3rd Quarter 2014 Market Commentary

2^nd Qtr Review

After an initial scare caused by the Russian and Ukrainian conflict in April, which sent the market down about 4%, stock markets recovered to have a decent quarter.  Both stocks and bonds had modest returns for the quarter with Emerging Markets leading the pack and Small Caps lagging.  Nothing dramatic occurred this past quarter, markets advanced in a very stealth manner.  In this issue of Allgen’s quarterly market commentary we will look at the seasonal trends of the election cycle, Long-Term (secular) trends in the market and we will give you an update on the bond picture.

Seasonal Trends of the Election Cycle

Last quarter we indicated that “Every midterm election year since 1962 the market has had a correction, on average just under 19%.  Those corrections usually occurred close to the summer months.  But, the fascinating thing about this trend is that the twelve months following the point at which the correction ended had a sizeable gain, on average 32%.”  We’ve further researched seasonal trends of the election cycle and as you can see in the chart below (on right side) the period we are currently in (Mid-Term Year and May-Oct.) is the poorest performing time frame of the entire four-year election cycle. The strongest period of the 4 year election cycle is the 6 month period following the current period starting in November of the mid-term election year, which in this cycle would be the upcoming November 2014 – April 2015 period.   This is not to suggest anyone should sell all their stocks and wait in cash until November.  Attempting to time the market by selling and going all cash then attempting to re-enter the market at a lower level is extremely difficult because you have to be right 2 times (the sell and the buy) and we do not recommend this. We have positioned the portfolios somewhat defensively to be ready for any potential pullback prior to the upcoming election.  If the market does pullback we will view this as a buying opportunity and will look to add to our stock positions.  A word of caution though: one cyclical chart is not enough evidence to make major changes in any portfolio, it’s just one of the many factors we look at.  We build portfolios for the long-term therefore we are not attempting to go back and forth from all cash to fully invested, rather, our portfolios are designed to weather the storms of the market we make changes to the portfolios when we believe conditions suggest, but we aren’t trying to time every turn in the market.

1926-5/14 Source: (http://www.schwab.com/public/schwab/nn/articles/Market-Snapshot-Will-Positive-News-from-Economy-Push-Fed-to-Move-More-Quickly) – The Leuthold Group.

Secular Trends

We periodically show the chart to the left because it allows you to see the long-term picture and helps you to keep things in perspective.  The chart spans over 100 years and as you can see there is a long-term trend that alternates between long upward trends and sideways stagnant trends.  The long upward trends are called secular bulls and the long sideways trends are called secular bears.  As you can see in the chart (on the bottom) we broke out of the 13 year secular bear that lasted from 2000 – 2013 in March of 2013, and have continued in this long-term bull trend that started in 2009.  Therefore, while we believe the chance of a pullback before election time is heightened, this doesn’t change our long-term view that the market began secular bull trend 5 years ago that could potentially last 10-15 years.

Bond Update

After a difficult 2013 for bonds in which the Barclays Aggregate Bond Index was down just over 2% for the year, bonds are up 3.93% for the first half of the year.  We believe a long-term upward trend in the interest rate cycle is in its initial phase and we’ve positioned our bond portfolios accordingly.  We believe a bond portfolio consisting of a core segment of investment-grade intermediate to short term (Government, Corporate, Asset Backed, Agency and Muni) bonds along with a satellite piece of short term to intermediate High Yield bonds with a slice of international and emerging market bonds is the best approach in the first few years of an upward trending interest rate environment.  Although we believe interest rates will start to trend higher as we approach 2015, there is a chance that rates could drop further and bonds prices could go up in the near term if the market was to pull back prior to the elections as a flight to safety. Our current bond portfolio mix is positioned well for the potential change in the long-term trend in interest rates.  While we believe over the next 5 years bonds won’t perform as well as they did in the past 30 years it’s important to remember that there are multiple reasons to hold bonds; 1) they protect capital, 2) reduce volatility and 3) they provide income. Therefore owning bonds even in a rising interest rate environment is important to the diversification of the overall portfolio especially if you are approaching retirement or already depend on your portfolio for income.

Going Forward

Historical trends in the presidential cycle point to the tendency of markets to have a weak phase in the mid-term election year prior to elections from the months of May-November, but the cyclical trend also shows that the time period that follows is the strongest time frame of the 4 year presidential cycle. While we believe a correction in the stock market may occur prior to the mid-term election, we would view a pullback in the market as a buying opportunity for stocks.  Also, looking at the long-term/secular trends in the market you will notice that the market has broken out of the 13 year sideways (secular bear) trend that occurred from 2000-2013 and we could potentially be in a long-term bull market that could last potentially 10-15 years if historical trends repeat.  While stocks provide growth potential, bonds play a significant role in protecting capital, reducing volatility and providing income.  We believe our current bond portfolio mix is positioned well for the potential change in the long-term trend in interest rates and is the best approach in the first few years of an upward trending interest rate environment. We will continue to constantly monitor all of our stock and bond investments and make changes if necessary.  We continue to manage risk first in all of our investments, while also seeking to outpace our clients’ appropriate benchmark over the long-term net of our fees.

Written by:

Jason Martin, CFP®, CMT, Chief Investment Officer Allgen Financial Services, Inc.;
Paul Roldan, Chief Executive Officer; Chris Damiano, Operation Specialist