In The Markets:
It was an unexciting first quarter in the markets. Large cap US stocks (as measure by the S&P 500) gained 1.81% and foreign stocks were practically flat, with the MSCI EAFE up 0.66%. Despite ongoing concerns over the prospect of rising interest rates, bonds performed well. The Barclay’s US Aggregate bond index gained 1.84% for the quarter, and municipal bonds (Barclay’s Municipal) posted a solid 3.32% return. In a significant turn from 2013, US REITs (MSCI US REIT) posted significant gains of 9.98% during the first quarter.
First quarter returns are indicative of the importance of a diversified portfolio and why investors must stick to a long-term plan. Through 2013 REITs, municipal bonds and emerging market stocks all posted negative returns. We could have speculated that this trend would continue, or take a contrarian approach and say they would all recover. In fact, REITs and bonds bounced back, while emerging markets fell again in the first quarter. There is no rule except that we can’t know what will come next, so investors have to remain diversified and rebalance back to a long-term investment policy in order to be successful over time.
In The Economy:
The broad US economy continued its modest expansion into late 2013. US Gross Domestic Product expanded by 4.1% in the third quarter of 2013, on track with the trend in economic growth during the recovery.
Despite a tick upwards in February that was largely weather-related, unemployment continued its devastatingly slow grind downward, currently at 6.7%.
On a positive note, the average hourly earnings of workers has been steadily increasing since 2012. This is the type of trend you expect to see late in an economic recovery as business revenue growth leads to an improved labor market and workers are able to demand higher wages in an improving economy.
Yet despite increases in wages, inflation remains subdued. The US Consumer Price Index (which includes food and energy costs) has been stuck between 1% and 2% for nearly two years as the economy struggles to break out of a sluggish growth period.
Finally, the US consumer is still in very good shape. Household net worth has boomed since the ’08-’09 bear market, and household cash flow has improved. Household debt service relative to disposable income remains at a multi-decade low as individuals have reduced debt burdens and have yet to return to borrowing levels we saw previous to the recession in 2008. This means more personal free cash flow for savings, investment and consumption.
Out Of Washington:
In March the Obama White House released its proposed 2015 budget for the federal government. While there has been much hand-wringing about some of the proposals (including potentially higher tax rates on high earners, increased spending on infrastructure and a cap on retirement plan assets as well as a limit on the value of retirement plan deductions), it is important to recognize that the budget proposal has become a political statement or “wish list” and most, if not all, of these proposals will never see the light of day. The Republican-controlled House has already offered it’s counter argument and the reality is that the 2015 budget will fall somewhere between either extreme.
The open enrollment period for individuals to purchase health insurance via a state or federal insurance exchange for calendar year 2014 ended on March 31st. In 2014 the Affordable Care Act eliminates discrimination due to pre-existing conditions and eliminates annual caps on benefits. A penalty for not carrying coverage is now in effect for 2014, which is the greater of 1% of household income or $95 per adult member of a household and $47.50 per child. This penalty increases in 2015 to 2% of income or $325 per person, and 2.5% or $695 per person in 2016. The penalty is essentially a tax and is due with an individual’s income tax filing.
While political actions out of Washington can affect our taxes and our businesses, it is important that we are not caught up in allowing politics to affect our investment decisions. While few would have argued that President Obama campaigned on a “pro-business” platform for the 2008 election, throwing in the towel on a broadly diversified portfolio of stocks the day after the election would have been a disastrous error for long term investors. Instead we must continue to filter out the noise of domestic and global politics if we want to participate in the long term returns that stock ownership offers.
Bason Asset Management 