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Market Commentary
June 2013
Greetings!
At this point, we continue to hold a positive outlook on the market. We are witnessing economic recovery, slow, but recovering. We believe that earnings will persevere even if the Fed were to change its accommodative monetary policies.

As always, the near-term direction of markets is impossible to predict.

Global stock and bond markets have declined in recent weeks. As of June 24, 2013, the S&P 500 Index had fallen 5.8% from its May highs, and even bonds were down over 4% from its April highs. Most foreign stock and bond indexes have fallen even more. In general, the selling pressure has been heavier abroad than in the U.S.

Why is the sell-off occurring?
Central banks have been attempting to keep interest rates low to induce investors to move out of cash and bonds and into riskier assets like stocks and commodities. As investors come to question the Fed's resolve, they also question the wisdom of remaining in those riskier assets. Triggered by the U.S. Federal Reserve commentary, the Fed stated it would curtail its program of purchasing bonds in the open market. The timing of this "tapering" plan has spooked the markets.

It is safe to say Ben Bernanke and the Fed did not intend to instigate a severe market correction. It is also safe to assume that the Fed will do something to mitigating fears. Just this week, Dallas Fed President Richard Fisher (who is not on the policy panel) cautioned investors not to overreact to expected scaling back of quantitative easing.  He stated the Fed will taper cautiously, not "cold turkey". He also said the markets are acting like "feral hogs" testing for weakness. In our opinion, its time for the Fed to get a better PR consultant for their sound bites.

Why is the Fed considering tapering its bond purchases?
The Fed's economic outlook has become more positive.

When will the Fed "taper"?
We believe the Fed will not begin to taper its bond purchases until next year. The economy will have to accelerate significantly in the second half of 2013 to meet the Fed's employment goal. As a political observer, we think Chairman Bernanke will let his successor make that policy decision (unless reappointed, Bernanke's term ends in January).

Is the economy strong enough to withstand tapering?
Yes! However, growth will remain anemic.

Why are bonds getting hit?
In anticipation of interest rates rising, bond prices move inversely.

What makes this correction different?
The usual defensive plays haven't worked. For instance, treasuries haven't rallied. Traditionally defensive sectors like utilities or consumer staples have not been safe-havens. Even dividend-paying stocks have taken a hit.

Why isn't stock/bond diversification working?
Diversification hasn't paid off as well in the short run. The market appears to be in a normal correction mode, unsettling, but normal.  Long term, diversification will work. In our opinion, bonds are stabilizers and diversifiers for the long haul. Bonds are intrinsically different from stocks given the timing and amount of their cash flows (interest and principal payments) are more predictable than stocks'. Even if rates rise, bonds are still less likely to suffer large corrections or experience wild volatility.

Should investors continue to hold bonds?
Yes! We think bonds still have a valuable role to play in portfolios as "shock-absorbers". Bonds also will remain essential to those with shorter time horizons, where capital preservation is primary goal. Remember, bonds come in all shapes, sizes, maturities and risk categories.  Overall, they are a viable asset class.

Based on the information available to us today, this is a correction. We will continue to monitor these events and will keep you informed if the situation changes.

Special thanks to our friends at Morningstar Investment Services.  Some of the content in this communication comes from their wisdom. Their market perspectives have been invaluable resource. The information, data, analyses and opinions presented herein do not constitute investment advice. It is provided solely for informational purposes.

For our clients, please advise us promptly if there are ever any changes in your financial situation or investment objectives.

 

Feel free to give us a call if you want to discuss anything further.

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Bill Harris, CFP