Against All Odds
At first glance, the impressive market performance we saw in this quarter seemed against all odds. US economic data was mixed at best, with improvements in manufacturing and employment figures offset by numbers in housing and the revision of Q1 GDP growth down to -2.9%, the worst so far in this five year recovery. Nevertheless, most asset classes were up for the quarter and unexpectedly, these gains came with reduced volatility in the markets. All in all, given the circumstances, it seemed to be a surprising quarter.
However, taking a closer look, this market performance probably should not come as such a shock. Unemployment continues to drop, but not so fast as to create inflationary concerns from a wage standpoint. Consumer confidence is rising, and businesses are still reporting impressive revenue numbers. Overall, save for the extenuating, weather-related circumstances we saw this past winter, most data reflects a continued recovery, albeit a slow one.
In addition to the improving economy, we also must remember the fundamental tailwinds markets continue to enjoy by way of global monetary policy. While the Federal Reserve continued to taper asset purchases this quarter by $10 billion each month, some have suggested that rate hikes may not be due for at least another year. Regardless of when we actually see this occur, it is becoming apparent that the Fed is in no hurry to raise interest rates.
Overseas, the monetary policy story is not terribly different. While the Bank of Japan has continued to purchase assets, this quarter’s most dramatic actions were seen in Europe. In June, the European Central Bank announced a series of measures to stave off deflation in the Eurozone, including negative interest rates on reserve deposits. This move, though historic, could potentially be the tip of the iceberg, with Mario Draghi stating that the ECB is open to further action in the absence of rising price levels. Undoubtedly, such steps towards looser global monetary policy are playing a role in the reduced volatility in the markets this year.
With that being said, it was not as though this quarter was devoid of concerning headlines. Many eyes still remain on the Chinese economy, which, by many accounts, appears to be slowing down. Chinese policymakers have attempted to right the ship, but attempting to rein in excessive credit imbalances while maintaining a high level of growth has proven difficult. Though Chinese real estate and global commodity markets have been the only major victims so far, concerns of a ripple effect on global financial markets lead us to believe this is a story worth our continued attention.
Elsewhere, geopolitical risks have loomed, occasionally roiling the markets. There are continued concerns over Ukraine, with the situation oscillating between escalation and resolution time and again. The ongoing strife took an even more tragic turn last week, with the downing of a Malaysia Airlines flight over Ukraine, most likely by pro-Russian separatists. Many are speculating that this incident will lead to further sanctions by both the US and the EU against Russia, and increased involvement from the international community.
In Iraq, security conditions appear to be deteriorating, as a strong Islamist insurgency splinters an already divided country. Meanwhile, tensions have heated up again in the Israeli-Palestinian conflict, with Israel launching an offensive against Hamas in the Gaza Strip. All of these situations, while disturbing enough on their own, have added gravity due to their potential to disrupt global energy markets, and in the process unsettle recoveries in the developed world. All of these concerns, though valid, have surprisingly only had fleeting impacts on the markets so far. While we don’t discount the possibility that investors have become too complacent, we still feel that globally, we are seeing continued signs of encouraging growth.
In an environment where we continue to remain cautiously optimistic, we’ve worked to further hone our abilities to balance opportunity and risk. To that end, much of the summer has been spent looking at the dynamics of the various asset classes in which we invest, and how best to allocate them in client portfolios. Our intern this summer, Matt Bean, an MBA student at Texas Christian University, has been invaluable to this project. Combining portfolio management theory with real world applications, he has helped us to develop tools we believe will help us structure portfolios more strategically in the future.
In a world where geopolitical risks multiply, equity market indices reach new highs and central banks continue to ease, there are plenty of causes for concern. Nevertheless, we continue to seek out new opportunities in the markets. As we’ve admitted recently, this is becoming increasingly difficult, and much of our time lately has been dedicated to further building out the tools we use to measure risk. We feel that these efforts will be fruitful, regardless of what may be ahead.
We hope that you enjoy the rest of your summer and, as always, greatly appreciate your support and trust.
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