As Thanksgiving came and went, Wall Street put taper concerns aside. The S&P 500 climbed another 2.8% bringing YTD total returns on the index to 29.12%, the best performance since 1997.
Domestic small-cap stocks beat large-caps with the S&P Small Cap 600 adding another 4.38% to finish the month up 37.8% YTD.
International equity markets were mixed. Developed markets as measured by the MSCI EAFE Index were flat, up less than 1%, while Emerging markets as measured by the MSCI EEM Index declined 2%.
Overall, developed markets finished near their peak creating unease that an equity bubble is inflating. But is it a record market? After adjusting for inflation the S&P 500 index remains well below its 2000 level. As for emerging markets, they remain 22% lower than their October 2007 highs. Yet, the risk of a correction in stock prices always looms and explains why investors should take a balanced approach, one that accounts for all investment related considerations, including the amount of bonds to own and whether or not to hold any cash.
Steady third quarter earnings and a stronger than forecast US jobs report pushed interest rates slightly higher for the month. The 10-year U.S. Treasury closed at 2.75% from October’s 2.55%, and year-end 2012’s 1.75%. In the Treasury markets, one-to-three and three-to-five year maturity bands returned 0.16% and 0.28% respectively. Led by the U.S. Treasury 20+ Year Bond Index, which was down 2.7% and off 12.25% YTD, all other segments of the curve were negative for the month,
The investment-grade tax-exempt municipal bond market, as tracked by the S&P National AMT-Free Municipal Bond Index, finished the month down 0.25%. YTD, the index is down 2.87%. The S&P U.S. Issued Investment Grade Corporate Bond Index fell 0.26% for the month. YTD the index is down 1.4%. The S&P U.S. High Yield Corporate Bond Index returned 0.37% for the month. YTD the index is up 5.93%.
The Dow Jones-UBS Commodity Index declined 80 basis points bringing YTD performance on the index to negative 11%. Oil prices decreased while precious metals, which hit their lowest level since July, made up the worst performing sector in the index, down 6% MTD and 27% YTD.
Despite some improvement in the labor market, the Fed is debating how to optimally support an economy that remains sluggish while maneuvering its way out of the quantitative easing box. Some argue for a shift away from the Fed’s monthly purchases of Treasuries and mortgage backed securities to a policy of reducing the interest rate paid on funds that banks keep on deposit with the central bank. These payments serve as a way of keeping inflation under control. However with U.S. inflation sagging to under 1%, some economists argue that it may well be time for the Fed to revisit the payment policy in order to get the banks to start lending again.
While tapering of the Treasuries and mortgage asset purchases may be off the table in the near term, the eventual curbing of the Fed’s quantitative easing program opens the door for interest rates to rise sooner than expected. Next year, investors will be able to buy floating rate US Treasury notes. The yield will be based on the 13―week Treasury bill yield.
Not surprisingly, hedge funds are increasingly muscling their way into the mass market. These funds are bounded by a lack of transparency and little regulation. It is best to avoid unnecessary risk and steer clear of these products.
In the spirit of Thanksgiving, we can be thankful for the U.S. averting a fiscal cliff and not defaulting on its debt, and for inflation staying under control. Also notable, is the Eurozone avoiding another crisis as did the emerging markets. And China’s economy staid put on its rails.