Third Quarter 2014: The Rally Concludes
Global tensions pushed volatility higher as the equity market rally that began in early 2013 finally came to a halt. The S&P 500 finished slightly higher than it began the quarter, while small-cap and international equities declined sharply. Investors fretted over the impact of continued conflict in the Middle East as the United States and its allies began targeted airstrikes against extremists in Iraq and Syria. European powers, meanwhile, imposed tougher economic sanctions against Russia, a move that could threaten their fragile growth prospects. The Eurozone continues to sputter as even Germany’s stalwart economy contracted on a seasonally adjusted basis in the second quarter.
The picture was slightly better stateside as strong employment readings continued during the quarter. Over 200,000 jobs were added per month in the summer as the US economy shook off the temporary winter blues to expand at a rate of 4.6%. Wage growth posted its highest gains in five and a half years. Despite slower economic growth projections for 2015 and 2016, the continued expansion was enough for the Federal Reserve to continue its asset purchase slowdown. Market participants’ eyes have shifted toward the timing of eventual rate hikes, something Fed Chief Janet Yellen noted won’t happen until “considerable time” has passed after the end of this round of quantitative easing, which is scheduled for October.
The ECB shifted toward a slightly more expansionary stance during the summer as Eurozone inflation neared historic lows. Japan, the world’s third-largest economy, continued its aggressive fiscal and monetary policy stance as a sales tax-hike in the spring had broad negative effects. Both central banks noted that their continued expansionary policy can only provide some lift and that continued reforms are needed. Consequently, the dollar strengthened significantly during the quarter. Fixed income returns were mostly positive for the quarter and are up for the year, with long-term bonds returning 13% since January.
Going forward, the equity market runup over the past year and half has left valuations stretched, and it remains to be seen if earnings will continue to expand quickly enough to catch up. Low energy prices, thanks to the domestic energy boom, should provide continued support to the economy, but geopolitical tensions between increasingly conflicted international powers could put considerable pressure on expansionary central banks around the globe.