BRADLEY S. LATOUR, Vice President at Indiana Trust Company, has been elected to the Friends of the David Owsley Museum of Art Executive Committee at Ball State University. “I’ll witness the vision of the museum’s new director unfold,” said Brad. “It’s an exciting time to be involved with the university.”
Volatility returned to equities markets in Q3. A strong August was followed by losses in September, when any rallies began to focus around selected winners rather than benefitting stocks across the board. Investors exhibited a decided preference for large caps; the S&P 500 closed above 2,000 for the first time ever and the Dow industrials also set new all-time highs. The Nasdaq returned to a level it hadn't seen since March 2000 and regained the lead for 2014. However, the Russell 2000, which has struggled for most of the year, fell deeper into negative territory year-to-date, while the Global Dow suffered from political conflicts abroad and concerns about global growth.
Bond investors continued to demonstrate surprising resilience. In early September, the yield on the benchmark 10-year Treasury fell to 2.35%--a level it hadn't seen in more than a year--as prices rose. However, as the Federal Reserve continued to taper its economic support and ramped up discussion of how and when to increase rates, demand began to taper off (though geopolitical anxieties and a strengthening dollar kept the decline in check). Gold, which started the quarter at roughly $1,320, ended below $1,220. It was hurt in part by a stronger U.S. dollar, which by the end of the quarter had hit its highest level against the euro in almost two years. Dollar strength coupled with weaker global demand also meant lower oil prices; a barrel fell from $107 a barrel to roughly $93 during the quarter, a level it hasn't seen since January.
Click on the link below to read the full story.
Throughout the second quarter of 2014, stocks rallied from a chilly first quarter performance. Lackluster returns in the first quarter were feared to be the beginning of the long-awaited “correction” in global stocks. Instead, the slow beginning to the year turned out to be a temporary case of frostbite in the global equity market. Despite the recent substantial downward re-statement of U.S. GDP growth for the first quarter to -2.1%, equity returns gathered steam in the second quarter, especially in international equity markets.
The U.S. equity market saw gains through the second quarter, benefitting from improving economic data, continued low interest rates, and remarkably low volatility. Indeed, by one measure, stock market volatility was recently at a low point not seen over the last decade. Some believe this is a reflection of investor complacency in the face of major near term risks: conflict in the Middle East and the potential for a sooner-than-expected interest rate increase by the Federal Reserve. Alternatively, the lack of volatility may be attributable to market and economic developments that have roughly met investor expectations already “priced in” to stocks: decent growth in corporate earnings, low inflation, and the Fed’s reaffirmation of its projection to hold interest rates steady until at least mid-2015.
Stronger returns abroad were boosted by relaxed tension in Eastern Europe and by the European Central Bank (ECB)’s joining the “easy money” camp of the Japanese central bank and the U.S. Federal Reserve. In an attempt to jump-start the economy, the ECB reduced overnight lending interest rates to a record low of 0.15%. It also reduced its overnight bank deposit rate to -0.1%, meaning European banks now pay the ECB interest for keeping reserves on deposit. This is one monetary stimulus step further than the Federal Reserve has taken in this country, as the Fed pays interest to U.S. banks on reserve deposits (a policy first implemented in 2008).
U.S. large cap stocks returned 5.2% in the second quarter while small cap stocks advanced 2.1%. Oil prices rose in the second quarter as worries arose about stability in Iraq, which drove oil and oil services companies’ stocks higher. The energy sector as a whole was up over 10% in the second quarter. Mergers and acquisitions activity also bolstered stocks in the quarter. Health care companies such as Medtronic, a leading medical device maker, sought out international acquisitions for strategic and tax reasons. The utilities sector also saw increased takeover activity.
European stocks rose over 3% in the second quarter. Mario Draghi, the head of the European Central Bank, loosened European monetary policy during the quarter in an effort to spur bank lending and to ward off the threat of deflation. As deflation dampens demand and shrinks economic activity, falling price levels increase the relative debt service burden for countries with high levels of debt such as Spain, Italy, and Portugal. The IMF urged the Europeans to undertake a similar quantitative easing strategy to that implemented by the U.S. as another policy move to thwart deflationary pressures.
Like large oil company stocks in the U.S., energy company stocks in Europe such as BP and Royal Dutch Shell rallied strongly in the second quarter. Acquisition activity also helped returns in Europe. One example was Bayer’s purchase of Merck’s consumer products division for $14 billion, which includes the Claritin and Coppertone brands. The euro weakened in the second quarter relative to the dollar (-1%), dampening overall stock returns for U.S. investors.
In Asia, Japan’s equity market rebounded in the second quarter (up 5%). Investors in Japan have shrugged off the 3% national sales tax which took effect in the quarter. Japan also appears to be on target to achieve its goal of 2% annual inflation – a notable achievement, as the last year Japan experienced at least 2% inflation was 1991. The Hong Kong stock market rose over 8% for the quarter, driven by gains in shares of financial companies. Hong Kong’s primary stock exchange announced that it was establishing links with exchanges in mainland China.
Emerging market stocks rose sharply in the second quarter (+6.6%) after a string of quarters with relative underperformance versus developed markets. Again, rising oil prices helped markets in commodity driven countries like Russia, where stocks rose by 11%. India’s stock market also leapt by 15% as a pro-business prime minister, Narenda Modi, was elected with the promise of an end to years of political stalemate. The Thailand stock market gained 9% despite a military coup in that country. Brazil’s equity market rose by 8% in the quarter; it is a presidential election year in Brazil, where high inflation has led the Brazilian central bank to raise its key lending rate to 11%. Brazilians are left wondering if there was a policy prescription which could have addressed the Brazilian national soccer team’s performance versus Germany in the World Cup. The Brazilians had not lost a competitive home match since 1975.
Meanwhile, in the U.S. bond market, the Federal Reserve continued tapering its bond purchases in the second quarter and announced in early July that it would cease purchasing bonds in October. Despite the ongoing exit by the Fed from the bond market, interest rates fell further in the second quarter. Longer-dated bonds had another strong quarter, as their prices benefit the most when interest rates decline. The overall U.S. investment grade bond market rose by 2.0% in the first quarter.
The low interest rate environment has provided ongoing incentive for corporate borrowing and refinancing of existing debt. Investment grade and high yield corporate bonds had a good quarter. Municipal bonds continued to rally in 2014 (+2.6%), as many state and local governments have seen upticks in tax revenues and stabilizing fiscal conditions.
Bond markets also rallied in Europe as investors reacted to the European Central Bank interest rate cuts. At the end of June, Germany’s 10 year note yielded 1.25%. Italy’s 10-year note yielded 2.85%, not far off the U.S. 10-year note yielding 2.53%. The extremely low interest rate levels abroad seem to be placing a “ceiling” on interest rates here in the U.S.
Athena Nominees Announced Lavone Whitmer, Vice President and Portfolio Manager located in our Muncie office has been nominated for the 2014 ATHENA Leadership Award. The award, presented locally by Women In Business Unlimited, honors individuals who strive toward the highest levels of personal and professional accomplishment, who excel in their chosen field, devote time and energy to their community in a meaningful way, and forge paths of leadership for other women to follow.
In addition to her contributions to Indiana Trust, Lavone serves as president of the local YWCA board and is involved in many other organizations and projects that benefit women and citizens of her community, including Altrusa International, A Better Way, and the CFA Society.
The low interest rate environment continues to be the defining characteristic of global capital markets. In 2013, the Fed tried to lower longer term interest rates using Quantitative Easing: a bond purchasing program with the intent to keep rates low and to thus stimulate the economy. The Fed has been buying $85 billion in bonds every month. In December, due to strengthening economic conditions in the U.S., the Fed announced a taper of purchases to $75 billion for its January purchases.
Bond investors are continually weighing the potential for higher interest rates against forces that keep rates low. As the market priced in the Fed’s future reduction of bond purchases, interest rates on longer term bonds rose in 2013. The 10-year U.S. Treasury note, an indicator of broad market interest rates, ended 2013 just above 3% whereas it began the year under 2%.
As the tapering of bond purchases begins in 2014, interest rates are falling rather than rising. The 10-year Treasury note is now below 2.7%. Forces keeping a lid on interest rates have begun to take precedence: U.S. dollar strength and the demand for less-risky assets, below-target inflation, and low short-term interest rate policy.
Emerging markets face a double-edged sword as it relates to the Fed’s Quantitative Easing program. Emerging market countries initially complained about Quantitative Easing as it weakened the U.S. dollar relative to their own currencies. This makes their exports less competitive. However, these same economies benefitted from Quantitative Easing as investors sought out their stock and bond markets in search for yield.
In January 2014, investors have been pulling money out of emerging markets and returning to the U.S. due to higher yields now available – which have come about as a result of the reduction in Quantitative Easing. Emerging market currencies have weakened which is good for their exporters, but those countries are now feeling the impact of capital flight in terms of higher inflation, higher interest rates, and weaker stock markets. This has led to general risk aversion at the start of 2014 which has crept into developed countries, generating declines in those stock markets.
Inflation and short-term interest rates in developed markets continue to be quite low. In 2013, inflation (CPI) in the U.S. was 1.5%. Euro zone inflation stands at 0.8% - the concern now is that Europe is entering a period of deflation. To meet its dual mandate of maximum employment and stable prices, the Federal Reserve has not wavered in its desire to keep its target short term interest rate at zero. The European Central Bank cut its short-term rate in November for similar reasons. These are all forces which may continue to keep interest rates low for an extended period. In such a low interest rate environment, stocks become attractive for capital growth potential. Along with strong corporate earnings and fair valuations, the low interest rate environment was a primary reason for the stock market’s low volatility and strong returns over the last two years.