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Mixed Results in the 3rd Quarter

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PantagesCheck out the third quarter investment returns in the table below. Large cap US equities were up 1.1% while small cap stocks lost -6.7% and are officially in a “correction” – down over 10% from their highs, a bear market is typically defined as down 20% from the highs fyi.

A strong US dollar (up 7% against a basket of currencies in Q3) ate into foreign equity returns in overseas markets. The EAFE index of developed country markets lost -5.9% in the quarter – mainly because of weaker currencies. Most bond yields moved sideways except for High Yield junk bonds which sold off as spreads widened against treasuries to 420 bp in a risk off trade.

This week – tear gas and pepper spray greeted protesters in Hong Kong. Citizens want the right to vote – as promised by Beijing. China’s President Xi Jinping is crawfishing on that promise wanting to keep Hong Kong in line and not encourage the rest of China towards universal suffrage.

The S&P 500 dropped to 1968, almost 1% over the week. Small caps lost closer to 2%.

Stocks have struggled ever since the S&P 500 crossed the 2000 level in late August – the reason? Investors have been too complacent amidst geopolitical storms; valuation is bit stretched and global growth spotty. We probably will need good third quarter earnings (about to be reported in October) to stabilize the market.

Yields on short term T-bills dipped below zero early in the week. Banks have cut back borrowing via “repos” to money market funds (MMF) – the banks were window dressing end of quarter balance sheets. The MMFs need high quality assets and were scrambling to buy short T-bills due Oct 2 at .1%. Meanwhile, ten year treasury bonds ended the week down a little – just shy of 2.50%.

There was lots of talk this week about the “illiquid bond market”. Dealers have been stepping back from making markets and inventories are low. Part of that is due to more regulations. Illiquidity means wider swings in prices.

Employment releases are the most influential macro indicators for capital markets. On that front, September’s employment report out Friday was clearly better than expected. Payroll employment rose a more-than-expected 248,000 and the prior two months were revised up +69,000. Private sector employment was solid.  Furthermore the unemployment rate fell to 5.9%.

Despite Middle East turmoil oil prices are falling. Brent dropped to $92, down almost 20% since the year’s peak of $115 on June 19. Ed Yardeni explains: (1) US crude production is soaring to 9.2mbd in September, up from 4.2mbd in 2009. Imports are down. Exports are up. (2) fuel efficiency in the US is way up (3) demand is down owing to global economic weakness.

A final reason is (4) strength in the dollar. Yardeni says “Commodity prices in general tend to rise (fall) when the dollar is falling (rising). That’s because a strong dollar increases the local currency prices of commodities, which tend to be traded in dollars. Rising local prices around the world tend to depress the global demand for commodities. The same applies to oil.”

India’s new pro-business Prime Minister was in Washington and NYC this week in an attempt to convince investors that India is once again open for business. AEI notes “He appears earnest about his desire to slash red tape and replace it with a red carpet for investors. But those expecting Mr. Modi to dramatically reinvent India’s government, rather than merely rein in its infamous bureaucracy, will likely be disappointed.”

Not much data out next week. The FOMC minutes from the September 16/17 meeting will be released on Tuesday. And the IMF annual meetings will be in DC where they will release new global growth predictions. Director Christine Lagarde indicates that growth next year will be less than previously forecast.

Jeff Pantages
Chief Investment Officer

10032014 MRC

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