Investment Review for First Quarter 2014

In a sharp contrast to 2013, real estate and commodities significantly outperformed other risky assets during the first quarter of 2014. Increasing 10.4% and 7.0% respectively, these asset classes far outpaced global stocks that appreciated a modest 1.1%. Emerging market stocks continued to struggle as geopolitical concerns in Russian and Ukraine weighed on investors.

While the general level of interest rates remains well above year-end 2012 levels, intermediate and long-term interest rates fell over the past three months. Increased demand for safer assets during the January stock market decline and Ukrainian conflict likely contributed to the drop in interest rates. Investment grade U.S. bonds rose 1.8% during the quarter and recovered most of their 2013 loss. Similarly, within the riskier, non-core bond category, emerging market bonds rose 3.7% after falling 5.3% the prior year.

Major asset class returns.

Russia and Ukraine.

The situation in Ukraine changed dramatically following the sudden decision to abandon a planned association agreement with the European Union. Citizens gathered in the streets and accused the Ukrainian government of being corrupt, unaccountable, and bowing to Russian pressures. After weeks of continued protest, failed negotiations, an overthrown government, and numerous sanctions, part of Ukraine now belongs to Russia. Questions remain as to what Russia’s next move will be and how this will affect global economic stability and the financial markets.

Corporate earnings and revenue.

Profits for large U.S. corporations increased significantly during 2013. Unfortunately, much of the profit growth was driven by cost cutting and company stock repurchases, rather than from increased sales. With little room for further cost cutting, it will be difficult for corporations to continue to grow profits at current levels without significant increases in sales. Therefore, many analysts have reduced their profit estimates for the first quarter as well as full year 2014.

Federal Reserve activity.

The Federal Reserve announced a reduction in its monthly bond buying program following its March meeting. Beginning in April, monthly asset purchases will be reduced by $10 billion to $55 billion. The aggressive bond buying program, which was recently at $85 billion per month, has led to a ballooning Federal Reserve balance sheet that now exceeds $4.2 trillion. What has yet to be determined, however, is exactly what effect a less active Federal Reserve will have on long-term interest rates, housing and mortgage markets, as well as broader financial conditions in general.

During her first press conference as Chair of the Federal Open Market Committee, Janet Yellen received several questions about the timing of future short-term interest rate hikes. These questions were in response to the economic projections of Federal Reserve participants, which indicated that an interest rate hike may come sooner than expected. In fact, when answering questions, Chair Yellen alluded to a potential interest rate hike approximately six months after the bond buying program ends.

Domestic economic growth.

Domestic economic growth increased modestly at 1.9% during 2013 and outpaced most developed economies including the European Union and Japan. Growth was stronger in the second half of the year, and exceeded 2% for three consecutive quarters. First quarter 2014 numbers, however, will likely be weaker due to the harsh weather conditions experienced in many parts of the country.