Third Quarter Market Commentary: Let's Reminisce

US stocks have risen each quarter of 2013, outperforming most other asset classes and emerging markets along the way. In the third quarter, the S&P 500 Index rose 5.24% and pushed the year-to-date gain to 19.79%. All sectors within the S&P 500 have produced positive returns this year, although the pro-cyclical groups have outperformed the defensive ones. Despite concerns over job growth, unemployment stuck above 7%, the Federal Reserve’s talk of “tapering” its bond purchase program, and the battle over funding of the Affordable Care Act, the stock market categorized these issues as simply noise and instead focused on the underlying economic recovery and improvement in housing.

Let’s reminisce. It has been 5 years since the subprime crisis of 2008 and collapse of the real estate sector. The fourth quarter of 2008 was an especially disastrous one for US stocks, as concerns over the entire financial system forced merging of Wall Street institutions, and governmental bailouts of others rocked the market. In the fourth quarter of 2008 the S&P 500 dropped 22%, ending the year down a staggering 37%. Stocks would not bottom until March of 2009. Since then investors have digested numerous acronyms, such as TARP, QE, QE2, QE3, LTRO, and more as the government tried to triage the sick economy.

When the S&P 500 reclaimed its all-time high in March of 2013 the media coverage was muted. The popular broad market index has risen nearly 150% from the March 2009 low, yet only recently have asset classes such as bonds and yield-based products been eschewed by investors. Much of the recovery in stock prices reflects the lengthy repair experienced in the housing sector. After the bubble bust, widespread speculative construction of new homes deteriorated. Eventually, the foreclosure pipeline progressed sufficiently to limit cheap supply, leading to a rebound in home prices for most markets. The resulting effect on bank collateral, the willingness of consumers to borrow and corporate executives’ ability to invest has supported high levels of profitability despite lackluster job growth. Consumer confidence has also improved due to low mortgage rates, low inflation and a drop in gasoline prices back to around $3.00.

In all, the performance of US stocks has been strong, corporate balance sheets are healthy and the economy is functioning as expected. In fact, the most dysfunctional aspect of the economy appears to be the US government itself. President Obama effectively scheduled the end of Ben Bernanke’s reign at the Federal Reserve during a media interview this summer. For its part, the Fed had consistently telegraphed its strategy to Wall Street regarding QE and its bond purchase program, as well as the eventual tapering that would be necessary once the economy was on sounder footing. However, the tapering plans were suddenly revised at the September Fed meeting, surprising Wall Street. With the imminent replacement of Bernanke early next year and sudden change in policy, the risk of a lame duck Fed appears plausible and adds to the fiscal and monetary clouds.

Discussions over funding Obamacare, the debt ceiling, and the government shutdown will undoubtedly dominate headlines near term. Dysfunction in Washington is nothing new, although the degree of discord, inflexibility, and bitterness does seem excessive. Fortunately, as the stock market has shown over the last 5 years, it retains the ability to look beyond the noise and focus on the underlying fundamentals of the economy going forward. Given the improvements both in Europe and many emerging markets, the prospects of a synchronized global economic recovery remain positive. This typically helps multinational US corporations and technology companies.

To summarize the year thus far, cyclical sectors have outperformed defensive ones. Domestic stocks have outperformed international stocks. Equities have performed well, while bonds, commodities and supposedly “safer” asset classes have waned. Small stocks have topped larger ones as investors gradually embraced more risky asset classes. Meanwhile, the contentious battle between Democrats and Republicans has yet to be decided with neither side likely to truly proclaim victory.

© Oak Associates

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