First Quarter 2013 Review
The Markets |
03/31/13 Close |
12/31/12 Close |
1st Qtr. Change |
03/31/12 Close |
12 Mo. Change |
YTD Change |
Dow |
14,759 |
13,104 |
+12.63% |
13,212 |
+11.98% |
+12.63% |
NASDAQ |
3,268 |
3,020 |
+8.21% |
3,092 |
+5.69% |
+8.21% |
S&P 500 |
1,569 |
1,426 |
+10.03% |
1,408 |
+11.43% |
+10.03% |
MSCI EAFE |
1,675 |
1,604 |
+4.43% |
1,553 |
+7.86% |
+4.43% |
10-yr Treas. yield |
1.85% |
1.76% |
+0.09% |
2.22% |
-0.37% |
+0.09% |
Fed funds rate |
0 to.25% |
0 to.25% |
n/a |
0 to.25% |
n/a |
n/a |
(stock indices are before dividends; yield and rate changes are absolute changes)
For the second year in a row, the first quarter was very strong for US stock markets. Although the NASDAQ has a long way to go to reach its tech boom levels, both the Dow and the S&P 500 reached new all-time highs near the end of the quarter. The Dow had its longest streak of positive days since 1996. All markets were not rosy, though, as the broad investment grade bond market had only its second negative quarter in four years. Emerging markets and commodities also struggled.
The fiscal cliff turned out to be a soft, grassy slope, at least as far as the markets and public outcry are concerned. Following the last minute tax agreement in January, Congress then missed the March 1 deadline and automatic cuts went into effect. Those cuts, of course, will have an increasing effect over time but initial impact was barely noticed other than the possible closing of some air traffic control towers. The impending debt ceiling fight was avoided as Congress agreed on spending bills through the fiscal year in September that retained the spending cuts but allowed more budgetary shifting than before. In short, nearly nothing has changed or been fixed. (Interestingly, the authors of the bipartisan Bowles-Simpson fiscal recommendations opined that the government should “go big or go home” on spending cuts.)
The greater drama was in Europe in general and in Cyprus, of all places, in particular. Cyprus had reinvented itself as an offshore banking haven and had attracted lots of Russian money. Unfortunately, in addition to the property bubble that has affected everyone, Cypriot banks invested heavily in Greek bonds. In exchange for a bailout, Germany required that bank depositors take losses. (Upcoming elections explain why German politicians would balk at such a small bailout yet commit much more to other countries). An initial proposal that all bank deposits be reduced by around 7% failed and Cyprus approached, and was rejected by, the Russians for a non-EU bailout. Ultimately, bank deposits above the insured limit of €100,000 will be reduced by 40% or more, bondholders will also take losses and the second largest bank will be liquidated. The question remains as to which EU country will be next to need a bailout (Slovenia has denied it will be them).
Housing and jobs were sources of optimism. Housing starts hit levels in February last seen in June, 2008 and were up 28% from 2012, while building permits were also at their highest since June, 2008. Existing home sales hit three-year highs with median prices 11.6% over 2012 and inventory at 4.7 months, below the normal six months. Investors made up 22% of sales, higher than normal, while first-time buyers were at 30%, still below normal. New home sales were stronger but still well below the level for a strong market, while new home prices are 37% higher than comparable existing homes. New claims for unemployment benefits trended down through the quarter and the four-week average hit five year lows. However, the last week of the quarter saw jobless claims jump to a four-month high and estimates of private-sector jobs created in March were the least in five months.
Both the manufacturing and service sectors stayed in expansion mode although both measures were at near-term lows in March. Consumer spending, incomes and savings rates were all up slightly, consumer sentiment softened in March and consumer debt increased to an all-time high, although the increase is entirely attributed to student loans. Core inflation remained in check at around 2% and the Fed reiterated that their stimulus programs will hinge on sustained economic improvement. Fourth quarter GDP growth was revised several times, ending up at +0.4% from the initial -0.1%. The leading emerging countries (Brazil, Russia, India, China and S. Africa) announced the formation of their own development bank for infrastructure to bypass the World Bank.
Looking Forward
It is hard not to wonder whether the stock market can hold its strong rally. Some observers have given in to the idea that conservative investors have finally tired of low interest rates and will continue to move into more risky assets (stocks, etc.), further driving the rally. Even if jobs slow down and housing plateaus, there won’t be another recession. So, the intermediate term outlook is positive.
The opposing view is that the housing recovery and employment numbers have created a false sense of confidence and the market is seeing only positive news. Shrugging off Europe’s woes and overlooking the fiscal cuts could come back to bite investors. Once government cutbacks start to hit more jobs and services, consumers will quickly lose that confidence. More local governments could meet the fate of Stockton, California, which became the largest US city to enter bankruptcy. And at some point the Fed will have to end its easy money policies, and the longer they go on the uglier will be the end.
Our Portfolios
Last quarter we defended the stock market as a legitimate source of capital for companies and a source of long-term investment growth. In short order, investors may have shaken off their fear of stocks, and perhaps at exactly the most inopportune time. (Individual investor sentiment has long been seen as a contrary indicator; that is, when individual investors are finally ready to buy, that’s the time to sell, and vice versa.)
Now the challenge is what to do when the market is at all-time highs. If the market adjustment is around 5% or so (new cash added to the portfolio, a rebalancing to target allocations, etc.), the investments should be made regardless of market fluctuations. Waiting for the “right time” to invest means that much time is spent monitoring the market and there is the possibility that the right time is missed or never comes. If the investment is for the long term the purchase point matters little.
If a lot of cash is involved or the adjustments are 10% or more of the portfolio, some caution is advisable. Given the added risk of losses in bonds if interest rates rise, holding cash is not a fatal decision. It does require acceptance of low rates and the loss of some purchasing power, since cash is earning less than the inflation rate. But cash can serve as a stabilizer to a portfolio if markets soften and any, alternatively, stock exposure will benefit if markets continue to rise.
Of course, dollar-cost averaging into markets is always an acceptable strategy, with the stipulation that the initial plan be followed once it is started, regardless of the markets. (A significant change in investor circumstances could warrant a change.) And, if either holding cash or adding to stocks would be acceptable in the context of a long-term plan, orders for exchange-traded funds can be placed below current market levels. If the market drops to that level, the addition will be at a slightly lower price; if not, the cash will still serve its purpose as ballast.
The basic premise of investing when the stock market is hitting new highs is no different than any other time – determine and pursue an allocation based on long-term goals and risk tolerance. Otherwise, you run the risk of succumbing to short-term concerns and jeopardizing long-term success.
Spring Cleaning
We really don’t clean our houses only in the spring and we probably don’t look at our investments only once a year, but spring is a good a time as any to take a real thorough look.
Windows – This is the big, obvious job that everyone can see. For a portfolio, that would involve an in-depth look at the portfolio allocation and composition. First, assess whether any of your circumstances or goals have changed. Then, translate those changes into adjustments in the portfolio allocation if necessary. Finally, compare the actual allocation to the target allocation and make changes to bring the two back in synch. Even if your goals and target allocation haven’t changed, this exercise will force you to sell investments that have increased in value and buy those that have not, a sound long-term approach.
There are plenty of free tools available for this job. For example, the Instant X-Ray tool at Morningstar.com creates a broad allocation as well as sector concentration, geographical distribution and stock size. At a minimum, categorize your portfolio based on the investment type (or fund objective) for cash, bonds/fixed income, US stocks and international stocks. There may also be an “other” category for real estate, commodities and other alternative investments.
Dust Bunnies – Dust bunnies live under the furniture, in the corners and other obscure areas of the house, and your portfolio may have some similar areas. These may include old accounts that you haven’t looked at for years or investments that you never really understood and can’t remember the reason for buying in the first place. This is especially true with the recent emphasis on more focused, exotic funds for every imaginable market; most investors have no business whatsoever investing in these vehicles that are very complicated and completely untested. Take a hard look in the obscure areas of your investments and get rid of the nasty stuff that may have accumulated there.
Closets – Closets are filled with things that we might need “sometime”, have emotional value or were bought under circumstances that have changed. Unlike dust bunnies, these items have been in the forefront for years but have just become obsolete. For investments, get rid of those holdings that have been poor performers for years or may no longer fit your current investing style. For example, there may be high-cost funds that can now be dumped in favor of much more cost-effective index funds. For individual stocks, revisit why you initially bought them and consider whether those reasons are still valid.
But be careful. Just because an investment “isn’t doing anything” is not necessarily a reason to get rid of it. The assessment should be in comparison to a peer group or overall market performance rather than some arbitrary criteria. A properly balanced portfolio will have some parts that aren’t particularly volatile or exciting, which is precisely their role.
Mattress – Maybe you don’t turn your mattress over but you should every now and then. For mutual funds, “turnover” is a measure of how often the fund manager changes the fund’s investments. A turnover of 100% means that, on average, the entire fund portfolio has changed over the course of a year. Funds with a longer term investing view have low turnover while funds that aggressively trade have very high turnover. Turnover adds to fund costs in ways that are not readily apparent in the fund expense ratio (trading costs can be found in the footnotes of a fund’s annual financial statements but even then are very difficult to evaluate). And active trading contributes to a fund’s volatility because the more decisions (changes) the fund manager makes, the more often he can be right or wrong. Simply put, lower turnover is better.
Like cleaning our houses, monitoring a portfolio does not have to be all-consuming. But if is never done, things can get real ugly real fast and can have significant costs over time.