Cambridge Advisors

In August, stocks started out trading within the range they had traded in for most of the year. Mid-month, investors were shaken when stocks stumbled and posted their worst monthly decline since August 2011.

After a rocky month in July, stocks resumed their march higher in August. The S&P 500 was up 4.0% for the month and is up 9.9% year-to-date. The small cap Russell 2000 index also performed well for the month, up 5.0%. Year-to-date, small cap stocks have lagged and are up only 1.75% as of the end of August. International stocks continued to struggle in August and year-to-date with performance of -0.4% and +2.93% respectively.

Stocks had another strong month in July with the large-cap S&P 500 index up 5.0% and the small-cap Russell 2000 up 7.0%. International stocks in developed markets were also 5.2% higher as measured by the MSCI EAFE index while emerging market stocks were up less than 1%. Bond prices stabilized during the month resulting in only a slight 0.1% gain.

Stocks sold off on the last day of the month but still managed to finish higher in May with the large-cap S&P 500 index up 2.2% and the small-cap Russell 2000 up 4.0%. International stocks finished the month lower with the MSCI EAFE index down -2.9%. Bond prices came under significant pressure as yields rose after Fed Chairman Ben Bernanke hinted that Quantitative Easing may be tapered off sooner than the market expected. The 10-Year US Treasury Yield rose sharply to end the month at 2.16%.

During the month of October, the S&P 500 traded within a 5% range. By the end of the month, stock returns for the S&P 500 reflected a loss of 1.8%. This decline is surprisingly low when you consider the stock market closed unexpectedly for two days and reopened after a major storm that caused extensive damage in highly populated areas along the East Coast. Treasury yields also did not significantly move during the month.

August was characterized by relatively low volatility as stocks continued to grind higher and bond yields traded in a fairly narrow range. The economy saw little change as the slow growth theme continued. European officials mostly took the month off so the sovereign debt crisis fell off the radar for the month. Politics have dominated the headlines, but a close race hasn't provided an impetus for investors to make significant portfolio changes.

More money has flowed out of stock funds and into bond funds consistently over the past three years even though stock returns have outpaced bond returns and forward looking bond fund returns are expected to be low and possibly negative. This movement reflects investor aversion to the inherent risk in stocks. Bond investments tend to provide some stability to a portfolio when stock prices decline.

We continue to deal with the added risk to the global economic system caused by the high degree of debt that exists throughout the developed world. A spirit of cooperation in Europe helped to put those concerns on the back burner in February. Solutions for Greece have been announced however, these are not permanent solutions and the problems go much further than Greece. We expect more turbulence from sovereign debt problems to reemerge in coming months.

The concerns over Europes debt problems continued and contributed to volatility in stock prices and bond prices. Although the markets have responded favorably to the partial solutions that have emerged, the issues are not entirely resolved. In this environment where the outlook can and does change quickly based on unfolding worldwide events, volatility is likely to persist. We continue to believe diversification across asset classes is the prudent strategy in this environment. Bonds provide stability, but stock exposure is needed for long-term growth.

While the improving domestic economic picture seems to be pointing to continued slow growth, the markets are focused on Europe as they continue the tumultuous process of finding a resolution to their debt crisis. Until a long-term solution is found, we will likely continue to experience above average market volatility. In this environment we continue to favor a diversified mix of asset classes with an emphasis on yield.

A consensus of economic analysts expected 1st quarter economic growth to be revised up to 2.2% but instead the final reading was left unchanged at 1.8%. This was a disappointment but the data hints that a good part of the slow growth is attributable to the earthquake/ tsunami / nuclear meltdown in Japan which created very significant supply chain disruptions that led to lower economic activity. These disruptions continued into the 2nd quarter so it is likely we will see disappointing growth continue a little longer.

Stocks pushed through volatility early in the month to post another respectable gain for the month of April. The S&P 500 was up 3% in April and is now up 9% year to date. Bond yields for the month were slightly lower but very close to where they started at the beginning of the year at 3.3% for 10 year Treasury bonds. Gold and oil prices reached new highs again during the month, mostly due to inflation concerns. GDP growth slowed to 1.8% during the first quarter. This was the seventh straight quarter with positive economic growth but it was less than the 20 year average of 2.5%.

We are encouraged by improving economic data on several fronts despite an unfavorable employment picture. As markets continue to heal, we are optimistic that the economic environment will become increasingly favorable for stocks. However, the healing process is far from over and shocks to the system remain a meaningful risk. We believe a well diversified portfolio combined with an emphasis on assets that benefit from a weaker dollar will be an effective strategy in the months ahead.

We have enjoyed the recent rally, but we expect volatility to continue. Investors should remain cautious. It is not necessary to chase stocks higher as buying opportunities are expected to present themselves throughout the next year. If Bill Gross is right, government bonds may not be the safe investment they once were. To reduce risk, broad diversification across many asset classes is the best strategy during these uncertain times.

Compared to U.S. government bonds, stocks may be a better investment if we stay in a slow-growth rather than negative-growth environment. Yields are low and the Federal Reserve is expected to keep short-term rates low for quite some time. Higher yields may be found in corporate bonds or foreign government bonds. Emerging market governments have lower debt as a percentage of their growing GDPs and may also provide higher yields to investors.