Investment Review for Third Quarter 2014

News around the world.

Headlines outlining a number of global events led to fluctuations in the stock and bond markets during the quarter. Events included:

1. Continued fighting and unrest in Ukraine that hurt both relations and trade between Russia and the rest of the developed world
2. A coalition led by the U.S. that began bombing ISIS strongholds in the Middle East
3. Argentina missed an interest payment on its debt
4. Protesters took to the streets in Hong Kong

Most risky assets fell during the quarter, giving back some of the gain that took place during the first half of 2014. U.S. small company stocks and commodities fell the most, and now stand in negative territory for the year. U.S. large company stocks and global infrastructure were the exceptions, gaining 1.1% and 0.3% respectively.

Interest rates changed little during the quarter. As such, investment grade bonds (as a whole) were little changed. In contrast, riskier bonds (such as high yield corporate bonds and foreign bonds) fell but remained positive for the year.

Major asset class returns.

Global yields.

Low levels of inflation, paired with continued monetary easing from central banks, have produced interest rates at or near historic lows throughout the developed world. Short term debt securities issued by the German government, which are considered to be some of the safest securities available, were trading at a negative interest rate during the quarter. In contrast, borrowing costs for some emerging economies, such as India and Brazil, are much higher due to inflationary concerns in those nations.

Labor market update.

With the addition of 1.3 million jobs in 2014, the total number of employed workers within the U.S. now exceeds the previous peak achieved in 2007. Economists are not thrilled with the breakdown between full-time and part-time jobs, and the fact that job gains have not kept up with population growth is a bit troubling. Today, only 62.7 out of every 100 potential workers is employed or looking for a job, a level not seen since 1978.

Central Bank activity.

Over the course of this year, the Federal Reserve has reduced the pace of its monthly bond purchases from $85 billion to $15 billion. With bond purchases expected to end in the near future, the next question on everyone’s mind is “when will the Fed begin raising rates?” While most investors and economists believe rates will begin to rise in 2015, opinions (even within the Federal Reserve itself) vary greatly on exactly when rates will rise and by how much.

Following the introduction of new easing measures in June, the European Central Bank (ECB) announced additional interest rate reductions and a bond purchase program during its September meeting. While details of the asset purchase program were not revealed until October, at that time the ECB stated that the program could potentially reach €1 trillion.

The dollar strengthens.

The U.S. dollar has strengthened recently, in part due to increased central bank activity in Europe and Japan. The strong dollar is great for consumers, but could prove to be problematic to U.S. exporters if the trend continues. Also, the depreciating foreign currencies hurt U.S. investors who own stocks and bonds denominated in those currencies.

Bill Gross leaves PIMCO.

Legendary bond investor Bill Gross left Pacific Investment Management Co. (PIMCO), the firm he founded in 1971, following a year of heavy outflows from his flagship bond fund and a fight with his former CEO. The news marks a huge shift in the mutual fund industry, where the 70-year-old Mr. Gross was widely viewed as one of the most influential bond investors of all time.