Executive Summary
- Though markets were whipsawed by the announcement, the Fed’s plan to step aside and allow normalization is a good thing.
- Today, the primary risk for investors to hedge is economic growth and the strong equity returns it tends to produce — not financial Armageddon.
- While risks in Europe and China persist, U.S. fundamentals look relatively strong.
- Two consecutive quarters of S&P 500 earnings growth prompts a forecast update.
First-Half 2013 in Review: A “Tale of Two Markets” Is Now “Getting Back to Normal”
The global equity market continued to be dominated by U.S. stocks during the first six months of the year, with small- and mid-cap equities leading the way (as they have also done for the past 12 months). This domestic success may have given some investors the mistaken impression that all is well in global markets in 2013, though international developed markets trail the U.S. by a considerable margin this year and emerging markets have tumbled.
But the big action has been in fixed income. Bonds have been the best performing and safest asset class over the past five years; not only have they been a logical defensive play against raging macro risks, they have also benefited from highly accommodative global central bank activity — led by the U.S. Federal Reserve before spreading to Europe and most recently Japan — that sent bond prices higher and yields lower. We described the environment in the first several months of 2013, in which bond yields continued to drop in the face of rising equity prices, as a “tale of two markets”. But May saw increased talk of Fed plans to taper its quantitative easing program and the central bank in June revealed a “potential” QE end date; bonds got hammered as a result, and we dubbed the developments “getting back to normal”. Through the first half equity returns have trounced bond returns by more than 1,000 basis points, it has been an arduous, unusual and unconventional five-year journey for the markets. Normal has never been so welcome.
Midyear Update in Forecasts
Normal has also been followed by two consecutive quarters of positive earnings growth. This is significant and different than the negative earnings growth reading we had at the start of 2013. To review the environment entering 2013, after 11 consecutive quarters of year-over-year earnings expansion, S&P 500 companies issued a negative earnings print in third quarter 2012, usually a warning signal of impending market malaise. However, Corporate America has gotten back on track after that one-quarter hiccup, posting positive growth in fourth quarter 2012 and first quarter 2013.
In light of this change of trend we take the opportunity at our midyear review to make the following forecast changes:
Tectonic Shifts
In the first half of 2013, our Tectonic Shifts — in particular, Energy and Technology — have shown themselves to be catalysts for economic growth, we believe more significant than the market is currently discounting. In Energy, the U.S. is increasing exports of oil and gas and decreasing its imports at a faster rate than the market expected; because of this trend, we expect the trade deficit that has persistently detracted from the country’s growth since 1975 will turn into a surplus within two years. In Technology, meanwhile, “Big Data” is impacting every economic sector and creating top-line, bottom-line and quality-of-life opportunities considered far off even a short time ago.
Portfolio Construction:
“Getting back to normal” is a paradigm shift suggesting that the best hedge against future market volatility is equity ownership. For those investors still defensively positioned, it’s not too late to rebalance back to a standard allocation, such as 60% equities/40% bonds.
This commentary has been prepared by ING U.S. Investment Management for informational purposes. Nothing contained herein should be construed as (i) an offer to sell or solicitation of an offer to buy any security or (ii) a recommendation as to the advisability of investing in, purchasing or selling any security. Any opinions expressed herein reflect our judgment and are subject to change. Certain of the statements contained herein are statements of future expectations and other forward-looking statements that are based on management’s current views and assumptions and involve known and unknown risks and uncertainties that could cause actual results, performance or events to differ materially from those expressed or implied in such statements. Actual results, performance or events may differ materially from those in such statements due to, without limitation, (1) general economic conditions, (2) performance of financial markets, (3) interest rate levels, (4) increasing levels of loan defaults (5) changes in laws and regulations and (6) changes in the policies of governments and/or regulatory authorities.
The opinions, views and information expressed in this commentary regarding holdings are subject to change without notice. The information provided regarding holdings is not a recommendation to buy or sell any security. Fund holdings are fluid and are subject to daily change based on market conditions and other factors.
Past performance is no guarantee of future results.
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