Stocks recovered from the losses in June as the S&P 500 was up nearly 5% in July. Both the Dow Jones and S&P 500 hit all-time highs last month, but (unlike 2000 and 2007) we have higher corporate earnings to help justify the growth. Bond investments did not bounce back as interest rates continued to creep higher, although not nearly at the pace we saw between May and June. As a result, bonds were mostly flat in July. As our Portfolio Barometer indicates below, 2013 has been a successful year for the typical, diversified investor thus far.
What makes the current investment landscape interesting is how the market appears to be so resilient to the geopolitical strife of Europe and the Middle East, yet so sensitive to our endless stream of economic data. After all, it was commentary from the Fed saying they may be slowing down their stimulus (because the economy is improving) which sent the markets into a mini-correction in June. The latest batch of data shows that the unemployment rate is down to 7.4%. This steady improvement might actually lead to challenging times ahead for investors.
Fed Chairman, Ben Bernanke, has said that they would keep short term rates near 0% as long as the unemployment rate was above 6.5%. As jobs continue to be added and more baby boomers feel confident with retirement, I would expect unemployment to hit that magical 6.5% mark sometime in the next 12-18 months. If June was any indication of how the market will react to the lingering possibility of rising rates, then we should secretly be hoping for slower GDP growth and fewer jobs being added to the economy. That way, the specter of rising rates (and falling bond values) can be pushed further down the road. This is only a short term solution and we still believe that the economy will continue growing and help lead the markets into even higher highs over the next few years.
Higher interest rates are correlated with a healthy, growing economy, so the sooner the investing world accepts the fact that interest rates will not remain at historic lows, the better. In spite of the GDP growth for the second quarter still sluggish at around a 1.7% annual rate, longer-term interest rates are still inching up. We don’t expect another spike of interest rates as we saw in May/June, but it is apparent that intermediate and long term rates are not waiting for the Fed to take action. Tightening up duration and decreasing exposure to interest-sensitive investments will be the themes we will be focusing on.
What can set this rising rate trend off course? Last summer, I wrote an article on the Affordable Care Act and discussed some of the new laws that go into effect in 2014. This will slow down the rate of job growth or at least dampen the amount of full time hiring. Another hindrance will be the fiscal budget talks by Congress this fall. There is still a political stalemate and possible government shut down already being threatened. If government spending is further sequestered or budgets get delayed, then we can see the improving unemployment trend diverted, causing the Fed to keep the stimulus in motion.
The number of things that can affect the market is infinite and the desire for an improved economy may actually hurt your portfolio in the short term. As a result, we simply encourage our clients to enjoy the rest of summer and hope for even better days ahead.
Index information is used to represent market performance, but you cannot invest directly in an index. Past performance is not indicative of future results.
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