3rd Quarter Commentary: A Choppy Quarter in the Markets


You could say that the markets took a breather in the third quarter of 2014, but you would come to that conclusion only if you looked at the overall returns and ignored the drama of the past 30 days. The markets experienced a difficult month in September, giving up some of the gains from the prior eight months and causing many investors to worry that there might be more of the same ahead. The end of the month was especially difficult, with a general market slide starting September 22nd that saw some indices drop more than 1% on the final day of the month.

The Wilshire 5000 – the broadest measure of U.S. stocks – did rise a meager 0.4% for the quarter, although it dropped almost 2% during September. Despite that, the index is still hanging on to a 7% gain for the year. Large cap stocks were the market leaders over the past three months, but again, gains were modest. The S&P 500 posted a 0.60% gain for the quarter, with the index now up just shy of 7% since January 1st and just 2% off its September 18th all-time high.

The news was worse for smaller company stocks. The Russell 2000 Small-Cap Index fell more than 7% in the third quarter, representing its worst quarter in three years – and is now down over 4% so far this year. Meanwhile, the technology-laden Nasdaq Composite was one of the few bright spots, managing to gain 2.5% for the quarter. It is now up almost 8% for 2014.

The rest of the world was a drag on diversified investment portfolios. The broad-based EAFE index of companies in developed economies fell more than 6% in dollar terms during the third quarter of the year, and is now down almost 4% in 2014. This was the pattern for most of the Eurozone and Asian economies. Ironically, the emerging markets stocks of less developed countries, as represented by the EAFE Emerging Market index, held up a bit better, losing “only” 4% during the quarter.

Looking over other investment categories, real estate investments, as measured by the Wilshire REIT index, fell 2.5% for the quarter, but the index is still standing at a robust 15% gain for the first three quarters of the year. The broad Commodities category, as measured by the S&P GSCI index, and which includes gold, fell 12.5% this past quarter, and now sits at a 7.5% loss for the year.

The expected rise in bond rates never materialized, confounding the experts yet again. 30-year Treasuries are now yielding 3.20% and 10-year Treasuries currently yield 2.50%. At the short end of the spectrum, 3-month and 6-monh T-bills are both still yielding less than 0.04%.

Nobody seems to have a convincing explanation for the recent stock market slump. The economy seems to be continuing along a long, slow, and steady growth arc, with corporate earnings continue well-above historical averages. Oil prices are at their lowest level since November 2012, consumer spending has rebounded, and although the Fed will cease its bond purchases this month, there is no indication that it is going to sell its inventory back on the market. The Fed’s policymakers still project low interest rates well into 2015. Corporate cash levels remain near an all-time high.

So, what then is causing these gyrations? Market pullbacks don’t always reflect reality. They are also affected by the sentiment of investors – in other words, human emotions and a herd mentality. Many investors seem to be worried that stocks are long overdue for a correction, and if these things operated on a schedule, they would certainly be right. We are in the fourth-longest bull market since 1928, not having experienced even a small 10% correction since the US government debt-ceiling crisis of 2011. The Conference Board reported that U.S. consumer confidence slipped dramatically and unexpectedly in September, lending some credibility to the surmise that the investing herd has been startled – and that collective anxiety may be creating the market reality we saw during the last month. Adding to these levels of anxiety, I’m sure, are growing concerns over the spread of Ebola, with this past week seeing the first case actually diagnosed here in the U.S.

Does any of this mean we should take action? As I’m sure you can recall me having said countless times before, in person or in writing, history tells us it is most often a poor decision to try to anticipate market corrections and that investors have historically been rewarded for sailing through choppy waters, rather than jumping off the ship as the waves roll higher and higher. I personally have yet to see jumping off the ship in the middle of a storm work out well for anyone (with the results being about you would expect from literally jumping off a ship in the middle of storm!)

It is, of course, unknowable whether the next 10%, 20% or 30% move in the markets will be up or down. But unless you believe the world is about to end, I’m sure you can anticipate, with some degree of certainty, in which direction it will make its next 100% move. That’s the best prediction of the markets you’re likely to get, even if it doesn’t come with a timetable.

I hope you are well and enjoying the start of Fall. As always, please let us know if there is anything we can do for you or if there is anything you would like to discuss.