LFC Viewpoint: 2Q2013 Economic Commentary


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2Q2013 edition of LFC Viewpoint, Lee Financial's quarterly summary of the economic markets.

Lee Financial is a fee-only wealth management firm in Dallas-Fort Worth, providing investment management and financial planning & advisory services to clients nationwide.

For more information, please call us 1-800-960-1703 and visit us at www.leefin.com.

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LFC Viewpoint: 2Q2013 Economic Commentary

  1. 1. June 30, 2013 Lee Financial Corporation LFC Viewpoint Market volatility has increased in recent weeks stemming from the Fed’s comments that simply reiterate most of what they have already said they would do: if the U.S. economy continues to pick up momentum and the unemployment figures improve, then the Fed may begin to taper their quantitative easing (QE) program, and the reduction could occur later this year or sometime in 2014. Despite this confirmation, Ben Bernanke seemingly sparked a sell off for both stocks and bonds. While the liquidity infusion the Fed has provided since 2008 has in some ways helped support a sluggish economy, it has in other ways created uncertainty with respect to asset market valuations. As such, an end to quantitative easing would be a welcomed signal regarding the health of the underlying economy, and it could mean a return to a more normal investment environment for stocks and bonds globally. The U.S. stock market has continued its march forward; however, bond-based strategies have been unable to generate positive returns for most investors year-to-date. With the housing market maintaining its recovery coupled with strong U.S. corporate balance sheets, we see positive trends to watch closely over the next 6 – 18 months. We will continue to position portfolios defensively towards interest rates and more offensively towards U.S. growth where appropriate.
  2. 2. ECONOMIC UPDATE 1 Second Quarter Recap U.S. equity markets have delivered a strong performance with the S&P 500 1 returning 13.8% year-to-date, 2.9% of that occurring in the second quarter. Despite the trek forward, this year’s rally has largely been isolated in U.S. stock strategies. In contrast:  The U.S. bond market declined 2.5% 2 year-to-date (after posting a decline of 2.6% in the second quarter).  Gold and emerging economies have experienced large sell-offs year-to-date with gold 3 declining 26.5% and emerging market stocks 4 declining 9.5%.  Oil and natural gas-based strategies saw increased volatility in the third quarter with natural gas 5 declining 13.2% for the second quarter. Interest Rates It’s official: at one point intraday on June 24 th , the ten-year Treasury bond posted a 100 basis points (i.e. 1%) increase in its yield – it took just over 37 trading days to get there with much of the increase occurring in the last several weeks. Despite the quick rise in interest rates, our expectation is that the ten-year Treasury may maintain 2.5 – 3% by year-end, so we have continued to position the portfolios towards less interest rate sensitive investment strategies as well as shorter-term instruments where appropriate. The yield curve should remain steep, which we also believe benefits active management in fixed income markets. Let us take a moment to review how several components of the market performed in this recent interest rate spike:  Exchange Traded Funds (ETFs): Our analysis that fixed income oriented ETFs and closed-end bond mutual funds would be impacted more than open-end mutual funds has proven correct for many of the bond strategies we employ; the ETF counterparts did indeed prove more vulnerable to investment fund flows. In fact, particularly on the heaviest of the selling days, many of the ETF funds also traded at discounts to their Net Asset Values 6 (NAV), which we see as a sign of overactive selling pressures in the marketplace. As such, we have kept allocations to fixed income oriented ETFs and closed-end bond mutual funds to a minimum (as appropriate).  Short duration strategies: Investors with shorter durations – a measure commonly used to estimate the price change of a bond for a given change in interest rates – certainly helped, but even shorter duration strategies were unable to produce positive returns over this time period.  Municipal bond securities: Municipal bonds declined as well, and commentary from one of our long-time managers indicated that they have not seen this dramatic of a sell off (ten year tax-exempt yields have also spiked 100 basis points) since the Lehman bankruptcy in 2008.  Large-cap equities: Large-cap equities held up relatively well, with many of our actively managed large-cap stock funds maintaining a positive return for the quarter.  Small- and mid-cap equities: There was a lot of dispersion in returns among small and mid-cap managers with several proving their worth relative to their broader indices.  Stock dividend strategies: Yield-oriented equities declined more than the broader equity indexes, but their year-to-date returns are now largely in line with broader stock markets. 1 Source: Bloomberg. As measured by the S&P 500 Index (Ticker: SPX). 2 Source: Bloomberg. As measured by the iShares Core Total US Bond Market (Ticker: AGG). 3 Source: Bloomberg. As measured by the SPDR Gold Trust (Ticker: GLD). 4 Source: Bloomberg. As measured by the MSCI Emerging Market Stock Index (Ticker: MXEF). 5 Source: Bloomberg. As measured by the Henry Hub Natural Gas price index. 6 Net Asset Values: A daily price calculated from the assets minus liabilities of the fund.
  3. 3. ECONOMIC UPDATE 2 Domestic Outlook We continue to expect some downward pressure on U.S. economic growth in the coming quarters as state level budget cuts impact the bottom line for U.S. companies and consumers; however, the U.S. housing market has continued to remain strong through the first half of the year, and we are cautiously optimistic in the positive implications this may have for bottom-line corporate earnings growth for the remainder of 2013. Provided mortgage rates remain low – despite the recent increase – home affordability rates may continue to remain near historic lows particularly as average home prices are still well below the levels attained in the last decade (as reflected in the chart to the left). 7 Increasing real estate prices coupled with rising stock markets over the last 18 months could allow economic growth to surprise to the upside with much needed support coming from an improved labor market. We anticipate that this would lead to renewed consumer confidence that could continue to be a positive contributor toward U.S. corporate growth. Particularly as corporations have continued to maintain a lean workforce, any near-term revenue growth would likely be incremental to their bottom- line. With corporate profits remaining stable and cash levels continuing to be at all-time highs, we anticipate mergers and acquisitions to rise over the coming quarters as companies look to invest their cash. Lastly, we continue to be optimistic about domestic energy production and the increased competitive advantage it may offer to the U.S. manufacturing and chemical industries. International Outlook In general, we believe growth will continue to lag in developed economies throughout the remainder of the year given the weak fundamental macro-economic backdrop in Europe. We are comparatively more optimistic about emerging economies as they benefit from secular trends and a recovering U.S. consumer. Additionally, Asia has the potential to surprise to the upside given leadership changes occurring in China and Japan. Global markets have sold off strongly with emerging market debt; equities and inflation (or commodity related strategies) seeing a particularly large decline as well. With China’s economy shifting from an investment led growth engine to a consumer driven economy, their decreased demand for natural resources from the emerging economies of Latin America and Africa could be more than a short-term trend that keeps downward pressure on commodity prices. Additionally, China has taken measures to slow interbank lending among small banks to reign in the credit-driven growth they have experienced over the previous cycle, and the immediate impact may mean struggles for Chinese businesses. From a long-term perspective, tighter regulation of their “shadow banking” system would be well supported by capital markets, but there could be a near-term reset that may occur. For any questions regarding the content discussed or for any other matters pertaining to your portfolios, please contact your Lee Financial investment representative. From all of us at Lee Financial, we thank you for your loyal business! 7 Source: Market Insights: JPMorgan Guide to the Markets® 3Q2013. Data as of 6/30/2013.
  4. 4. ECONOMIC UPDATE 3 Disclaimer The information provided herein is provided for informational purposes only, and does not constitute an offer, solicitation or recommendation to sell or an offer to buy securities, investment products or investment advisory services. It has been prepared without regard to the circumstances and objectives of those who received it. Research prepared by Lee Financial personnel is based on public information. Lee Financial makes every effort to use reliable comprehensive information but we do not represent that it is accurate or complete. All information, views, opinions and estimates are subject to change or correction without notice. Any use of estimates contains forward-looking opinions by the Investment Analyst which may differ from the views of Lee Financial. All estimates are based on assumptions that may not be realized and actual results can be meaningfully different. Actual events in the markets, company or stock may cause adjustments in expectations from those currently expressed within. All securities are subject to actual known and unknown risks, uncertainties and other factors that could cause actual results to differ materially from those projected, including potential of significant losses. These forward-looking statements speak only as of the date of the communication, and do not include transaction fees. Prices, values, interest rates, indicated are based on best current information at the close of the date indicated, and will change. Nothing contained herein constitutes financial, legal, tax, or other advice. The appropriateness of an investment or strategy will depend on an investor’s circumstances and objectives. These opinions may not fit to your financial status, risk and return preferences. Investment recommendations may change and readers are urged to check with their investment advisors before making any investment decisions. Estimates of future performance are based on assumptions that may not be realized. Past performance is not necessarily indicative of future returns.