautious.
Adding to this cautious attitude, the end of Federal Reserve’s quantitative easing (QE) program is predicted for October. This program stabilized the bond market and encouraged lenders to make money available to borrowers. This allowed companies and individuals to borrow at lower interest rates and encouraged investment. The Fed has used similar programs in the past and the conclusion of these programs is always a delicate time for the markets.
Meanwhile, the EU continues to struggle with price stability and deflation is now a significant concern for EUmember nations. Mario Draghi, president of the European Central Bank (ECB), followed through on his plans to take interest rates even further into negative territory and proposed a variety of possible QE measures similar to those used by the Federal Reserve. Those QE measures are expected to be announced in early October. Investors with European interests are waiting impatiently for the direction of the EU economy to come into focus, and much of that picture is dependent on the actions of the ECB in coming months.
The Scottish independence vote was also a source of uncertainty in September. Since Scotland controls large portions of the oil in the North Sea and the more liberal Scottish voters would surely subject the petroleum industry to additional taxes and regulation, investors were paying careful attention to this vote. Additionally, Scottish leaders proposed staying on the British Pound, but there was no formal agreement. Some economists speculated that Scotland might join the EU and adopt the Euro. Even without a formal currency agreement in place, no one seriously thought that they would create their own currency, which means that the Scottish government would need to negotiate the use of either the Euro or the Pound. In either case, the more liberal Scots were sure to adopt a much different attitude toward corporate interests than their British counterparts.The failure of the Scottish independence referendum was a relief to investors, once the vote was certified later in the month.
ISIS/ISIL continues to wreak havoc in the Middle East. Over the summer, investors were merely concerned about oil supplies from the region. Now, it appears that the West is planning to get involved in the conflict and investors are wondering how large those operations will be. With most western nations still running deficits and western citizens wary of new military conflicts, it is unlikely that large or long-term military operations would be beneficial to western economies.
The events of September were a valuable reminder that diversification is crucial. Nearly every asset class suffered as many investors scaled back the risk in their portfolios. A variety of our portfolio holdings managed to stay relatively flat, but there were no significant gains. This was welcome relative to the dismal performance across the major equity markets. The investment selection of our portfolios helped to weather some of this recent volatility.
Some investors lost by chasing the record highs of the US stock market. Some investors also lost by betting against the market and holding large amounts of precious metals. However, our carefullyconsidered, diversified portfolios were weathered the uncertain events of September. We benefited from our allocation to several investment categories. Our Investment Team continues to closely monitor the market and economic developments, and these situations will continue to factor in to our future investment allocations. The following summarizes the major movements within our portfolios:
- This pattern of risk reduction carried through all asset categories. Both US and foreign equities pushed negative, but the largest declines were in those asset classes that carry the most risk. In equities, those were small caps (VB) and emerging markets (VWO), which significantly underperformed large cap stocks (IVV & VEA).
- US treasuries (SHY) and US mortgage-backed securities (MBB) both saw nominal gains for the month and functioned as safe havens for investors that were looking to reduce their risk without going to cash. This greatly benefited our lower risk portfolios.
- Foreign bonds saw more significant declines than US bonds. Also, high-yield (JNK) and emerging markets bonds (PCY) ventured further into the red. Regardless, these bond types are critically important as they are typically less sensitive to interest rate changes relative to many other bonds.
- When markets respond out of fear, we would expect precious metals to do well. This was not the case as metals (GLTR) and commodities (DBC) continue to underperform most other investments. In looking at these September figures, it is important to review the year-to-date numbers. Every asset category still shows a positive return for the year. Digging a little deeper, 18 of the 23 asset classes in the models are still in the black for the year, and every model in the Core Allocation Series is still well into positive territory.
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