The equity markets continued their positive advance in the 3rd quarter with the S&P 500 closing out the three month period up +5.24% leaving the year-to-date gains at +19.79%. A great year by any standard, but the enthusiasm has been tempered recently thanks to the standoff on Capitol Hill.
Cyclical names performed the best in the 3rd quarter as Materials, Industrials and Consumer Discretionary names gained the most, +9.68%, +8.31% & 7.38% respectively. Interest rate sensitive sectors were the worst performing with Telecoms falling -.81% and Utilities down -5.45%.
The long term outlook for equities remains constructive given reasonable valuations (for the most part), low interest rates, low inflation and the housing market coming back to life. Valuations, although certainly higher than this time last year (the market has risen almost +20% the last 12 months), do not strike us as excessive given the strength of corporate balance sheets, solid cash generation, low interest rates and the lack of attractiveness of other investment options.
The short-term outlook is much less clear as the government shutdown, debt ceiling and Obamacare implementation create uncertainty. We continue to assess investment opportunities based on a longer term view and expect volatility in the short run as these issues come to pass.
The fixed income markets continue to be challenging, particularly within the context of continually contradictory statements from Chairman Bernanke and the Federal Reserve. Surprisingly, in late June the Fed was out with an unexpected announcement that their years-long quantitative easing program might end sooner than the market thought. That is, they would begin reducing their monthly $85 billion bond purchase program sometime in late 2013. The market reacted violently, going straight down (yields higher).
Chairman Bernanke has always been fixated on the data as a prelude to the end of easing – inflation north of 2% and unemployment south of 6.5%. The data is not that, has not been that, and shows no signs of becoming that any time soon. In September, the market perceived that the Fed had reversed course, suggesting no end to easing until the data shows its hand. The market went straight up (yields lower), again violently.
Rates on the ten year Treasury ended the quarter nearly where they began: 2.61% at the end versus 2.49% at the beginning. Twelve basis points are not a lot, but the round trip from a low of 2.47% to 3.00% and nearly back again was not pleasant. For the quarter the Barclays Intermediate Government/Credit Index gained .62%, bringing year-to-date performance to negative -.84%.
Longer term the interest rate trend will be up and as the economy continues to improve rates will rise. However, we continue to believe rates will remain artificially low for some time given the lack of more robust economic improvement.
We remain vigilant seeking good long-term investments in which to commit your capital – and ours. As you know, these are important decisions to us and we do not take them lightly. It’s really a two-sided process – try to pick above average investments and try to avoid obvious mistakes. We are continually grateful for your trust and confidence in us.