The End of QE3
By mid-month, the US stock market was in the midst of a slide, and many international markets were in similar trouble. Financial reporters were speculating that this was the beginning of the “overdue market correction” that some people have been predicting since last year. The consensus was that the Eurozone was on the verge of yet another recession and that this would be a drag on markets worldwide. Fortunately, the US market pulled out of its decline and recovered to finish the month at another record high.
The US market was buoyed by encouraging economic data, especially the news that the US economy expanded by an annualized 3.5% during the third quarter. This was great news for US investors. Ever since the harsh winter, investors and analysts have been waiting for the actual growth of the US economy to match expectations. Analysts kept saying that the economy was healthier than the data suggested and that, sooner or later, the data would catch up to the reality. This 3.5% figure was just the news that analysts were hoping for and that good news gave investors the confidence that they needed to pump more money into the US stock market.
This confidence happened to coincide with the Federal Reserve’s announcement that its most recent stimulus program, known as “Quantitative Easing” or “QE3,” is ending. Historically, the end of these programs is a delicate time for the US market, but the resurgence of investor confidence seemed to soften the blow. So far, any negative reaction has been lost amidst news that the US dollar is gaining strength and the US stock market is pushing to new highs. Hopefully, the results of the US elections do not halt this momentum.
In contrast, the Bank of Japan (“BOJ”) surprised investors, both at home and abroad, by announcing a more aggressive round of stimulus. Japanese currency fell, but stocks saw noticeable increases in prices. This is a good reminder that the power of surprise is a useful tool for central banks. Globally, central banks continue to clear guidance as to their upcoming decisions and hope that transparency offers stability. The downside to those efforts is that they do not allow for large changes in policy. The Bank of Japan was able to offer a jolt to its economy by defying expectations. While the success of this move is uncertain, it provoked a
reaction from one of the world’s most sluggish economies.
Meanwhile, the Eurozone continues to struggle. Many of the member countries are teetering on the edge of deflation. This threat was looming at the beginning of this year and it continues to do so. However, there was one spot of good news for the Eurozone as it prepares for winter. Surprisingly, the good news comes from Ukraine. After halting natural gas delivery in June, Ukraine and Russia just struck a deal to resume the flow of natural gas until March. This is a relief the European markets dependent on Russian natural gas supplies that arrives via the Ukrainian pipeline.
Speaking of energy issues, oil prices continued to decline in October due to a strong US Dollar and decreasing demand. The upside to this is that consumers are able to purchase gas at cheaper prices and that eases a burden on household budgets. The downside is that it puts downward pressure on prices, which can be bad for the economy.
October proved to be an interesting month for investors and defied expectations. Just last month, analysts and investors were preparing for a rocky end to QE3 and suggesting that the US stock market was on the verge of a correction. Instead, the markets delivered reminders that market timing is difficult and even the professional consensus can misjudge the direction of the market. For the month, most of the portfolios outperformed the global equity markets, even the lower risk portfolios with larger allocations to bonds.
- US stocks hit another record high. Our current large allocation to Small Caps (VB) and Mid Caps (VO) proved beneficial as these market segments significantly outperformed Large Caps (IVV).
- Overall, US bonds remained relatively flat for the month.
Our sizeable allocation to High Yield Bonds (JNK) across the portfolios added value as lower quality bonds outperformed.
- Outside the US, the picture was not so optimistic. Foreign stocks got some assistance from the Bank of Japan at the end of the month, but that was too late to help them stumble out of the hole created by the struggling Eurozone.
Although many investors have feared the Emerging Markets (VWO), we maintained this exposure and it performed positively relative to the developed countries moving in the red for the month.
- Meanwhile, foreign bonds found no consolation in Japan’s efforts. In Europe, where banks continue to struggle and nations are running spending deficits, bonds were not attractive to investors. Although foreign bonds were relatively flat, our exposure to Emerging Market Bonds (PCY) contributed positively.
- Hard assets continue to pull back. Master limited partnerships (AMJ), Precious Metals (GLTR), and Commodities (DBC) pulled back in October. Some of this can be attributed to improving confidence in the US market, yet this exposure is advantageous during times of market turmoil and inflation.
- Preferred Stocks (PFF) and Convertible Bonds (CWB) provided respectable performance for the month.
Our portfolios continue to benefit from these hybrid securities.
Since the beginning of the year, the higher risk portfolios are keeping pace with global stocks and the lower risk portfolios are significantly outpacing the global bond market. Over the last several years, US Stocks continue to pull ahead relative to global stocks and other investment types. Although this may tempt you to shift more assets domestically, these market trends are not uncommon for relatively short time periods and the benefits of broad global diversification are significant over longer time periods.
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THE PERFORMANCE INFORMATION PRESENTED IN THE ASSET CATEGORY SECTION OF THIS REPORT IS BASED ON EQUAL-WEIGHTED AVERAGES OF THE FOLLOWING: US STOCKS (ISHARES S&P 500 ETF, S&P DIVIDEND ETF, VANGUARD MID CAP ETF, WISDOMTREE MIDCAP DIVIDEND ETF, VANGUARD SMALL CAP ETF, WISDOMTREE SMALLCAP DIVIDEND ETF), FOREIGN STOCKS (VANGUARD MSCI EAFE ETF, ISHARES INTERNATIONAL SELECT DIVIDEND ETF, VANGUARD EMERGING MARKET ETF, WISDOMTREE EMERGING MARKETS EQUITY INCOME ETF, ISHARES MSCI EAFE SMALLCAP ETF, VANGUARD FTSE ALL WORLD EX-US SMALL ETF), US BONDS (ISHARES BARCLAYS 1-3 YEAR TREASURY ETF, ISHARES 3-7 YEAR TREASURY BOND ETF, ISHARES 10-20 YEAR TREASURY BOND ETF, ISHARES BARCLAYS MORTGAGE BACKED ETF, ISHARES IBOXX INVESTMENT GRADE CORPORATE ETF, VANGUARD SHORT-TERM CORPORATE BOND ETF, ISHARES BARCLAYS TIPS ETF, PIMCO 1-5 YEAR US TIPS INDEX ETF, SPDRS HIGH YIELD ETF, SPDR BARCLAYS SHORT-TERM HIGH-YIELD BOND ETF, POWERSHARES SENIOR LOAN ETF), FOREIGN BONDS (SPDRS BARCLAYS INTERNATIONAL TREASURY ETF, SPDR BARCLAYS SHORT-TERM INTERNATIONAL TREASURY BOND ETF, POWERSHARES EMERGING MARKET DEBT ETF, SPDRS DB INTL GOVERNMENT INFLATION ETF, POWERSHARES INTERNATIONAL CORPORATE BOND ETF), HARD ASSETS (POWERSHARES DB COMMODITY ETF, SPDRS GOLD ETF, ISHARES SILVER TRUST ETF, JP MORGAN ALERIAN MLP ETN, SPDRS DJ GLOBAL REAL ESTATE ETF), AND HYBRIDS (ISHARES S&P US PREFERRED STOCK ETF, SPDRS BARCLAYS CONVERTIBLE SECURITIES ETF).