Does a new market high signal that it is too late to invest?

As we close out the first half of 2014, the U.S. equity market (represented by Russell 1000® Index) is positioned near an all-time high.  Market highs are often seen as times to rejoice, but there appears to be as much trepidation as enthusiasm this time around, leading many investors to delay committing additional assets to their investment portfolios until the “inevitable” market correction occurs.

It may be that the last two bear markets (March 2000 – September 2002 and October 2007 – March 2009) are weighing heavily on investors’ psyches. While there is no magic elixir to help people forget those difficult experiences and feel better about investing today, maybe addressing a few common concerns can help ease the apprehension.

Buying near the market high

Timing investment purchases sounds great on paper, but is very difficult to accomplish in reality. When times are good, investors can be concerned about buying in too late. When times are bad, investors tend to hesitate due to fears of things getting worse.You can always find excuses not to invest, but generally markets tend to move in an upward direction over a moderate period of time.

For instance, as shown in the chart below, the U.S. equity market (represented by the Russell 1000®Index) hit 432 new daily market highs between the beginning of 1995 through May 27, 2014. You could argue that hitting a high almost doesn’t feel special anymore. But, when you consider that the market had a cumulative return of over 600% during that period – the equivalent of a 9.9% return per year – it doesn’t look so shabby. In fact, it’s in line with longer-term averages for U.S. large cap equities. We can’t predict the future, but reasonable expectations are that this pattern could continue over the long term.
Russell 1000 Index

Source: Russell Investments. Indexes are unmanaged and cannot be invested in directly. Returns represent past performance, are not a guarantee of future performance, and are not indicative of any specific investment.

Worries about valuation levels

Astute investors recognize that price levels alone are not a good indicator of relative market attractiveness. The relative cost an investor pays for each dollar of earnings, book value or cash flow also impact future market returns.  When current valuation measures are lower than past norms,history suggests that future market returns may be higher than historical averages. When valuation measures are higher than historical averages, it suggests that future returns may be lower than long-term averages.

Today’s price-to-earnings (P/E), price-to-book (P/B) and price-to-cash-flow (PCF) for the Russell 1000® Index suggest that valuations are slightly higher than average, but relatively close to historical norms. These results could suggest that future returns may be tempered, but do not foretell a looming market correction.
Russell 1000 index valuations

Source: Russell Investments. Indexes are unmanaged and cannot be invested in directly. Returns represent past performance, are not a guarantee of future performance, and are not indicative of any specific investment.

Concerns about the economy

Although markets don’t move in lock-step with economies, markets tend to be heavily influenced by current and anticipated economic conditions. Last year’s strong global equity returns were heavily influenced by the anticipation of positive global economic growth in 2014. This year is anticipated to be the first year since 2010 where positive growth will be experienced across Europe, Japan, the United States and the emerging markets. Delivery on that growth expectation will help to justify 2013’s strong results and hopefully enable markets to keep moving forward.
Imf projected growth


The bottom line

Is the market overvalued? Is it too late to invest? Is a correction coming?

If you are asking these types of questions, consider the following:

  • Although U.S. equity markets (represented by the Russell 1000® Index) are at or near all-time highs, that doesn’t necessarily indicate they’ve peaked. Since January 1995, the U.S. equity market has seen 432 new daily highs and has eventually moved higher after each one.
  • Market valuations are a good indicator to help set future return expectations. At today’s levels, markets appear to be slightly more expensive than historical averages. This does not suggest a correction, but helps establish a reasonable expectation for more modest positive results.
  • The global economic recovery continues to move forward. 2014 is the first year since 2010 where there is an expectation for positive growth across all the major economic regions. Positive economic growth tends to bode well for capital market results.

Source: Russell Investments



The Dow Hits Record High This Year Mostly Because of This Stock

The Dow Jones Industrial Average is at record highs and it’s mostly because of just one of its components.  Caterpillar is doing a lot of heavy lifting when it comes to moving the Dow index, a huge change from last year when it was up just 1 measly percent against the Dow’s 26 percent gain.

Though it’s just 4 percent of the entire average, the equipment maker is up nearly 17 percent through May 9. To put it in perspective, Caterpillar accounts for more than half of the entire Dow’s gains. And, were it not for Caterpillar, Merck and Disney, the Dow would be down in 2014.

This is a good example of how difficult it can be at times to make heads or tails out of market headlines and sound bites alone.  It also illustrates how challenging it can be to filter short-term market noise.

Just as Caterpillar has returned to favor after a dismal 2013, we have seen other sectors move from the bottom of the heap to the top.  Most notable among these are Real Estate Investment Trusts, or REITs.  This area has gained around 8% through the first part of May.  Another asset class that was beaten down in 2013, commodities, have picked-up 5% so far this year.

Diversification, which was detrimental to performance last year, has helped smooth volatility and, at least so far this year, has been additive to returns.

Source: Yahoo Finance

Update on Heartbleed Security Flaw

You may be aware of reports of a security issue that can affect some web sites, which is being referred to as the “Heartbleed” security flaw. We have been in contact with Fidelity and Jefferson National and can tell you that their customer sites and services do not rely on the versions of the SSL technologies associated with this security issue and both remain safe to use.

According to Fidelity, “our sites offer strong protection. We closely monitor our online environment and have multiple layers of security in place to protect our customer sites and services. We are aware of certain external analysis that purports to assess our site security related to SSL. It is inaccurate in its assessment. Our sites offer strong protection. For security reasons, many of our protections are purposely not visible or detectable externally.”

It is not a good practice to use the same password for multiple sites. Since some Internet sites are affected by this vulnerability, if you do use common passwords for multiple sites, please take the time to update and change your passwords appropriately, including changing the password you use to access Fidleity’s and Jefferson National’s (if applicable) sites and services.

December market review: Wrapping up a strong year for equities

By Mike Smith, Russell Investments

December put a bow on what turned out to be both a strong fourth quarter and year for equity asset classes. U.S. equity1 posted the best asset class results for the month, quarter, and year ending December 31, 2013. The Russell 3000® Index’s 10.1% return in the fourth quarter provided an appropriate bookend for its 11.1% return in the first quarter of the year. Unlike earlier quarters, U.S. large cap stocks nosed out U.S. small cap stocks for market leadership in the fourth quarter, with the Russell 1000® Index returning 10.2% and the Russell 2000® Index returning “only” 8.7%. Developed international stocks also finished the year in impressive fashion: the Russell Developed ex-US Large Cap Index returned 5.8% during the quarter, adding to a 21%+ return for the year. All in, developed markets global equity markets, as measured by the Russell Developed Large Cap Index, were rewarded with an 8.1% quarter and a 27.4% 2013.

Capital market returns chart

Sources: US Equity: Russell 3000 Index, Non-US Equity: Russell Developed x-US Large Cap Index, Emerging Markets: Russell Emerging Markets Index, US Bonds: Barclays Aggregate Index, Global REITs: FTSE EPRA/NAREIT Developed Real Estate Index, Commodities: DJ UBS Commodities Index, Balanced: 30% US Equity, 20% Non-US Equity,5% EM,35% Bonds, 5% REITs, 5% Commodities. Index returns represent past performance, are not a guarantee of future performance, and are not indicative of any specific investment.

In contrast, the rest of the capital markets generally did not fare as well during the last quarter or the year. Emerging markets equities were probably the biggest disappointment for the year as much was expected of them going into 2013. Bonds finished the year out much as they performed for the majority of the other nine months: the Barclays U.S. Aggregate Bond Index posted a -0.6% return for December, -0.1% return for the quarter, and -2.0% return for the year. Rising rates also impacted global REITs: the FTSE EPRA/NAREIT Developed Index returned -0.7% during the fourth quarter. Commodities posted a solid December, but it was not enough to generate a positive return for either the quarter or the year, as the Dow Jones UBS Commodity Index was down -1.1% during the quarter and -9.5% for the year. Commodities were hurt by concerns about rising rates and concerns about the direction of economic growth in the developing markets.

Global Equity Markets Reaped Big Returns in 2013

Developed market equities had a historically strong year in 2013. Major indexes have been tracking global equity performance since 1970 and 2013’s return of 27.4%2 was the seventh best calendar year result in that 44-year period. Even more dramatic was the spread between global equities and fixed income. The 29.3% difference between these two asset classes was the second largest spread since 1970, trailing the largest calendar year difference by only 40 basis points (0.4%).3 For perspective, the average annual spread between global equities and bonds since 1970 has been 4.1%. The combination of improving economic expectations and rising interest rates created an environment for equity markets to excel and bond markets to struggle.

Chart growth of dollar 2013

Source: Global Equity represented by Russell Developed Large Cap Index; Bonds represented by Barclays U.S. Aggregate Bond Index. Index returns represent past performance, are not a guarantee of future performance, and are not indicative of any specific investment.

The Bottom Line

Developed equity markets delivered historically strong results and drove double digit market returns in 2013. Unfortunately having exposures to additional diversifiers, such as fixed income and commodities, wasn’t as clearly beneficial. Such disparity can tempt investors to question the value of being invested in “these other asset classes.” Of course, markets can turn quickly – and that’s when “these other asset classes” can be helpful.

1Represented by the Russell 3000® Index

2 Represented by Russell Developed Large Cap Index

3 Global Equities represented by Russell Developed Large Cap Index and Fixed Income represented by Barclays U.S. and Aggregate Bond Index.

Diversification does not assure a profit and does not protect against loss in declining markets.

Returns represent past performance, are not a guarantee of future performance, and are not indicative of any specific investment.

The Fed begins taper but stresses easy policy

The Federal Reserve Open Market Committee completed their final meeting of 2013 on Wednesday, and while some economists called for the closely-watched tapering decision to be put off until 2014, a $10 billion/month program was announced.  No doubt, you are probably as tired of hearing about tapering as we are, so this provides a bit of closure to the question, although there is still a long road ahead.  Probabilities for this happening had risen over the past week, although there were plenty of well-regarded economists who called for it to begin in January or March of next year.

Why the change?  The economy continues to be growing at a ‘moderate’ pace, according to the committee.  Since October, better labor numbers and improved capital expenditures added a few points to GDP, while flattened housing figures offset that somewhat.  Also, inflation remains quite low and below the committee’s target.

The Fed might also have been weighing whether or not to lower the unemployment target from 6.5% down to 5.5-6.0%, which it did not end up doing.  The minutes from the October meeting alluded to discussion about the topic.  The second component of today’s news release was an acknowledgement by the committee that it could ‘likely be appropriate’ to keep rates at zero ‘well past the time’ that this target is hit—which came as somewhat of a surprise.

The Fed has dual mandates of maximum employment and price stability.  Unemployment is still higher than desired (far below ‘maximum employment’) and inflation is not yet problematic as measured by their conventional metrics.  Therefore, despite the tapering of the stimulus, there is still ample stimulus as they continue to operate on the side of accommodation as opposed to pulling off the gas too early and risking a sputtering of the engine.

At the same time, QE is a dramatic emergency measure, and one could argue whether this policy continues to be as appropriate several years after the depth of the financial crisis.  Naturally, the longer this goes on and the more positive and sustainable the underlying economic data looks, the greater the counter-argument against stimulus.

We bring this back full-circle to what this means for us in an asset allocation context.  Risk assets traded higher on the news, which reflects the stronger underlying economic conditions, while bond rates ticked upward.

  • Fixed income:  Continued stimulus and easy policy means lower bond yields for longer (although the rate ‘spring’ has been getting increasingly compressed and tapering only releases some of the tension).  As economic growth improves, it is fair to expect higher rates.  This could be quite damaging to conventional fixed income portfolios depending on how quickly rates rise.
  • Equities:  As economic growth continues, this translates to both improved company revenues/earnings as well as a positive feedback loop as consumers feel increasingly comfortable about forward-looking prospects.  When this occurs they increase their own spending.  It would not be surprising to see continued strength vs. fixed income while accepting the occasional bouts of volatility we expect from this asset class.

Performance Anxiety: Why Investors Continue to Chase Stocks Higher

Stocks have to be the only entity in the world that become more attractive to investors as the price goes up. Imagine if prices at Macy’s were at all-time highs this Christmas? It’s safe to say there’d be no lines and unbelievable service.  But if you apply the same attribute to the Dow Jones Industrials, for example, it’s only then that people really start to get interested.

“Decades of research into behavioral analysis suggests that people chase returns,” says Jeff Kleintop, chief market strategist at LPL Financial who just published a report on the subject. “They don’t get ahead of them, they get behind them.”

And right now there’s an even greater enticement out there than the seemingly endless string of new all-time highs that stocks have posted this year. Specifically, five-year average returns.

That’s right. Kleintop’s research shows that it’s five-year average returns that influence investors the most, acknowledging that the one-year and three-year averages have been hugely positive for years already.

Of course it’s no secret that the second half of 2008 was a disaster for the stock market, but Kleintop says for the first time in years, the one, three and five-year averages are all boasting double-digits returns. A number that not only makes 2% bond returns look all the more feeble, but one that is also about to get even great as the averages shoot north of 20%.

“It’s the 5-year trailing return that individual investors have (historically) tended to follow with the (money)-flows into U.S. equity mutual funds,” he says.

“Investors are worried they’re missing out and they’re finally moving in en masse,” he says. “Individual investors have trillions of dollars that they could move into this market and they’re just starting to do it.”

According to Russell Investments, hitting a high mark doesn’t necessarily signal the end of this rally.  So it may not be too late for investing newcomers.  As the chart below shows, most of the 62 market peaks since 1995 don’t look like peaks when considered in a historical context.  And when you view current valuations, stocks aren’t necessarily over-valued.


All things considered, this bull market may be long from over.

Sources: Russell Investments, Morningstar, Bloomberg and Yahoo! Finance



Why Investors Should Ignore Economists

By Morgan Korn | Daily Ticker


Ben Bernanke, chairman of the Federal Reserve and inarguably one of the most important economists today, has publicly chided his fellow economic brethren for their inability to correctly forecast the future.  “Economics is a highly sophisticated field of thought that is superb at explaining to policymakers precisely why the choices they made in the past were wrong,” he told Princeton University graduates this May. “About the future, not so much.”

This week Bernanke and other central bankers will convene in Jackson Hole, Wyo., for their annual summer retreat. They’ll speculate, they’ll pontificate and they’ll ruminate about how to fix the sluggish U.S. economy and boost job growth. Solutions and proposals will be shared and debated. But very few of this year’s attendees will accurately predict how the U.S. or global economy will perform next year.

For these reasons investors are better off tuning out the economic noise, says Barry Ritholtz, CIO of The Ritholtz Group.  “Economists distract investors from what’s important,” he tells The Daily Ticker.

Ritholtz points to the monthly nonfarm payrolls number as a perfect example of what he’s talking about — a data point that is closely tracked by investors, economists and policymakers. An upside surprise in the jobs report could lead to a 100-point spike in the Dow Jones Industrial Average. Yet a number that misses the consensus estimate could send U.S. markets plunging. Ritholtz says these diversions confuse investors and cause them to take their eye off the [investing] ball.  “The jobs report is overrated… it’s meaningless,” he says. “All we care about are the long-term trends: is the economy creating jobs? Are wages going up or are wages flat? What does this mean relative to inflation?”

Ritholtz lists 10 reasons why economists should not be taken too seriously in a recent Washington Post editorial. There are exceptions to every rule, and Ritholtz does name a handful of economists that he says are getting it right.  When it comes to grading the Federal Open Market Committee (FOMC), Ritholtz does not hold back:

“The Fed overly relies on models,” he argues. “They’re kind of winging it. I think they’re doing the best they can do. They don’t have a cooperative Congress. They’re in uncharted waters. They’re flinging stuff against the barn wall to see what sticks.”

Bond Investors Struggle With Recent Losses

As U.S. stocks continue their recent rally, the bond markets gave up ground in May and so far in June.  U.S. bond funds suffered their second-worst withdrawals last week in more than two decades after speculation about an eventual end to the Federal Reserve’s bond purchases sent fixed-income markets lower.

Investors pulled $9.1 billion from fixed-income mutual funds and exchange-traded funds in the week ended June 5, Denver-based Lipper said yesterday in an e-mailed statement. That’s the second-biggest redemptions for a week since the company started tracking the data in 1992. Corporate high-yield funds saw redemptions of $3.2 billion, Lipper said, the largest weekly withdrawal on record.

While retail investors have favored the perceived safety of bond funds over equity funds since the financial crisis, money managers and analysts have been predicting a reversal as interest rates near zero would eventually rise and send bond prices lower. Global bond markets posted their biggest monthly losses in nine years in May, as the more than $40 trillion of bonds in the Bank of America Merrill Lynch Global Broad Market Index fell 1.5 percent on average.

Market ‘Disarray’

Federal Reserve Chairman Ben S. Bernanke told Congress on May 22 that the central bank’s policy-setting board could start scaling back its bond purchases in its “next few meetings,” if the U.S. employment outlook shows sustained improvement.

Economists polled by Bloomberg this week predicted the Fed will trim its so-called quantitative easing program to $65 billion a month at the Oct. 29-30 meeting of the Federal Open Market Committee, from the current level of $85 billion.

‘Keeps Going’

“Every year for the past four years, people have said the bond trade is over and yet it keeps going,” Lee Spelman, head of U.S. equity client portfolio managers at New York-based JP Morgan Asset Management, said in an interview last month.

Economists surveyed by Bloomberg expect U.S. rates to rise over the next four quarters.

Jeffrey Gundlach disagrees. The manager of the $41 billion DoubleLine Total Return Fund, said this week that while rates may move higher in the near-term, he expects the yield on the 10-year U.S. Treasury note to drop to 1.7 percent by the end of the year. It closed yesterday at 2.08 percent, according to data compiled by Bloomberg.  “It’s a horrible time to be exiting bonds,” Gundlach said.

Meanwhile, Loomis Sayles & Co. is buying 30-year Treasury bonds on a bet that the Federal Reserve will continue printing money, according to money manager, Matt Eagan.  The Fed’s bond-buying plan “will be around longer than the market thought,” Eagan, who is co-portfolio manager of the Loomis Sayles Strategic Alpha Fund and Strategic Income Fund, told reporters in London today. “The economy is not strong enough despite the recovery. The market is getting ahead of itself. Even if the Fed starts to taper, they will still be injecting liquidity into the market.”

Source: Bloomberg News


From Here to QEternity

It’s been just over four years since the Federal Reserve announced the first of several rounds of Quantitative Easing (“QE”) programs launching the most aggressive monetary intervention program in U.S. history.  Every time one of the QE programs has ended the economy and markets have pulled back.  So this last time the Fed stepped back in, it decided to leave the program open-ended.

In case you are wondering how long this round will last?  In short, we do not know, however, it may be longer than you can imagine – if history is a guide.

In 1935, at the urging of the US Treasury, the Federal Reserve announced a standing bid for US Treasuries at 2.5% (the price depended on the maturity and coupon rate of the bonds). This standing bid essentially put a floor underneath the price of US Treasury bonds so that any buyer of bonds had limited risk. This was the point. The US government needed bond buyers to be confident of their purchases.  This standing bid lasted for 17 years, until 1951.

During this time, inflation fluctuated wildly due to the recession of 1937-1939, the second World War, and the boom that followed that war. Inflation was briefly negative at a couple of points during that time frame, and also reached near 20%. And the yield on US Treasuries never rose above 2.5% because of the Fed.

The point is that Keynes, the noted economist, might have been wrong about many things, but one statement stands out as solid – the markets can remain irrational longer than you can remain solvent. Of course this statement requires an ending phrase – particularly when the market is driven by a guy with a printing press!

Source: Rodney Johnson, HS Dent Investment Management

Secular Resurgence of U.S. Manufacturing

The U.S. manufacturing sector is in the early innings of a long-term resurgence that will likely have far-reaching effects across the economy. While the sector lost many jobs during the past decade, this period of major adjustment has allowed manufacturing to emerge with greater efficiency and competitiveness.

Since 2002, U.S. manufacturing output has increased 17%, but costs have declined in several areas. Manufacturers reduced their unit labor costs significantly, and when paired with the weakness in the dollar over the same period, U.S. manufacturing labor costs have become much more competitive versus other economies in the global market. In addition, manufacturing has benefited from dramatically higher energy efficiency and lower energy prices. Even with the increase in output, energy consumption has fallen 16% since 2002, and U.S. prices for natural gas and electricity—which respectively constitute 30% and 13% of manufacturers’ energy needs—are now among the lowest in the world, thanks to technological advancements in shale production that have yielded a natural gas bonanza.

Despite the sector’s share of GDP contracting from 28% in 1953 to 12% in 2010, manufacturing remains an important contributor to U.S. economic growth.  Globally, manufacturing employment has tended to fall due to productivity gains and competitive pressures, and the U.S. has been no exception–manufacturing has shed 3 million jobs since 2002.  After the recession, however, U.S. manufacturing employment has slowly improved and should continue to benefit as domestic and foreign firms relocate to profit from the improvement in U.S. competitiveness and to avoid the high costs of shipping and supply chains.

Manufacturing may have the largest multiplier effect of any sector in the economy. According to the National Association of Manufacturers, every $1 in final sales supports $1.34 in economic activity in non-manufacturing sectors such as construction and services. Manufacturing also contributes significantly to national productivity growth and provides about two-thirds of private sector research and development.  And with manufactured goods comprising more than 50% of U.S. exports, a healthy manufacturing sector has broad implications for trade deficit reduction.  The resurgence in U.S. manufacturing is thus poised to provide a broad-based tailwind for the U.S. economy for years to come.

Source: Fidelity Investments