Stocks took a breather in the third
quarter as the S&P 500 returned just over 1%, while small cap stocks fell
along with both developed and emerging international stocks. Nonetheless, the S&P 500 has still managed
a total return of 8.35% for the year to date, and bond indices have produced
healthy returns in the 4% area.
Bond indexes
produced remarkably similar total returns to the blended stock benchmark this
year (4.41% for taxable bonds, 3.75% for tax free bonds), while real estate (as
measured by the REIT index) has been the best performer, after a weak 2013. In spite of generally weak commodities prices
this year and weak gold prices last quarter, our inflation hedge positions in
aggregate have been strong this year led by MLPs and energy royalty
trusts. Lastly, insurance-linked
securities have performed well, besting all bond sub-categories this year to
date while providing unmatched diversification.
This year to date (through 9/30), the
total return of our standard blended stock index (60% large US, 15% small US,
15% established international, and 10% emerging international stocks) was up 4.36%,
as the S&P 500 Index gained 8.35%.
Diversifying stock exposure away from large US companies and into
smaller US stocks and international stocks has not helped performance this
year. In fact, it has not helped
performance over the 3 years or 5 years ending 9/30! We remain committed to diversifying stock
exposure with both smaller and international companies while recognizing that
from time to time there are lengthy periods in which such diversification will
lag the S&P 500 in performance. The
last such extended period was in the “irrational exuberance” era of the late
1990’s, a period with some uncomfortable parallels to the current environment. As you may recall, that episode was followed
by years of much better relative performance from our diversified stock strategy
(as well as from value, yield, and quality – three of the cornerstones of our
equity approach).
Looking
forward, high stock valuations persist by virtually any long term measure and
the extraordinary policies of the Federal Reserve in recent years have almost
certainly created substantial financial market excesses (the details of which
can only be fully known after the fact).
On the other hand, both inflation and interest rates remain low (at
least for now), and seasonality is now turning positive (more on that will be
coming in a separate report). We are keeping
portfolios positioned relatively defensively, yet we are happy that markets
have offered some gains this year so far.
At this point, emerging markets stocks and private real estate appear to
offer the best opportunities for future returns.
Stock
market volatility has kicked up in recent weeks, and that could be a precursor to a market correction. But if that were to happen, we would consider
that both an overdue and, in the long run, a healthy development.