27 June 2013 Despite Fed Concerns, Equities Still Look Attractive Markets Roiled by Fears of Fed Moves For some time now, investors have been focused on (and perhaps obsessed with) any hint of a change in US Federal Reserve policy. Last week’s Fed meeting in which chairman Ben Bernanke indicated that the central bank would likely be removing some of its long-standing stimulus added fuel to the fire. Equity market volatility soared last week and stocks took a beating, with the Dow Jones industrial average dropping 1.8% to 14,799, the S&P 500 index declining 2.1% to 1,592 and the Nasdaq composite falling 1.9% to 3,357. Events were even more dramatic in fixed income markets, with US Treasury yields spiking higher (prices move in the opposite direction of yields). For the week, the yield on the 10-year treasury rose from 2.13% to 2.54%. Investor Sentiment Sours It does seem clear that market sentiment has shifted in recent weeks, primarily due to the fact that investors are uncertain about the future path of monetary policy. For years now, policy has moved in only one direction (toward easing) and investors are highly unnerved by the prospect of even a well telegraphed and gradual change by the Federal reserve. The US economy can probably withstand a reduction in the pace of Fed asset purchases (or “tapering� as it is being called), but investors are certainly rattled. It is important to note that the selloff in treasuries and the exodus from bond funds is occurring at a time of lower inflation expectations. In other words, the climb in yields is not being driven by inflation expectations, but rather by investors demanding more compensation to hold bonds. This backup in rates has been particularly harmful to asset classes such as gold and US dividend-paying stocks, which have been hit hard in recent weeks. In addition to concerns over Fed policy, markets have been responding to additional evidence that the global economy is slowing. Last week brought new evidence on that front in the form of weaker Chinese manufacturing data. Although investors have become accustomed to slower growth, they are less used to seeing a slowdown in merging markets and Asia, which until recently have been holding up relatively well despite weaker data from the United states and Europe.
Expect More Volatility, but Stick with Stocks So what does all of this mean for the financial markets? First and foremost, we would point out that higher levels of market volatility should persist for the coming months, but the case for stocks remains intact. Investors are likely to continue to struggle with the possibility of a less dovish Fed and with weaker growth, which will translate into higher levels of uncertainty. That said, however, the basic ingredients of the equity bull market remain intact. Stocks are reasonably priced, interest rates are low, inflation is not a threat and corporate balance sheets remain healthy—all reasons why we believe stock prices should move higher over the intermediate term. Global Outlook Investors have become nervous recently about the path for US Fed policy and the trajectory of Chinese growth. Growth in the US is sub- par by historic standards but, importantly, it is stable, which has emboldened the Fed to talk further about removing some of its stimulus. Eurozone growth is more problematic but the relative stability in periphery bonds has been an important offset to a weaker economic backdrop. Regarding China, most investors had thought that an economic slowing would produce a policy response but this view has been re-assessed lately and caused Chinese shares to fall further. Investors continue to be cautious regarding the Asian region as a whole for now. Goods’ and wage inflation globally is modest and recent readings for consumer prices in the US and Europe have been weak. Monetary policies remain very loose and this still looks a necessity in several of the major regions. Therefore, short rates are likely to stay at ultra-low levels for a protracted period to come. Nonetheless, investors are becoming very sensitive to comments from the Fed that it will ‘taper’ the extent of its policy generosity. Other central banks are generally neutral in their stance. As for the ECB, analysts still expect that it will stay highly accommodative during 2013 and, as previously discussed, it will likely deliver further policy initiatives, albeit the hurdle for these may be higher than initially thought. Bonds German bund yields reached a 14-month high on the back of the Fed’s comments regarding economic growth and the scope to reduce financial stimulus. For the same reasons, US 10-year treasuries hit their highest yield in just under two years. Italian and Spanish bond prices fell for the seventh week as demand for higher-yielding assets was hardest hit. Overall, the Merrill Lynch over 5 year government bond index finished the week almost 2% lower. Currencies The dollar strengthened over the week, especially against the yen, after the Fed commented on the improving economy. The €/$ rate finished the week at 1.31, a weakening of almost 2%.
Commodities Oil prices retreated on the week, on the back of expectations that the Fed will trim its monthly bond purchases as early as September. Brent crude oil closed at $101 per barrel, a fall of almost 5%. Gold prices rebounded at the end of the week, having hit their cheapest level since 2010. However, the price finished the week 7% lower. House View Performance Thomond Asset Management maintains an investment house view on how we feel your funds should be invested with each fund manager. Below we have provided you with the performance of each of these managers on an annualized basis. Fund Manager Zurich New Ireland Standard Life Aviva Friends First Irish life
1 Year 8.10% 4.22% 7.23% 9.41% 7.02% 8.96%
3 Year 17.43% 13.59% 18.73% 19.20% 12.98% 15.34%
5 Year 27.83% 15.27% 22.61% 29.31% 14.11% 33.56%
*Performance provided by Financial Express
Note: The performance of the above portfolios may not directly correlate to an individual’s portfolio. Please speak with your financial advisor to understand your specific portfolios performance. Asset allocations between fund managers will differ. Source: Bloomberg, Aviva Investment Mangers, Zurich Investment Managers & Blackrock