Island Light Investment Notes (Nov 2013)
December 6, 2013 | Investment Notes
Another month brought another new equity high. In November, the bull market in US equities continued as the S&P 500 hit new three new all-time highs during the month and closed above 1800 for the first time on November 22. It has been a great year for the US equity investor, and in this time of Thanksgiving and holiday celebration, all should rightfully celebrate. Wall Street’s professionals should be happy with their year-end bonuses, and those investors who were willing to take big risks have been handsomely rewarded.
But I’m not sure that Main Street is paying attention. Headlines reflect an undercurrent of worry about the economy, jobs, growth of income, government debt and bad fiscal management. Main Street is not listening to Wall Street talk about record corporate profits, earnings multiples that are not very expensive, modest inflation and improving economic trends. Main Street is focused on jobs, corporate greed, and income disparity. Wall Street and Main Street are watching different channels.
The trouble with this picture is that Main Street remembers the losses of 2008 too well, is still scarred by the Great Recession, and knows that good jobs have not magically appeared. Therefore, many on Main Street were not able or willing to participate in the great American equity rally.
But that may be changing, according to a Wall Street Journal article (“Stocks Regain Broad Appeal”, Nov 10, 2013). Individual investors are returning to equities. Whether this is good or bad news for equities remains to be seen. Many professionals believe that positive individual investor sentiment is a negative indicator for equity market growth. But other professionals take the view that the equity market is still relatively undervalued, even at this stage in a bull market. So far, we have seen little to indicate that equities will not keep on trucking along. Main Street investors should certainly have some of their savings in the global equity market, preferably in well-diversified risk-managed portfolios.
U.S. equity markets posted strong results in the 4th quarter to date with all major indices achieving measurable gains. Non-US developed markets also performed well, as European economic growth translated into stock market gains. Non-US emerging markets lost ground in November after strong October and September returns. Small cap stocks outperformed large cap stocks. Value and growth by as returned approximately the same, although small cap growth performed slightly below small cap value. Gold bullion continued its year-long downward spiral losing more than 5% of value in November.
Domestic Fixed Income
The US Bond market dropped marginally in November after rising somewhat in October. The 10 year Treasury interest rate edged upward to 2.8% at the end of November from 2.6% in October and September. The continuing dominant driver of interest rate expectations remains the Fed’s commitment to monetary stimulation through quantitative easing (“QE”), despite signs of an improving economy and a drop in joblessness in November to 7.0%. Conditions are now sufficiently positive that the Fed could justify tapering QE at any of its next few meetings. Our suspicion is that there will be no change from current policy at least until Janet Yellen becomes chair of the Fed in January. Main Street concerns that tapering QE will halt the fragile jobs recovery will also likely keep the Fed from changing current policy in the very near term.
Global inflation expectations remain low and the US inflation rate for the 12 months ended October 31, 2013 at 0.9%. The low inflation expectations have contributed to inflation-protected security poor performance, despite a record global monetary accommodative policy.
We remain positive on equity markets in general, and particularly relative to bonds, because of seasonal factors, improving economic news, record corporate profits and moderate earnings multiples. But we also recognize that the US equity market is one exogenous shock away from a market correction and that at least one likely shock will occur when whispers of Fed tapering begin again, probably in early spring. That correction will cause Main Street great anxiety and give Wall Street another reason to buy on the dip. Until that occurs, we remain overweight equities. Keep on truckin’.
Matthew V. Pierce