Presented by Sean Gross, CFP®, AIF®
Strong May marred by volatility at the end
May was another strong month for equity markets, with a total gain of 2.34 percent for the S&P 500 Index, 2.24 percent for the Dow Jones Industrial Average, and 3.82 percent for the NASDAQ. The S&P 500 and the Dow notched all-time highs, though the positive ultimate results masked a great deal of intra-month volatility. The first weeks of the month showed almost uninterrupted increases, while the last week was volatile, with multiple daily gains and losses of more than 1 percent and a noteworthy sell-off on May 31. Fundamentals were unchanged for the month, valuations crept higher with the market itself, and technicals remained relatively strong.
Volatility was driven largely by comments from Federal Reserve (Fed) Chairman Ben Bernanke, who seemed to suggest in a May 22 appearance before Congress that the Fed might reduce its bond purchases much sooner than had been anticipated.
Chairman Bernanke’s comments also caused volatility in the fixed income markets. The Barclays Capital Aggregate Bond Index lost 1.78 percent for the month, and 10-year U.S. Treasury yields rose from 1.66 percent to 2.16 percent. The floating-rate bank loan sector was the only fixed income sector to post a positive return, and long-duration Treasuries and TIPS were hardest hit.
Figure 1: U.S. 10-Year Treasury Yields, January 2013–May 2013
International stocks significantly underperformed U.S. equities in May. The MSCI EAFE Index was down 2.41 percent, and the MSCI Emerging Markets Index declined 2.94 percent. Japan experienced very wide swings, with large gains in the first half of the month erased and turned into losses in the second half. Brazilian equities struggled greatly, losing 7.11 percent.
The real economy continued to grow
Early in May, employment gains for April came in above expectations. Housing showed strength as well, with both new and existing home sales increasing. In addition, house prices climbed more than 10 percent year-over-year, per the S&P/Case-Shiller 20-City Home Price Index, and the supply of houses for sale remained well below normal. Tight supply and strong demand suggest that the home price trend may continue.
Rising home values and stock prices brought overall household wealth levels close to pre-crisis peaks. These factors, together with declining gasoline prices, pushed consumer confidence up.
Economic growth for the first quarter was revised slightly lower, from 2.5 percent to 2.4 percent. But this downward revision was mostly due to a larger-than-estimated decline in government spending.
Growing economy puts Fed on the spot
With the real economy growing and stock markets performing relatively well, the Fed is in a quandary. At some point, it will have to wind down its stimulus program. The question is: When? Chairman Bernanke’s comments on May 22 surprised financial markets, leading to market turmoil and a drop of more than 2 percent that day and a further decline the next day.
Real economy solid, markets less so
At month-end, the real economy appeared well positioned to continue growth at current levels, but financial markets appeared less stable. Much depends on when and how the Fed reduces its stimulus. Interest rates will be the primary channel. If rates tick up significantly, stock and bond valuations could be at risk.
Rate increases don’t appear likely soon, though they are inevitable at some point. Investors should be aware of this and plan for the volatility that may come when the Fed does move. When that day arrives, the recovery in the real economy should be more firmly in place, which may provide a firm foundation if markets wobble.
For investors, cautious optimism is the appropriate stance. The end-of-month market instability serves as a reminder to be positioned with long-term goals in mind rather than with the objectives of following short-term trends.
Disclosure: Certain sections of this commentary contain forward-looking statements that are based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance is not indicative of future results. Diversification does not assure a profit or protect against loss in declining markets. All indices are unmanaged and investors cannot invest directly into an index. The S&P 500 Index is a broad-based measurement of changes in stock market conditions based on the average performance of 500 widely held common stocks. The Dow Jones Industrial Average is a price-weighted average of 30 actively traded blue-chip stocks. The NASDAQ Composite Index measures the performance of all issues listed in the NASDAQ Stock Market, except for rights, warrants, units, and convertible debentures. The Barclays Capital Aggregate Bond Index is an unmanaged market value-weighted index representing securities that are SEC-registered, taxable, and dollar-denominated. It covers the U.S. investment-grade fixed-rate bond market, with index components for a combination of the Barclays Capital government and corporate securities, mortgage-backed pass-through securities, and asset-backed securities. The MSCI EAFE Index is a float-adjusted market capitalization index designed to measure developed market equity performance, excluding the U.S. and Canada. The MSCI Emerging Markets Index is a market capitalization-weighted index composed of companies representative of the market structure of 26 emerging market countries in Europe, Latin America, and the Pacific Basin. It excludes closed markets and those shares in otherwise free markets that are not purchasable by foreigners.
Sean Gross, CFP®, AIF® is a financial advisor located at Telos Wealth Management, LLC, 385 E. Penny Rd., Suite 103, Wenatchee, WA. He offers securities and advisory services as an Investment Adviser Representative of Commonwealth Financial Network®, Member FINRA/SIPC, a Registered Investment Adviser. Sean can be reached by phone at 509-664-8844 or by email at Info@TelosWealth.com.
Authored by Brad McMillan, vice president, chief investment officer, and Sean Fullerton, investment research associate, at Commonwealth Financial Network.
© 2013 Commonwealth Financial Network®