2013 Second Quarterly Letter

The beginning of summer is always marked by great change for my family – the mad bustle at the end of a school year, sports programs coming to an end and sad rainy days followed by excitement over a new summer at camp, a quieter pace of life and finally…SUNSHINE!  The markets experienced great change this quarter, as well.

Investors tend to pay the most attention to the markets in the country in which they live and, therefore, gauge the performance of their entire portfolio by the performance of domestic markets. This is especially true in the US, where we have the largest and most liquid stock and bond markets in the world. US equity markets experienced double digit gains this quarter. However, global markets presented a different picture as commodities and emerging stock and bond markets suffered losses and even investment grade US bonds and global bond markets had modest losses. In fact, June brought volatile equity market swings and the biggest single-month exodus from bond funds.

Since 2008, central banks have been printing trillions of dollars in order to stimulate economic growth in its quantitative easing (QE) program. However, this monetary repression has reached a point where the negatives may now be outweighing the positives, which is why Fed members are considering a reduction of its bond purchase program. After increasing speculation, Ben Bernanke provided markets with more clarity at the end of May on how the Fed expects to phase out its current QE program. Mr. Bernanke noted in particular:

“If the incoming data are broadly consistent with this forecast, the Committee

currently anticipates that it would be appropriate to moderate the monthly pace of

purchases later this year; and if subsequent data remain broadly aligned with our

current expectations for the economy, we would continue to reduce the pace of

purchases in measured steps through the first half of next year, ending purchases

around midyear. In this scenario, when asset purchases ultimately come to an end,

the unemployment rate would likely be in the vicinity of 7%, with solid economic

growth supporting further job gains – a substantial improvement from the 8.1%

unemployment rate that prevailed when the Committee announced this program.”

This timetable seems to be validated by dangers of the Fed’s rapidly expanding balance sheet and US economic progress…and really, should not have been a surprise. However, Mr. Bernanke’s comments were met with a sharp selloff in global fixed income, equity and commodity markets.

A broad bond market selloff caused a loss for bond investors. A rise in interest rates across fixed income sectors applied downward pressure on the bond market and no sector was safe as government, corporate, Treasury Inflation Protected Securities (TIPS), mortgage backed securities and global bonds were all affected.

In this market environment, it is important for investors to distinguish between logical market reactions and over-reactions. A selloff in fixed income markets seems justified because the yield on the 10-year Treasuries rose significantly. A selloff in the stock market seems extreme, though, because Ben Bernanke reduced uncertainty – he did not increase it – by laying out a plan to end QE. It is also important to remember why investors own bonds – the potential for capital preservation, steadiness of returns, income and growth and a typically low correlation to equities. Despite what markets are doing today, these financial needs are long term and bonds should always have a place in a balanced portfolio. Patience is necessary. A plan of action is to be diversified by maintaining an allocation to global bonds.

The Fed has been patting their backs and trying to convince us for so long of the benefits of the QE program that it seems it may have convinced the market that the economy can’t survive without it. This is not the case, as the economy is capable of coping with higher interest rates. The economy is in its fifth year of recovery, stock prices have risen dramatically and unemployment is down 2.4% from its peak. Home prices are increasing and not because of lower interest rates but because of a chronic shortage of supply. Consumer confidence has surged to 81.4%, which is the highest reading since January 2008. Recent economic data points to a stabilizing economy and our deficit is shrinking. And this is all good news for investors.

Please find enclosed your 2nd Quarterly Portfolio Report for 2013.  If you have any questions or concerns, please call me at 518-867-4245 or email me at olivia@mussettwealth.com.

Warm regards,

Olivia A. Mussett, CFP®