Regular readers of my Monthly Outlook will recall that in my June 2013 report I highlighted a concern about rising interest rates and the bond market. Well that concern was warranted as interest rates (as measured by the US 10yr Treasury) have continued to climb rapidly to over 2.5% as of this writing. The fact that interest rates are rising is not a surprise. What is a surprise is the speed of the move. Another surprise was the reaction to commentary by Federal Reserve Chairman Ben Bernanke on June 19th. Mr. Bernanke indicated that “Based on its review of recent economic and financial developments, the Committee sees the economy continuing to grow at a moderate pace, notwithstanding the strong headwinds created by current federal fiscal policies” and “In the projections submitted for this meeting, 14 of 19 FOMC participants indicated that they expect the first increase in the target for the federal funds rate to occur in 2015, and one expected the first increase to incur in 2016”. As far as the current level of monetary easing via asset purchases he stated “Although the Committee left the pace of purchases unchanged at today’s meeting, it has stated that it may vary the pace of purchases as economic conditions evolve. Any such change will reflect the incoming data and their implications for the outlook, as well as the cumulative progress made toward the Committee’s objectives since the program began in September.” Bernanke was very clear in saying that whatever direction the Fed takes it will be “data dependent.” If the economy slows it likely means no changes. But all the financial markets “heard” was, “Interest rates are going up,” even though that is not what Bernanke said. Clearly this is a case where perception becomes reality.
I think what has been happening over the last few weeks is a combination of a normal correction for a market that had achieved double digit gains through May and an overreaction to Fed commentary. I expect volatility to continue for the next couple of months but that the panic selling will dissipate and markets will stabilize as economic data remains positive.
There is an old market axiom, “It’s TIME in the market, not TIMING the market.” To demonstrate this: over the 25-year period ending on 12/31/2011 the buy and hold investor saw returns of 6.81% per year (basis S&P 500). This includes those who stayed the course during the dot-com bubble in 2000 and the financial meltdown in 2008. However, if you tried to “time the market” and you missed the 10 best sessions your annualized return falls to 3.67%. Miss the 20 best and you experienced only a 1.65% yearly gain, and missing the 40 best yields a negative 1.62% return. Conversely, if you managed to miss the 10 worst days the prescient investor realized a 10.89% per annum gain, while missing the 40 worst shows annualized returns leaping to a 17.74% – according to a study from Hepburn Capital Management. However, in timing the market it is nearly impossible to only miss the worst days and not the best days. This supports the approach that the management of “risks” is more important than the management of “returns”.
My focus is, and will remain, on managing risks. To that end client portfolios have a substantial allocation to cash and other short-term investments. While this approach has meant forgoing some of the equity market gains earlier this year, it now provides some cushion during this correction and should create opportunities to participate in the return to growth I anticipate later this year.
Although the information included in this report has been obtained from sources we believe to be reliable, its accuracy and completeness are not asserted. All opinions and estimates included in this report constitute the judgment of the financial advisor as of the dates indicated and are subject to change without notice. This report is for informational purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security.
Investing involves risk and you may incur a profit or a loss. Diversification does not ensure a profit or ensure against a loss. There is no assurance that any investment strategy will be successful. Past performance is no assurance of future results.