Tim Hansen

What's your idea of financial security?

Tim Hansen
Frankfort, IL
Thursday, April 24, 2014

Our economic outlook

An editorial opinion 
by Derek Vogler, CFA
Vice President - Investments

April 16, 2014

A few years ago, two of my colleagues had a spirited conversation about which political party each supported. Neither could understand how the other voted since they both had such strong feelings on their views of the world. Similarly, they were each confused about why the other had selected their party of choice. After a “lively” discussion, they figured out that they actually agreed on most issues. In fact, their views were almost identical. So how did they come about supporting different parties? Simple --  there were a few hot button issues that they weighted differently as they decided how to fill out their ballots. For example, one voted based on his thoughts of fiscal discipline, while the other voted based on his thoughts on social issues, even though they generally agreed on both issues. 

There is a similar experience investors deal with every day in the financial markets. Positive and negative fundamentals and reactions to specific events drive many investment decisions. Yet with the abundance of data points, investors have to decide which to weight more heavily and determine their decision to buy or sell. For example, we would probably all agree that the geo-political risks have been elevated recently given the actions of Russia in Ukraine, the unwinding of years of excesses in China, the constant Eurozone growth problems, etc. We would also probably agree that if we focused only on geo-political risks, we would never buy an equity security again, and instead invest only in U.S. Treasuries so we could sleep well at night.

If, instead, the focus were to be on the positives, most investors would likely agree that fundamentals have continued to improve here in the U.S. as we look at the labor markets, housing, consumer spending, business activity, etc. Those same investors could easily make the case that a more sound economic environment would lead to increasing corporate earnings and higher prospects for the stock market. They would also not feel the need for the ultimate safety derived from U.S. Treasuries, which would cause bonds to decline in value over time.

So which is it? Do we have negative geo-political risks or positive economic fundamentals? We obviously have both. However, as with the decision on which political party to support, investors have to weigh which of these factors they want to focus on, since all are constantly present. There are countless potential catalysts (both positive and negative) lurking at all times, so investors never have an easy job figuring out what is going on in the markets. 

Over the last couple of weeks, investors as a group have decided to concentrate on geo-political issues and other negative influences. The result has been a minor correction in stock prices to the tune of about 4%. In terms of stock market adjustments, this is very minor, especially given the huge run-up in prices over the last few years. Could this mini correction continue? Absolutely, especially given that it has been led by some of the highest valuation, momentum names in the market. But the real question everyone wants answered is if this is the end of the bull market or even the beginning of a large, broad market selloff. At this time, we think that any additional downside will be relatively short-lived and this is a healthy adjustment that is taking some of the froth out of certain areas of the market. If the situation in Ukraine deteriorates, or the risks in China accelerate, certainly this could become more problematic in the near term and lead to a further selloff – providing an even better buying opportunity. Either way, we still expect the underlying economic growth in the U.S. to be strong enough to support   higher stock prices as we progress through the year. 

As investors have become more cautious on stocks, they have increasingly pushed money to the bond market. Part of this movement is likely due to the often-cited flight to safety, but there are a number of other variables that have encouraged investors to take another look at bonds. One reason is an increased demand from international investors as a result of declining yields overseas. Another is continued de-risking of pension fund portfolios by selling equities and buying fixed income assets that better match the future liability streams.

This increased demand for fixed income securities has pushed both investment-grade corporate issues and municipal bond yields lower, providing investors with a return of around 3.0% during the first quarter. While that may not sound overly impressive, it happened at a time when most Wall Street predictions were for below-average gains. Even well respected money managers like PIMCO got it wrong as they have been recommending investors avoid long bonds for fear of the Fed tapering. Instead, the yield on the 30 year U.S. Treasury has fallen to 3.5% from 4.0%, providing investors with a hefty 9.0% return.

The flipside of these positive bond performance numbers is that rates are now back down and investors will find it increasingly difficult to make much return going forward. This relatively unattractive bond environment, combined with healthier economic prospects could be what encourages investors to step back into the stock market and limit the downside of this recent pullback.

People who achieve financial security rarely do so alone

With all of the current economic uncertainty, this is a perfect time to contact your financial representative for an in-depth review of your situation. Backed by a team of experts, your financial representative is equipped to give you the guidance you need. 

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