The S&P 500 continued its winning streak in the 3rdquarter, rising 1.1%, but other global equity indices were unable to follow the lead of U.S. large caps. U.S. interest rates ended the quarter hardly changed from June 30, with the 10-Year Treasury note yielding 2.51%. The Barclay’s Aggregate index (representing domestic investment grade bonds) rose a slight 0.2% for the quarter. Commodities had double digit declines as oil prices sank amidst falling demand and robust output from the U.S.
With a U.S. economy that appears to be picking up, an improving employment picture and an end in sight to Fed stimulus efforts, the U.S. dollar surged during the quarter, gaining more than 8% against the euro and the yen. However, growth remains muted by historical standards. While the unemployment rate continues to decline, labor force participation is at an all-time low. The Fed confirmed in its September meeting that short-term rates should remain low for a “considerable time” after the end of its bond-buying program, which is expected to follow its October meeting. In contrast to the U.S. Fed, the European Central Bank (ECB) and Bank of Japan are moving towards further monetary easing. On September 4, the ECB cut rates and announced an asset purchase program to fight sluggish growth and low inflation.
The gap between large and small company performance in the U.S. widened during the quarter as small caps retreated 7.4% and micro-caps even more (-8.2%). Mega caps were the top performers (Russell Top 50 +3.0%). Growth outperformed value across all market capitalization ranges.
Overseas stocks managed to eke out small gains in local currency terms, but the strength of the dollar erased those gains for U.S. investors. The MSCI EAFE (US$) index of developed countries lost 5.88% for the quarter. Portugal and Austria were weakest, both retreating more than 20% (US$). Emerging markets also fell for the quarter, losing 3.5% (US$). Greece and Russia were hardest hit, with 20.0% and 15.1% declines, respectively.
Municipal bonds rose 0.8% for the quarter, while high yield bonds fell 1.6%. Unhedged international bonds suffered from currency weakness in both developed and emerging markets. The Barclays Global Aggregate ex-US Unhedged fell 5.4%, while local emerging markets gave up 5.66%.
Most asset classes gave back some gains during the third quarter, following multi-year run-ups for most of them. The Russell 2000 index, a measure of domestic small cap stocks, has been particularly weak, trailing the S&P 500 by almost 16% for the year ended September 30. Yet over longer time frames, small cap has significantly outperformed. By broadly diversifying and avoiding overcommitting to any one or two asset classes, investors have the best chance of success, of participating in the long-term growth the markets have to offer, and of achieving their long-term goals.
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