Yesterday I hosted the Wealth Engineers Q2 2014 Market Review webcast to discuss capital market performance across global asset classes for the second quarter of 2014.
For those of you who were not able to join, a recording of the presentation can be watched in the video above.
A full transcript of the webcast would be too long to really be useful, so instead I am including some of the key thoughts and takeaways. If you are a client and would like to discuss your account or personal circumstances, please call or email me.
Summary of Q2 2014 Returns
Broadly speaking, all major asset classes experienced a strong quarter of returns. Stocks across US (Russell 3000 index), international developed (MSCI World ex USA Index), and international emerging markets (MSCI Emerging Markets Index) were all positive. REITs (S&P Global REIT Index) delivered another strong quarter, following up an already generous start to 2014.
Not to be left out, the US bond market (Barclays US Aggregate Bond Index) also delivered positive returns, as interest rates declined during the quarter. This was probably a surprise for many investors. Global bonds (Citigroup WGBI 1-30 Years Hedged Index) performed similarly, up about 2%. Once again, the bet on rising rates proved incorrect, which should serve as a reminder to investors that forecasts are merely guesses with roughly 50-50 odds. Would you risk your wealth on the flip of a coin?
Although there was a lot of chatter about the significant decline in first quarter GDP, such fears did not prevent US stocks from delivering nearly 5% returns for the quarter on a marketwide basis. Investors must remember that the stock market is forward looking and that singular events or headlines rarely explain returns by themselves. Certainly, there are some days in the market where we can point to a systemic event as being responsible, but on most other days that is not the case.
Looking beyond marketwide returns, we saw large cap stocks outperforming their small cap counterparts during the quarter by a bit more than 3%. While the “small cap premium” is well-documented, it is certainly not guaranteed. Anything can happen over short and even intermediate time periods. That’s why investors who deviate from the market portfolio must understand and accept those risks. More importantly, they must be committed to sticking to their plan for the long haul, as an investor often must wait years for the risk to pay off.
Looking at value vs. growth, both returned similar performance during the quarter. Again, although value stocks generally offer a higher expected return, this expectation must be considered over years and even decades. Nothing useful can be gathered from a single quarter’s performance.
International Developed Market Stocks
Returns from international developed markets were led by Canada, Hong Kong, and Norway which all posted performance exceeding 7% for the quarter. On the other end of the spectrum, we saw Portgual and Ireland struggle moving towards mid-year 2014, with returns of -5.2% and -8.69%, respectively.
Looking at the aggregate developed market indexes, we saw value stocks lead the way, outperforming growth by about 1.2%. Similar to what the second quarter brought to US markets, small cap stocks also underperformed their large cap counterparts by about 2%.
The depreciation of the US dollar relative to many of the major international developed market currencies also added to returns. The returns on international developed stocks to a US investor exceeded local investors by roughly 1% thanks to the declining value of the dollar.
International Emerging Market Stocks
In what was probably a surprise for many investors, emerging market stocks led all global equities, posting returns of 6.6% for the quarter. This is the first time since Q3 2012 that emerging market stocks found themselves outpacing developed market stocks.
More importantly, the last few years illustrate perfectly how investors are often their own worst enemies. Emerging markets have indeed struggled over the last 3 years, posting slightly negative annualized returns. Almost like clockwork, investors proceeded to pull nearly $30 billion out of emerging market equity funds during 2013. They doubled-down there efforts to kick off 2014, with reports of another $35 billion in outflows.
Unsurprisingly, and right on queue, emerging markets posted quarterly returns that outpaced the rest of the globe. This buy high, sell low phenomenon is incredible on two fronts. Most importantly, it devastates investor returns and demonstrates how any advice centered around timing the market is unlikely to be successful for the majority of investors. Secondly, even as the message of long-term investing has probably its strongest voice ever, most investors struggle to adhere to their plan.
Ultimately, for those who did weather the storm, the second quarter rewarded them with strong local currency returns that were boosted even further by the depreciation of the US dollar relative to many emerging market currencies.
Real estate investment trusts (REITs) strung together back-to-back quarters leading all major asset classes to kick of 2014. In a reversal from Q1, international REITs led their US peers, with returns of about 9.8% vs. roughly 7.2%.
Over the last decade, however, global REIT returns (assuming a roughly 50/50 split between US and international REITs) have approximately matched large cap stocks. There is no guarantee this will hold in the future, but projecting similar returns from REITs and large cap stocks is a reasonable estimate.
With interest rates largely declining across US fixed income markets, bond returns were positive for the quarter. As both intermediate- and long-term rates dropped, while short-term rates generally held, we saw a flattening of the US Treasury yield curve. That said, the curve remains upward sloping, leading to a positive risk/return profile for duration risk.
As would be expected, long-term bonds, of the government, municipal, and corporate variety, all did very well and outpaced their intermediate-term peers. I think it’s fair to say that few investors would have pegged long-term government bonds (with a year-to-date return of 10.9%) as the leading asset class half way through the year.
Note: If you are a portfolio management client and have any questions about your account, please let me know. If you are not currently a portfolio management client and would like to discuss a portfolio management relationship, I would be happy to speak with you about your goals and objectives.
This post is subject to the terms and disclosures outlined in the webcast presentation and on our web site.