Island Light Quarterly Commentary (Oct 2014)
Quarterly Market Review: July-September 2014
Volatility returned to equities markets in Q3. A strong August was followed by losses in September, when any rallies began to focus around selected winners rather than benefitting stocks across the board. Investors exhibited a decided preference for large caps; the S&P 500 closed above 2,000 for the first time ever and the Dow industrials also set new all-time highs. The Nasdaq returned to a level it hadn’t seen since March 2000 and regained the lead for 2014. However, the Russell 2000, which has struggled for most of the year, fell deeper into negative territory year-to-date, while the Global Dow suffered from political conflicts abroad and concerns about global growth.
Bond investors continued to demonstrate surprising resilience. In early September, the yield on the benchmark 10-year Treasury fell to 2.35%–a level it hadn’t seen in more than a year–as prices rose. However, as the Federal Reserve continued to taper its economic support and ramped up discussion of how and when to increase rates, demand began to taper off (though geopolitical anxieties and a strengthening dollar kept the decline in check). Gold, which started the quarter at roughly $1,320, ended below $1,220. It was hurt in part by a stronger U.S. dollar, which by the end of the quarter had hit its highest level against the euro in almost two years. Dollar strength coupled with weaker global demand also meant lower oil prices; a barrel fell from $107 a barrel to roughly $93 during the quarter, a level it hasn’t seen since January.
Quarterly Economic Perspective
After contracting 2.1% in Q1, the U.S. economy grew at an annual rate of 4.6% during the second quarter. The Bureau of Economic Analysis said increases in consumer expenditures, exports, business spending on equipment, and spending by both state and local governments were major contributors to the growth. Meanwhile, after-tax corporate profits also rebounded from their Q1 slump, rising 8.6%.
The Federal Reserve’s monetary policy committee continued to unwind its economic support. Its September bond purchases were only $15 billion, and they are scheduled to end in October. The committee also reaffirmed that the key Fed funds interest rate won’t increase for a “considerable time” after that. However, a survey of members showed that most now expect steeper increases than previously estimated, with rates hitting 1.4% by the end of 2015 and 2.9% by December 2016.
Despite a slight improvement in August’s unemployment rate (6.1%), the number of new jobs added in August was a disappointing 142,000, according to the Bureau of Labor Statistics. The continued slack in the labor market is one reason cited by the Federal Reserve for its caution about raising interest rates.
The housing recovery showed signs of tapering off. New home sales fell in both July and August, and the National Association of Realtors® said a shortage of the cash buyers who had helped boost existing home resales in July cut resales the following month. Housing starts and building permits also slowed in August after a strong July, according to the Commerce Department, while the rate of home price increases in the S&P/Case-Shiller 20-City Composite Index began to taper off.
After a strong July, manufacturing gains began to taper off. The Commerce Department said durable goods orders rose and fell based on orders for commercial aircraft, which hit a record high in July and plummeted a month later; aside from transportation, durable goods orders rose 0.7% in August. Auto production also saw a strong July and weaker August, and after six straight months of gains, the Fed’s gauge of industrial production edged downward in August.
By quarter’s end, the Bureau of Labor Statistics said falling energy costs had helped cut consumer inflation by 0.2%. That left the annual inflation rate for the previous 12 months at 1.7%, down from Q1’s 2.1%. The 1.8% annual inflation rate for final-state wholesale prices also was lower than Q1’s 2%. The Bureau of Economic Analysis said both personal income and consumer spending saw gains throughout the quarter.
Conflicts over Ukraine continued to raise concerns about how Russian retaliation for Western sanctions might affect the fragile European economy. A eurozone GDP that essentially flatlined in Q2 and weakness in both Germany and Italy led the European Central Bank to promise more aggressive stimulus measures.
The Chinese economy continued to show signs of slowing in some key areas. By August, growth in industrial production was almost 7% instead of the previous month’s 9%, housing sales were down nearly 11% from the beginning of 2014, and HSBC Corp.’s Purchasing Managers’ Index remained at 50.2–barely above the level that would represent contraction.
Eye on the Month Ahead
With October’s Fed bond purchases expected to be the last, next month’s monetary policy committee announcement will be watched to see if a rate hike is still a “considerable time” away. Global investors will assess whether additional expected support from the European Central Bank is likely to help jumpstart the economy there.
Matthew V. Pierce, President