Market Commentary, March 2015
Up and Down
A recent Google search on “stock market correction in 2015” yielded 20,900,000 results in just 1⁄3 of a second! Though widely anticipated, such a setback did not occur in the first quarter. Nevertheless, it was a period of heightened volatility. The S&P 500 Index was almost unchanged for the period, but there were eight swings of 3.5% or more. Moreover, during February and March there was a span of 28 business days during which the index did not have consecutive up days. Apparently, a streak of such duration has only occurred two other times since WWII – in May 1970 and April 1994.
Higher volatility is a byproduct of elevated uncertainty. Consider the wide variety of factors that conjure both optimistic and pessimistic interpretation. Plunging energy prices are deemed positive for the consumer but negative for business capital spending. A stronger U.S. dollar hampers the profitability of multinational corporations but reduces inflation and helps maintain lower long-term interest rates. Labor market progress is continuing with unemployment down to 5.5%, but this magnifies unease about monetary policy. In addition to these fundamental factors, we have a daunting lineup of geopolitical risks. Perhaps the surprise is that markets haven’t been even more volatile.
Fed Watch
During 2014, the Fed gradually ended its unconventional “Quantitative Easing” program. This strategy had been implemented to suppress long-term interest rates following the financial crisis. Though the shift to less accommodative policy provoked considerable worry about interest rates, we welcomed it as a validation of economic improvement. As it turned out, the Fed maneuvered carefully and deliberately, economic progress continued, interest rates stabilized, and equity markets delivered solid performance.
Now in 2015, there is renewed apprehension about monetary policy. Amid continuing growth and falling unemployment, the Fed is expected to raise its short-term policy rate, which has been held at 0 – 0.25% since the end of 2007. A month ago, the expectation was for an increase in June, but following a softer monthly employment report on April 3, consensus opinion is now anticipating a move not sooner than September.
As with the end of Quantitative Easing last year, we are not alarmed by the prospect of higher short-term interest rates. This seems like a prudent adjustment, warranted by ongoing progress. After all, an economy growing moderately with unemployment at 5.5% does not require zero short-term interest rates. So, we look for gradual policy changes in 1⁄4 point increments. This is not the financial equivalent of Pearl Harbor, regardless of how it is characterized by the media.
Navigating Short-Term Volatility
Bartlett is accustomed to turbulence and mindful of the media sensationalism that is always aroused by market volatility. As noted in prior commentaries, making major strategic changes based on anticipated market corrections is foolish. It requires almost perfect timing to sell and repurchase with a profitable outcome, and this is further complicated by the drag from taxes and transaction costs. We think the wiser course is a humble recognition of the inevitability of occasional setbacks and a determination to manage prudently, with appropriate balance and diversification. With safeguards in place, occasional market declines can be navigated with equanimity. Setbacks can be times of opportunity for the well-prepared and alert, who can purchase quality stocks when prices are lower or add bonds when yields are higher.
Managing Long-Term Risk
History shows that overconfidence usually results in sorrow, so we are always on the lookout for significant valuation excesses. After all, the NASDAQ index is still below levels reached fifteen years ago during “New Economy” euphoria, and many real estate markets only recently returned to valuations reached a decade ago during the housing bubble.
Bartlett first addressed the risk of a major stock market decline in an April 2013 commentary, and revisited the topic in a January 2014 report. Most of the insights from those periods remain relevant today. The fundamental outlook is decent based on factors including economic growth, corporate profits and dividends, equity valuation levels, interest rates and inflation. Furthermore, we have not witnessed the excessively high investor enthusiasm usually evident before significant market declines. There is nothing comparable to the misplaced certainty over rising home prices in 2006 or internet stocks in 1999. Market conditions are always evolving and we will update our assessments based on incoming data, guided by realism rather than optimism or pessimism.
We are keenly aware of the impact of strong equity performance. Consider that a balanced portfolio of 65% stocks and 35% bonds at the beginning of 2010 would now be close to 80% stocks and 20% bonds. The discipline of rebalancing toward policy targets is important for balanced portfolios, a vital safeguard against the complacency that sometimes results from expanding prosperity. Carefully selected bonds and alternative investments have enduring value in controlling risk, helping assure that unforeseen turbulence won’t disrupt financial plans. Thoughtful asset allocation, appropriate diversification, and judicious rebalancing are continuing imperatives as we seek to achieve solid long-term investment performance.
Concluding Comments
We hope you will mention Bartlett to family, friends, and associates who may benefit from our expertise and client-focused approach to investment management and financial planning.
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The material presented here was prepared from sources believed to be reliable but it is not guaranteed as to accuracy and it is not a complete summary or statement of all available data. It represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results.
