The big news event of the second quarter revolved around the sudden rise in US interest rates based upon the possible conclusion of the FOMC’s latest stimulus program. Consequently, the US stock market posted its first monthly decline since October 2012 as the second quarter came to a close. The DJIA declined by 659 points alone in a 4 day trading period between June 19th and June 24th. In addition, gold, precious metals, REIT’S, developed international and emerging markets all traded lower based upon that assumption as well as the prospect of a China slowdown, including its own looming credit crisis. Consequently, during the latter half of the second quarter volatility returned to the capital markets in full force.
The Equity Markets
US equities though negative in the final month of June did peg positive returns in the second quarter, with the US Broad market advancing 2.76%. Developed international equities declined (-2.13%) while faster growing emerging market equities declined an additional (-8.94%) and are now in negative territory for 2013 (-10.89%).
The Bond and Credit Markets
The chairman of the Federal Reserve first spooked the bond market during off the cuff remarks on May 22 regarding the possibility for tapering of its current bond buying program. Then Mr. Bernanke’s press conference remarks following the two day FOMC meeting on June 19th added to the confusion and roiled all capital markets. In essence, The Fed Chairman called for a possible tapering off of the monthly $85 Billion monthly purchase of US Treasuries as early as the 4th quarter of this year and possibly ending the purchases all together by mid 2014, should the US unemployment drop below 7% and should inflation heat up. As of now, neither of these conditions are evident.
As noted in our last quarterly commentary, sentiment finally changed and institutional fixed income selling accelerated sharply in the latter part of the 2nd quarter, even though the Fed did not actually curtail its bond buying program or even hint at raising rates. Investors noted no difference between tapering and tightening. The magnitude of the movement in interest rates was more reflective of the latter which is not even on the horizon at this point in time.
The most shocking part of the recent price bond decline is that the 10 year US Treasury had just recently hit the 2013 low on May 1st posting a yield of just 1.61%.The sharp increase of more than 100 bpts within 60 days took even the most seasoned fixed income professionals by surprise.
All the areas of the bond market sold off, however some more than others. Tips declined by (-7.14%) and municipal bond market index declined by (-2.95%). Emerging market debt and high yield bonds also declined sharply during the quarter. Bonds eventually did stage a minor quarter ending rally as bargain hunters swooped in. The 10 year treasury traded as high as 2.667%, a twenty two month high before retreating to 2.485% on June 28th.
The Barclays Aggregate Bond index now yields 2.36%. The 30 year treasury bond yields 3.22%. Municipal bonds, which historically trade at 85% of treasury yield, are now yielding above the US Treasury. With the pending investment tax on the horizon, the municipal bond space warrants another look, as there appears to be an attractive entry point created by the selloff. On many levels it appears as though the markets may have overshot, especially commodities.
Gold and precious metals performed very poorly on continued fears of a China slow down, and on renewed strength of the US Dollar as the end of the treasury buying program weighed on investors’ minds. One important takeaway is that the prospect for higher interest rates are bad for higher gold prices. Gold dropped an astounding 6% on June 20th alone and was negative an astounding 23% during the second quarter. Gold ended the quarter at $1,230 after beginning the year at $1,674. It is now 35% off its high of $1,900 per ounce achieved in September 2011.
Oil ended the quarter at $95.50 per barrel, and is approximately 12.4% higher than a year ago.
The capital markets finally appear to be at an inflection point where they will once again begin to function on their own merits including existing economic and current macro conditions rather than on government engineered economic policies. However, it may take some time for the markets to regain their balance as the stimulus is finally withdrawn. Regardless, the recent movement in interest rates has created many compelling entry points across a broad array of asset classes. Investors should take note.
Very Truly Yours,
CRA Financial LLC