Market Update: Dec 7, 2014

November Review:

U.S. stocks continued their positive trend in November as U.S. 3rd – quarter growth was revised up, to 3.9%. The positive news helped propel returns on the S&P 500 index, to 2.69% for the month, bringing YTD returns on the index to a healthy 13.98%. The S&P Mid Cap 400 index returned 1.85% for the month while the S&P U.S. Small Cap 600 index declined slightly. At month end, YTD returns for the S&P Mid Cap index were 8.87% and 2.82% for the S&P Small Cap index. Volatility continued to decline from its mid-October peak.

While the U.S. ended quantitative easing, the People's Bank of China, the European Central Bank and the Bank of Japan embraced monetary stimulus. The resulting optimism sent returns on the MSCI World Ex U.S. index 1.23% higher for the month. In U.S. dollar terms, European stock returns rebounded 2.66%. It was a mixed month for Asian-Pacific equities. China, Hong Kong and Taiwan collectively posted a hefty 4.49% return but continued steep declines in the price of oil weighed on the Australian markets and the energy sector in particular. Despite tipping into a technical recession, Japanese Large Cap stocks finished November in positive monthly territory for the first time since July.

Overall, developed markets, as measured by the MSCI World index, ended the month with solid 6.6% YTD returns. However, absent the robust U.S. performance, the Ex-U.S. markets ended the period with negative 1% YTD results. From a macro-economic perspective, lower energy costs and a fall in foreign currencies are reasons to be optimistic towards foreign corporate profits over the intermediate-term.

Emerging Market country returns, for the most part, were positive in November, but consolidated returns, as measured by the MSCI Emerging Markets index, were negative 1%. Lower oil prices pushed currencies and markets down for countries dominated by petroleum production. Russian markets returned negative 10.78%. Columbia performed worst, finishing the month with negative 13% returns. Turkey did the best, returning 7.46%. Emerging markets have endured a torrid year. Still, the broad MSCI Emerging market index and the corresponding small cap index finished November with 2.54% and 3.97% YTD returns, respectively.

Real estate securities continued their upward momentum in November. Domestic REITs returned 2.11%. Non U.S. REITs returned 0.93%.

Gold sank to $1,165.80. Commodity prices are headed for their fourth straight year of losses. Both medium and long-term treasury yields declined. The U.S. 10 Year Treasury bond closed at 2.19%. The U.S. 30 Year Treasury bond closed at 2.89%. Barclays U.S. aggregate bond index returned 0.71%. The S&P National AMT Free Municipal Bond index was flat. Barclays U.S. Corporate High Yield Index returned negative 1.65%. Barclays U.S. Tips Index returned 0.26%. Italian, French, Irish and Belgian government bond yields fell to record lows. Spain’s benchmark bond yield dropped below 2%. Germany’s 10-year bund rate fell to 0.77%.

The message from the commodity and bond markets is a global economy that is operating below what is required to regain its potential. Yet, at least in the U.S., major stock market indexes are hovering around benchmark highs.

Many analysts find the divergence between stock, bond and commodity markets puzzling and remain concerned that low interest rates may be artificially boosting asset prices. A big question is what will happen when the Federal Reserve changes its interest rate policy? Many observers expect that without a meaningful increase in global economic growth, stock market valuations will come under pressure.

As to what happens next, no one knows for sure. That is the nature of risk. Remember that markets are unpredictable and do not always react the way the experts predict they will. In his Wall Street Journal column, Jason Zweig recently asked readers if they are ready for the next market crash. Citing a series of published experiments, he observed that the stress of a collapsing stock market fundamentally changes how people make financial decisions. The question is, what one can do today to mitigate emotional investment behavior triggered by a future downturn? The answer lies in a sound investment philosophy, a disciplined approach, broad diversification, and a suitable asset allocation based on one’s unique needs and preferences.

Are you prepared for a stock market correction? Do you have questions about your asset allocation? Contact me. I am here to help.

In the News:

An Active Headache for Fund Managers

Financial Times
By John Authers | December 4, 2014

Active Managers Can Only Look Forward to a Better Year Ahead. 2014 has been bad thanks to lower volatility and dispersion.
Read More

How to fix America’s pension system

The Economist
From the Print Edition | November 29th, 2014

Americans are living longer but retiring earlier than they did 50 years ago. Their workplace pensions have become less generous, as has Social Security, and their medical expenses have risen. Given this, they have not saved nearly enough to provide for their old age.
Read More

As Indexes Soar, Active Stock Pickers Can’t Get Off the Ground

The Wall Street Journal
By Jason Zweig | November, 28 2014

Among all mutual funds that invest in big U.S. stocks like those in the S&P 500, only 9.3% are beating the index through Sept. 30, according to Denys Glushkov, a senior researcher at Wharton Research Data Services at the University of Pennsylvania. Although the year isn’t over, that is well under the previous annual low of 12.9% in 1995 and the average of 38.6% over the past quarter-century. Data through Oct. 31 from Lipper, a fund-research firm, show results nearly as dismal.
Read More

Mean Reversion in the Dimensions of Expected Stock Returns

Dimensional Fund Advisors
By Jim Davis |Vice President, DFA | November 18, 2014

This study looks for evidence of mean reversion in the equity, profitability, size, and value premiums. Regressions test for statistical evidence of mean reversion, and trading simulations examine whether mean reversion in historical premiums was strong enough to permit profitable trading strategies. Evidence of mean reversion is weak, and 780 simulated trading strategies show very limited evidence of reliably positive abnormal returns.
Read More   

Disappearing Act of Mutual Funds

Dimensional Fund Advisors
By Wes Crill, PhD |Research, DFA | October. 2014

The mutual fund industry has expanded considerably over the past two decades, but this growth obscures a high attrition rate within the industry. A significant number of mutual funds are closed every year, and these non-surviving funds are often poor performers. Neglecting such underperformance imparts bias in fund rankings. Consequently, investors should take caution in interpreting performance metrics that consist only of funds currently available.
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How MLPs Could Still Move the Needle

The Wall Street Journal
By Jason Zweig | October, 31 2014

In the first 10 trading days of the month, the Alerian MLP Index, the leading measure of performance for these securities, fell 14%—its steepest decline since the financial crisis and nearly triple the drop in the broader S&P 500 stock index over the same period.
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Are You Ready for the Next Market Crash?

The Wall Street Journal
By Jason Zweig | October, 31 2014

Stress brought on by a collapsing stock market fundamentally changes how people make financial decisions. The question is what you can do today to mitigate emotional investment behavior triggered by a future downturn. Taking moderate action now, while markets are still calm, should help you avoid doing something reckless when investing turns suddenly stressful.
Read More