For the equity markets, 2014 began modestly with a +1.81% S&P 500 return for the first quarter. We believe this is a healthy pause following 2013’s strong showing, giving the market room to consolidate those gains. Earnings continue to grow, lending support to these higher prices while keeping valuations in line and attractive in many areas. With interest rates still very low and falling during the quarter, the yield-oriented sectors of Utilities and Health Care were the top performers while Consumer Discretionary was weakest.
The fixed income market as measured by the Barclay’s Intermediate Government/Credit Index was up by an even +1.00% during the first quarter. The 10 year US Treasury bond began the year yielding around 3.02%, fell sharply to around 2.57% (prices up) in early February, and drifted volatilely higher to end the quarter around 2.69%. The Federal Reserve, under new Chair Janet Yellen, continued its taper of quantitative easing for the third time to a current level of $55 billion monthly, down from a high of $85 billion monthly. Increases in interest rates now appear as if they could begin sometime in mid-2015.
Geopolitical events were once again front and center for the markets this quarter. Rising tensions and the potential for military action between Russia and Ukraine moved stock, bond, commodity, and currency markets around the world, reinforcing the global, interconnected nature of both trade and financial markets. Stocks tend to sell off and treasuries tend to rally (yields fall) on each piece of bad news in a classic ‘flight to quality’. Then that trend seems to reverse itself as each mini-crisis either passes or is averted. In a world with plenty of international tension and a 24-hour news cycle, expect that type of volatility to continue.
This quarter we witnessed the beginning of Janet Yellen’s tenure as Chair of the Federal Reserve. We believe that she will continue her predecessor Ben Bernanke’s accommodative, low-rate policies for the foreseeable future unless we see a sharp rise in employment and/or inflation. While these policies have provided a tailwind to the stock and bond markets (at considerable cost to savers) over the past few years, the true fuel for stock market gains is economic growth. As investors and citizens, economic growth is something we are hopeful to see more of in 2014, as it means good things for employment and incomes as well as the financial markets. Our economy took a big hit in the Great Recession of 2008-2009, and it has become evident that we can’t quantitatively ease our way out of it, and we can’t legislate our way out of it, we have to grow our way out of it.
We view every equity investment in a literal sense: a percentage ownership in an operating company. Focusing on the fundamentals, we try to filter out the noise of news and politics to identify companies that can execute in a variety of economic environments. For bond investments, we apply a similar strategy to identify companies with strong and growing capacity to honor their obligations. In all situations we seek reasonable valuations for those investments.