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Island Light Investment Notes (August 2013)

The End of Summer

Summer ended with a whimper in August, as a combination of slowing growth expectations in the US and market fears of Federal Reserve tapering contributed to negative returns in most asset classes in August.stocks 201308b   US equity markets were most strongly impacted by the decline in expectations, falling off July highs and somewhat reducing still impressive year-to-date gains.

Fears of U.S. involvement in the Syrian civil war contributed to an increase in equity volatility and a return to the fear trade as gold bullion rebounded off very poor first half performance lows.

Global inflation expectations remain low although the US inflation rate for the 12 months ended July 2013 hit 2%.  The low inflation expectations have contributed to inflation-protected security poor performance, despite a record global monetary accommodative policy.   

Volatility also returned to the markets at the end of August, returning to levels not seen since the Fed-induced bond riot in late June and the fiscal cliff resolution in the last days of 2012.

Signs of rebirth in the European economy contributed to a strong third quarter-to-date for bonds 201308bEuropean equities, a trend that is expected to continue with higher European consumer confidence.  However, the Japanese latest foray into massive monetary stimulation to grow the domestic economy and inflation rate (“Abenomics”)  has not yet contributed to real economic growth, leading Japanese equity investors to take early 2013 profits. 

Somewhat higher yields are now available to the fixed income investor as the yield on the ten year treasury bond hit 2.78% at the end of August, upyields 201308b one percent from the beginning of the year.  The speed of interest rate acceleration in 2013 has exceeded all expectations.  Despite the higher yields, longer duration fixed income remains a questionable short term investment as the market still anticipates further interest rate increases.  Our expectation is for the ten year interest rate to move above 3% over the next few months.

Looking forward to the end of 2013, we expect political tensions in the Middle East to keep volatility high and for the US economy to grow at an uneven pace with continued high unemployment.  The Commerce Department announced that the second quarter grew by 2.5% annualized from April through June, sharply higher than the advance estimate of 1.7% released in early August. If growth is increasing, as expected in a late stage economic recovery, then equities should still represent a better risk-adjusted asset class than fixed income.  European equities should benefit from expectations of further growth in the Eurozone, while most emerging markets equities will remain soft.  Weaknesses in some emerging economies have been exposed recently (witness the Indian rupee losses) and we expect this trend to lead to short term losses in emerging markets equity markets.

Our globally diversified portfolios are developed using advanced statistical and quantitative methods which include advanced estimation for improving capital market forecasts and enhanced optimization methods to improve the construction of optimally diversified portfolios.  We believe that global diversification and exposure to different and non-traditional asset classes can enhance and protect wealth over the long run.

Matthew V. Pierce, President

 

 

 

 

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