1Q14 Financial Market Commentary


After a rough 2013, many taxable bond-fund categories rebounded somewhat at the start of this year as rates came down. Long governments led the charge followed by preferred stock and long-term bond.

Following outstanding 2013 returns, stocks saw a meager 0.6% return in the first quarter according to Morningstar U.S. Market Indices. Most stock sectors turned in positive performances for the quarter. Utilities led the way, followed by health care and basic materials. Communications services and consumer cyclical were the worst performers during the past three months.

The first three months of 2014 have been anything but calm. Many strikingly interesting events shaped financial market results during the first quarter. Growing concerns about emerging-markets, effects of weather on retail sales and travel, GM’s massive recalls, the huge fine for Toyota, the Fed leadership change (Bernanke to Yellen), equity valuations, mixed (and sometimes confusing) economic data, and escalating world tensions over Ukraine-Crimea sent stocks on a fairly volatile ride.

Economic data released during the first quarter were far from stellar. From the housing market to manufacturing to jobs, there were too many signs that the economic recovery may be slowing, dampening what had been building hopes at the end of last year that the recovery had gained meaningful traction. The real question was if the weak data was merely an anomaly like the abysmal, perverse weather or a sign of true underlying economic weakness. Economic analysis suggests it is likely a combination of both, with some sectors of the economy seeing a fundamental slowdown while others are only experiencing a temporary shift in demand. GDP is expected to grow between 2.0% and 2.5% for the full year with anticipated improvement in housing, less restrictive fiscal policies, and energy production to power the recovery for the foreseeable future.

The Fed remained a key focus, as well, for investors as Janet Yellen took the reins of the central bank from Ben Bernanke. The Federal Open Market Committee, following its most recent meetings, stayed the course on tapering its quantitative easing program despite the softer economic data. The FOMC under Yellen did make a few changes to how the Fed is communicating when it may actually begin to raise rates. Committee members dropped the explicit 6.5% unemployment-rate target. Instead, the Fed is looking at a broad range of metrics and also stated rates could rise as soon as six months after QE taper is complete. That timeline is a bit earlier than many in the market expected, causing some brief volatility, but it is also a sign that monetary policy might be normalizing and that the economy is doing a good job absorbing the Fed’s exit so far. Despite the taper, yields on Treasury bonds fell during the quarter. The 10-year Treasury started the year at a 3.0% yield but was at 2.7% during the last week of March. Congress stayed out of the limelight this quarter ahead of the midterm elections. The debt ceiling was quietly raised in February, avoiding the fireworks that had characterized recent fiscal negotiations.

The Fed’s removal of its extraordinary monetary policy doesn’t just affect the U.S. and its investors, however. Emerging-markets currencies went on a wild ride through January with major swings in the currencies of many markets including Turkey, Brazil, and Venezuela as investors worried about the tighter monetary policy in the U.S. as well as growth and political stability in some cases. Aggressive moves by central banks stemmed the currency slide, but many of the underlying fears remain unresolved. China, in particular, is still a question mark on the growth front. Data indicated the country’s manufacturing sector was slowing considerably and that growth would be well below levels achieved in the recent past.

Of course, the ongoing geopolitical crisis in Ukraine also contributed to the volatility during the quarter. Stocks wavered as investors weighed the shifting possibility of a full-scale war between Russia and Ukraine over Crimea and what impact that would have on Europe and the rest of the world.

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Sources used in development of this Commentary include Web sites, data and information published by Vanguard, T. Rowe Price, Fidelity and Dimensional Fund Advisers.