2nd Quarter Market Performance
- International stocks continue to outperform U.S. stocks in 2015
- Rates on long-term bonds moved up around half a percent in the quarter
The second quarter was not a particularly exciting one for most investors. Returns ranged between up 1.1% in Pacific market stocks (Japan, Australia, Korea, Hong Kong, Singapore) to down 1.7% in the most widely tracked bond index (the Barclay’s Aggregate bond index).
Long-term interest rates, measured by the 30-year Treasury yield, moved up by half a percent in the quarter—but this didn’t spell doom for investors. And as we covered last quarter, this rise in rates doesn’t automatically spell trouble for stocks and, other than the longest duration bonds, there wasn’t a major impact on intermediate and short-term bond investments either.
A few areas did see significant movement in the quarter. They were: commodities, REITs, managed futures and long-term bonds. All these areas were somewhat impacted (either positively or negatively) by rates rising in the quarter.
Year to date, very little has changed. Pacific market stocks are the best-performing region so far this year and International stocks continue to outperform U.S. stocks. This speaks to the importance of being a disciplined, “deliberate investor,” since it would have been easy to succumb to a “home country” bias and overweight U.S. stocks due to their great run over the last 5 years.
While this deliberate, disciplined approach is indispensable to investment success (because what worked the last few years isn’t necessarily going to work over the next few) there are two additional reasons a global allocation is important right now.
- The US market, while not extremely overvalued, is more expensive than other global markets—especially Europe and the Emerging markets.
- The US market only represents roughly half of the global opportunity set. Focusing solely on US markets leaves out a huge component of the market, and areas that are more attractively priced.
We mentioned that interest rates have moved up some this year and most people expect them to rise further. While this may, or may not happen, the data shows there is currently favorable reward for taking on some duration risk (i.e., the average length of a bond maturity). The additional compensation for owning a 5 yr bond (roughly where we are positioned) vs. a 2-year bond (a typical short-term bond allocation) ranks in the 78% percentile since 1976 (meaning only 22% of the time has the compensation bean greater). This is called a “steep yield curve”.
Additionally, while the level of interest rates is low, so is inflation; more about that in the next section.
Low Yields, High Valuations, But No Inflation: What Does It "Real-ly" Mean?
- After accounting for the current low rate of inflation, yields on bonds and stocks don’t appear as poor as they do before inflation is factored in.
Everyone knows interest rates are low. And many people think the stocks market (at least in the U.S.) is fully valued, or slightly overvalued. But most of the time this measurement, and subsequent assessment, is made before inflation (a nominal basis).
What you as an investor care about is what you can get for your money—it’s purchasing power. How it can support your lifestyle, your financial goals and your objectives.
For example, let’s say inflation is 10%: something (we’ll use a cell phone) that cost you $100 this year costs $110 next year. If you earn 12% on your money, after inflation (called a “real return”) you are only 2% better off. Investing $100 turned it into $112, but it now costs you $110 to purchase the same phone.
But, if inflation is just 2%, netting a 4% return will put you just as far ahead. Your $100 may have only turned into $104, but after you purchase the inflated cell phone for $102, you’re still left with $2 in your pocket—a $2 “real return”.
This fact, that it’s real returns (net of inflation) that matter, is often neglected.
Currently the rate on a 10-year Treasury bond is about 2.3%. This seems quite low and in fact it is, on a nominal basis—sitting in the 4% percentile since 1953 (meaning 96% of the time rates were higher).
With stocks a typical measure of valuation is the Price to Earnings ratio. Using the version created by Yale economics Professor and Nobel Laureate Robert Shiller, the current Cyclically Adjusted Price to Earnings ratio (CAPE) of 26.2 ranks in the highest 10% of all months since 1953.
However, again after adjusting for inflation again we’re about average. The real earnings yield of 3.7% is higher (i.e., cheaper) than all but 75% of months since 1953.
Inflation could obviously move up in the future, but right now, both bond rates and earning yields on stocks appear pretty normal for the last 60-plus years.
If you are a client and have any questions regarding anything covered in this quarterly investment review, please send us an email or give us a call.
If you’re not a client of Cordant, we focus on managing wealth for current and former employees of Intel. If you want to learn more about how we work with our clients you can do so here or feel free to give us a call at 503.621.9207.
 Data on the10-Year Treasury Constant Maturity Rate dates to 1953 in FRED, Federal Reserve Bank of St. Louis https://research.stlouisfed.org/fred2/series/GS10/, July 24, 2015.
 We get the real earning yield by taking the inverse of the CAPE. (1 / CAPE – Inflation)