March proved to be a bumpy road for global stocks. The S&P 500 fell 1.6% on modest economic data and mixed earnings reports. The unemployment rate remained unchanged, inflation was positive at 0.2%, and the consumer confidence index increased slightly to 101.3. U.S. large stocks were outperformed by small stocks as the Russell 2000 posted a 1.7% gain. It was a similar story for international stocks as international large cap fell 1.5% and international small ticked down 1.0%. Emerging markets also fell 1.4%. Bond returns were mostly positive as the 10‐year U.S. Treasury yield fell to 1.9%. U.S. intermediate‐term bonds returned 0.5% and international bonds gained 0.9%, but inflation‐protected bonds fell 0.5%. REITs, which over the past year have spoiled investors with extraordinary returns, were flat for the month. After a solid February return, commodities fell 5.1%.
- The final estimate of fourth quarter U.S. real GDP growth remained at 2.2%, unchanged from the second estimate but below the initial estimate of 2.6%.
- Inflation (CPI) in the most recent month was 0.2% bringing the year‐over‐year inflation rate to ‐0.1%.
- The March jobs report was weaker than expected with employers adding just 126,000 jobs. The U.S. unemployment rate remained at 5.5%.
- The S&P 500 Index returned ‐1.6% and U.S. small stocks gained 1.7%. Returns were predominantly negative across sectors except for healthcare, which returned 0.9% for the month.
- Developed international large cap stocks fell 1.5%. The UK was a drag on the index with a 5.8% decline.
- Emerging markets fell 1.4%. Brazil pulled down the index with a decline of 11.3% as President Rousseff received continued accusations of political corruption.
- The 10‐year U.S. Treasury yield fell to 1.9%, down from 2.0% the month prior.
- The Federal Reserve gave investors more confidence that they will raise short‐term rates in the near future.
- REITs were flat for the month, and commodities declined 5.1% primarily due to a 9.2% decline in energy.
FOMC: from “patient” to “cautious”
The Federal Open Market Committee (FOMC) met on March 14th to discuss monetary policy. As many anticipated, they changed their stance on raising rates from being “patient” to being “cautious.” While this may seem like merely a change in semantics, it actually provided forward guidance to markets that the committee is likely to raise short‐term interest rates in the near future. Most analysts forecast the first rate hike to fall between June and September.
So the big question is: how will this affect your portfolio? Many are particularly concerned with how this will affect their bond portfolio. As we know when yields rise, bond prices fall, which can lead to short‐term losses that will eventually be offset by higher yields. Because of this it may seem intuitive for concerned investors to flee to cash or short‐term bonds.
What many investors don’t realize is that the market has already “priced in” the expected rise in rates. Short‐term treasuries are yielding near zero and intermediate treasuries are yielding around 2%. This means that holders of longer maturity bonds are being paid a premium for taking on interest rate risk. So, longer‐term rates might not be as affected when the Federal Reserve (Fed) raises short‐term rates. The Fed only has influence over short‐term rates, while the market sets longer‐term rates, where higher yields are already priced in.
In summary, rising interest rates should not be as scary as it seems on the surface. Higher yields are actually a sign of a better economy. Also, it is reasonable to expect that the Fed will make a smooth transition to higher rates by raising rates slowly. Furthermore, income tends to be the bigger driver of bond performance for longterm investors, so higher rates could be good for those with longterm investment horizons. Bonds remain an important tool for preserving capital and hedging the higher volatility in equities.
Sources: Bureau of Economic Analysis (BEA), Federal Reserve, Institute for Supply Management, JP Morgan, Morningstar Direct, Standard and Poor's, Wells Fargo, Yahoo! Finance, BofA Merrill Lynch, wsj.com