The wide-spread gains of the first-half of the year narrowed as several asset classes hit highs and lows throughout the quarter. Again, market movement was commanded by overall economic and political uncertainty due to the heightened focus on previously existing risks (global growth worries, shift in monetary policy and geopolitical tensions), and new concerns over the resurgent movement of religious militants in Iraq and Syria, political unrest in Hong Kong and the Ebola epidemic threatening parts of West Africa. While the possibility of a market correction is possible, experts believe the U.S. economy is still in mid-cycle as corporate profitability is favorable and U.S. growth is continuing to improve, showing further signs of divergence from the rest of the world.
The fixed income market as measured by Barclay’s Aggregate Index (standard benchmark) was up slightly (+0.2%) for the quarter, bringing the year to date return to +4.1% through September 30th. The current interest rate environment helped intermediate to longer-duration fixed-income during the quarter, while high-yield, emerging-markets and inflation-protected bond sectors struggled. Short-term rates are expected to be hiked by the central bank sometime next year, though there is considerable debate over the exact timing and we expect continued low interest rates over the next several months. Many investors are watching the Federal Reserve closely – the Fed announced it would, as expected, end its quantitative easing program in October, and rates would stay low for a “considerable time” after the end of the easing. The European central bank, however, lowered key rates further in an effort to keep price levels in the Eurozone from falling further. We continue to believe exposure to multi-sector bonds adds value to a long-term diversified portfolio. We will continue our current allocation emphasis on lowering effective duration to shorter to intermediate and actively managed bond funds and holding individual positions to maturity as we consider interest rates and make adjustments to our fixed income allocations as appropriate.
Equity markets across the board had a choppy third quarter due to concerns over conflicts across the globe. Broad-based equity indices ended the quarter on a positive note with the Dow Jones Industrial Average posting +1.3%, the S&P 500 Index +0.6% and the Nasdaq Composite index generating +1.9%. While U.S. large cap stocks (Russell 1000) rose slightly (+0.7%), mid cap and small cap stocks (Russell 2000) fell (-7.4%). Both developed-country international markets (as measured by the MSCI EAFE Index) and emerging markets underperformed, posting -5.8% and -4.3% during the quarter, respectively. Emerging markets have been negatively affected due to rising rates as capital returns to the U.S. We expect choppy markets to continue, and believe periodic market setbacks are inevitable. We continue to see investment opportunities in equities globally and continue to take profits as we begin to bring equity allocations closer in line with market weight of our models.
The alternatives space (MLPs, REITs, commodities, currencies and hedge fund replicas), which includes non-traditional, less-correlated asset classes had mixed returns for the quarter. REITs lost ground in September against the backdrop of a weakened broader market. Domestic REITs and MLP’s erased some of the year’s gains, but are still having a great year compared to the broad market indices. Commodities struggled this quarter due to a pullback in prices attributed to slower global economic growth, particularly in China.
As we begin the last quarter of 2014, the headlines about uncertainty in the world today continue, and investors are faced with the growing concern of a market correction. No one can predict short term market movements, but we expect the path ahead for both equities and bonds to be more irregular than in recent years and will continue to stay focused on the long-term horizon. Volatility is likely to remain elevated, but we view near-term corrections as opportunities for long-term investors to increase allocations and rebalance as appropriate.
In all that we do, your satisfaction is our primary goal and we recognize that today seems like a particularly uncertain time. Especially in times of heightened volatility, we believe all investors should be diversified across various asset classes, and your portfolios are managed accordingly. Please feel free to call or email us to discuss broad topics such as those above or more portfolio-specific issues.