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The pivotal event last month was the press conference held by Ben Bernanke who sparked an interest rate rally. The 10-year Treasury rose over 1% in just a matter of weeks, hitting a high over 2.7% recently. Ben Bernanke tried to communicate the ground work for their program over the next 18 months. Although that sounds simple enough, investors’ reaction was to immediately jump to the end result of higher rates with bonds getting crushed. It appeared the markets wanted to fast-forward 18 months almost overnight. We would suggest that there was a short-term overreaction, but the future path of interest rates is probably higher. Most regard the stock market as a leading indicator, so in many ways it makes sense that stocks reacted rather quickly to the prospect of higher rates and less stimulus. The Federal Reserve has kept rates low for several years now, but we quickly learned that they do not have total control over interest rates. We see this as mortgage rates have spiked recently, which could potentially put the brakes to the housing recovery. Refinance and new mortgage applications along with housing values are already dropping from the rate rise in some areas.
Investors are now rotating out of bonds and bond-like investments aggressively. However, it appears they are moving to cash and not to equities, as equities continue to see outflows as well. Very few, if any, saw this knee-jerk reaction coming. Now that the pain from the initial reaction is gone, the question is what to do next? We believe that most investors have focused on the end of the historic monetary experiment underway, rather than listening to what Bernanke actually said. There are two possible outcomes: (1) the economy continues to improve and the need for more stimulus gradually fades; or (2) the economy weakens or remains choppy and the stimulus will be extended.
Quarterly corporate earnings will be a significant indicator for the direction of the stock market for the remainder of the summer. On one hand, expectations have been set so low many believe they will be hard to miss. On the other hand, one recent statistic for pre-announcements stated the ratio of negative earnings releases to positive releases has been 6.5 to 1. This is the worst ratio since 2001. While the stock market saw a short drop down 7% from its highs in the spring, we have now recovered those losses in July and are now once again at all-time highs.
Gold and precious metals continue to take a beating as inflation expectations stay low and the dollar has strengthened due to other countries’ devaluation of their currencies. If there is a currency war going on, the U.S. is certainly not winning. Although commodities still maintain their insurance value against any inflation risk, the view on this asset class continues to be bearish in the short-term. The other area that has surprisingly dragged this year is emerging markets. This area has been hit hard by the slowing Chinese economy and the European recession that continues to deepen every quarter. One might suggest it is a positive that investors are not as focused on Europe as shown last week when Portugal was on the brink of a crisis, and it received very little attention in headlines. However, it is also worrisome if investors have now become numb to the risks of Europe which are still very significant.
2013 Outlook Update
Below are a few bullet points from our outlook for 2013. Overall, they have not changed much from the prior newsletter, but we have added a few additional comments.
Disclosures: This commentary is submitted for the general information of Cornerstone Wealth Management, LLC clients and may not be distributed to other individuals. This commentary is not deemed to be investment advice and information contained herein may not be current. An investor should consider the investment objectives, risks, charges, and expenses of each investment carefully before investing. For more complete information, you may contact us at 858-676-1000. Past performance is no guarantee of future results. Individual performance may vary and investment performance numbers may not be audited.