Nola Kulig
Kulig Financial Advisors
Longmeadow, MA, 01116 USA
Add to Contacts

Second Quarter 2013 Markets Review

July 31st, 2013

This month’s commentary discusses the following topics:

  • Second Quarter Markets Review
  • Portfolio Implications
  • Off to an Investing Conference

Second Quarter Markets Review

The second quarter went well until June, when Federal Reserve Chairman Ben Bernanke began to introduce markets to the idea that quantitative easing would not go on forever (please see the June 2013 post for details on his comments and the market’s reaction). That’s when things began to get rocky. The markets haven’t been sure that economic growth (especially on a global basis) is sufficiently strong for the Federal Reserve to reduce its stimulus measures. While the US is gradually improving, parts of Europe remain in a depression, and China’s growth is slowing.

In case you did not read our June comments, please be clear that rates increased due to fears that the Fed might pull back its stimulus. The Fed has not actually changed its policies, and went to great pains to try to explain that. But the markets were not buying it.

Despite the increased volatility, if an investor’s portfolio was balanced between asset classes, he/she wasn’t hurt too badly. The following summarize some observations on the markets:

  • Cash was still “trash” (offering negative returns after taxes and inflation), bonds were a bummer, US stocks were still strong, and emerging markets were very weak.
  • A lot of questions have been posed about whether the second quarter was a correction, a pull back, or a bear market. In some markets, the tone was definitely bearish, but for US equities, the declines were statistical noise. Note the strong returns in the table that follows for the year-to-date and one-year numbers for the S&P 500 Index (the average yearly return for the S&P since 1926 has been 9.8%).
  • Sectors dependent on interest rates staying low or those investors have been purchasing for income as alternative to bonds were the ones that suffered most. Many of these are not shown in the table, but utilities and other high dividend paying sectors lagged.
  • Other areas that suffered were commodities (particularly gold), and emerging markets. Commodities and emerging markets depend on growth in Asia, particularly China, and with Chinese economic growth looking weaker, those markets softened considerably.
  • Gold was hit hard by many factors, not the least of which was greater competition from interest-bearing assets as rates rose. (Since gold pays no dividend or interest, the cost of holding it is low as long as rates remain near zero.) However, the declines were particularly vicious, and some analysts have raised questions about the amount of dumping of gold exchange traded funds. As is usually the case, fingers have been pointed at hedge funds as culprits.


Market Returns
Market Index Month Q2 2013 YTD
Year Ending
Large Cap S&P 500 Index -1.3% 2.9% 13.8% 20.6%
Midcap S&P Midcap -1.9 1.0 14.6 25.2
Small Cap S&P Small Cap -0.2 3.9 16.2 25.2
Non-US Developed Mkts. MSCI EAFE -3.6 -1.0 4.1 18.6
Emerging Markets MSCI Emerging Mkts. -6.4 -8.1 -9.6 2.9
US Bonds Barclays US Aggregate -5.3 -6.3 -8.0 -2.0
REITs S&P US REIT -1.9 -1.5 6.4 9.3
MLPs Alerian MLP 3.1 1.9 22.1 28.4
Gold Dow Jones-UBS Gold Sub index Total Return -12.2 -23.4 -27.2 -24.3
Commodities Dow Jones-UBS Commodity Index TR -4.7 -9.5 -10.5 -8.0

Sources: AJO Partners, Factset, Dow Jones Indexes

There were a few interesting outcomes in the second quarter’s results:

  • Asset classes diverged in performance, so that diversification was a benefit. This is in contrast to much of what we have experienced since the financial crisis in 2008, and is occurring despite synchronous loose money policies implemented by the world’s largest central banks.
  • Although REITs are dependent on low-rate financing, the declines were rather moderate compared to the rhetoric in the press and to what one might have expected with concerns about the potential for change in Federal Reserve policy.
  • A sector which investors have been purchasing for yield, the energy-related MLP sector, held up well and actually rose in value.

The observation on portfolio diversification bears repeating, especially since monetary stimulus has meant that in recent years, many asset classes have risen in tandem. If your portfolio is diversified, something will likely always be underperforming. Last quarter this meant bonds and commodities did poorly, but if you have maintained your stock exposure, your portfolio has survived intactThis reminder on diversification is something worth repeating to yourself every time we experience market volatility.

Since we covered what happens to stocks and bonds in rising rate environments last month, we’d also recommend referring to that post to become comfortable with your portfolio during times like these.

Portfolio Implications

The rocky price action in some sectors has provided opportunities to rebalance your portfolio if it is already diversified, or to create a diversified structure if you have been waiting for an opportunity.

Importantly, the following comments are not intended to be speculative investment recommendations. Instead, these are tweaks one could make to a diversified portfolio that has been designed to fit your financial situation, risk tolerance, and most importantly, your risk capacity (risk that you can afford to take). Those who are clients at Kulig Financial will be familiar with all of those terms and concepts.

The following are just some of the areas an investor can consider. Many of them are in the bond sectors, but there are also some in the stock markets:

  • For the first time in quite a while, we are seeing positive real yields on Treasury Inflation Protected Securities (TIPs). The stated yield on TIPs is called the real yield (meaning a yield net of inflation), while the principal is adjusted for inflation over the life of the bond. For quite some time, investors have been concerned about inflationary prospects due to loose money policies by the Federal Reserve, and TIPs became so popular as a way to hedge against inflation that yields actually went negative. In other words, investors were willing to pay the government to get the inflation coverage. With concerns about potential tightening measures, rates have risen across all bonds, and we now have positive, although small, real yields.
  • Municipal bonds and emerging markets bonds were beaten down, so these markets may also represent opportunities to rebalance.
  • Emerging markets stocks are trading at low prices relative to developed markets. Some analysts are finding this an intriguing area. Economic growth has disappointed year to date, although it remains at higher levels than in developed markets (which have also seen downward revisions to expectations). More recently the economic growth has been exceeding investor expectations, which tends to help these markets. Analysts have also noted that by some estimates the S&P 500 trades at levels roughly 45% more expensive than emerging markets. Of course, the fact that a market becomes relatively cheap says nothing about when it may rise in value. All you really know is that you have reduced the risk of overpaying.
  • Gold is intriguing more analysts at these levels. They note that the macroeconomic concerns that make gold attractive (namely loose money policies which could eventually manifest in hyperinflation) remain in place. Gold is also an asset class (like stocks) that is volatile on a stand-alone basis, but very diversifying for a portfolio. Small weightings result in lower overall portfolio volatility.

In summary, with US stocks having had such strong results over the last year (and looking further back, ever since 2009), if you haven’t reviewed your portfolio’s allocations across different asset classes, it is time to do so. You may find your portfolio is over allocated to stocks (unless you have avoided them since 2008, as some have).

We have discussed reallocating to bonds in previous posts as stocks have risen this year. We would stand by those comments and reiterate them here for new readers (others can skip this section since you have heard this before).

Many ask whether it is even worthwhile purchasing bonds at today’s low rates. It is admittedly a difficult time to think about making new purchases, but we have to look at the role they play in a portfolio. Normally we look to them as income instruments, and it is difficult to do so now. But the other role they play is as portfolio stabilizers. No matter how poorly bonds may do, their worst historical returns have never been as volatile as stocks.

If you are concerned that bonds are expensive, there are several things you might consider in order to “play defense” and help preserve your capital (note: these strategies paid off in June’s rocky bond markets):

  • Keep maturities short. The longer the maturity, the more negative the price impact if rates rise.
  • Stick with higher quality bonds. If you reach for yield, you are likely to end up holding junk bonds or other lower quality securities. Many investors bought these earlier in the year and got hammered in the recent downturn for bonds. When these markets decline, they can exhibit stock-like volatility. That usually isn’t what investors are looking for in their bond portfolios.
  • Be careful with closed-end funds. Some purchase these securities for their higher yields, but many of them are leveraged, meaning they invest with borrowed money. Leverage works great so long as the fund’s investments keep rising; but if they decline (as bonds have recently if interest rates rise), then leverage works in reverse and you lose money. Think about highly indebted borrowers in the housing market in 2008, and you get the picture. It can happen with any asset class. Avoiding leverage is difficult with closed-end funds since most use it, but only purchase non-leveraged ones if you can. At a minimum, know what your fund does with leverage and assess whether you can deal with the risk that may introduce.
  • Be careful with bond indexes in today’s environment. I am usually a fan of index investing, but in today’s world passive bond funds could be vulnerable. Many analysts think that the Treasury and government agency markets are some of the most overvalued. These sectors currently comprise large percentages of traditional bond indexes. For example, Vanguard’s Total Bond Market Index has a bit over 68% US government and agency securities, making it very nearly a government bond fund. Even if you have a positive view on these types of bonds, you’ll want to integrate other strategies into your bond portfolio for broader diversification.

So where will rates go from here? The truth is that nobody really knows. Many knowledgeable veteran bond investors think the markets overreacted to Fed commentary, especially looking at the slow growth and continued unemployment in the US, not to mention that Europe looks worse and remain a drag on the global economy. But even if they are wrong, as we noted in June, it is possible to play defense with bonds, rather than desert them entirely.

So what is the message from all this? It is boring to hear this yet again, but stay diversified in your portfolios and make sure the risks you are assuming fit your situation.

Off to an Investing Conference

Next week I’ll be heading to a conference in Newport, RI for a few days. The topics will range from how to attempt to hedge macroeconomic and market risks to investment opportunities, plus taxation issues and a myriad of other things. I’ve attended this conference for several years, and it is always interesting to see what the latest thinking is. While there really is nothing new under the sun, sometimes a new idea comes along that we later see a lot of in the market place. I’ll report back on this conference next month’s post.

Stay cool in these hot summer months, especially regarding things financial!

Sheryl Garrett Named one of 30 Most Influential People in NAPFA’s 30-Year History

July 31st, 2013

All of us in the Garrett Planning Network were very pleased at this announcement:  Sheryl Garrett was named one of the industry’s 30 most influential people in the industry by the National Association of Personal Financial Advisors (NAPFA). Sheryl, of course, founded our network and makes our work possible for all of you.  For detail on her career and accomplishments, please see

June 2013: Shaky Markets and How to Cope

July 31st, 2013

Just when I thought I might switch to a topic less focused on the markets or tax policy (like savings tips to build that nest egg so you can invest it), we got a big jolt to the markets last week.  Ben Bernanke summarized his views on the future of quantitative easing, which the markets did not take well. The decline was large enough that it is worth spending time on how the markets reacted and how to cope with times like these. I have some interesting data and commentary on how stock and bond markets respond to rising rates that might just get you through this!

Topics in this Issue

  • What Upset the Markets Last Week?
  •  How bad are Rising Rates for Bonds?
  •  Are Rising Rates Bad for Stocks?
  •  How to cope With Volatile Markets
  1. Define Your Cash Needs and Keep a “Cash Stash”
  2. Build Diversified Portfolios
  3. Consider Averaging into Investments
  4. Think About and Do Something Else!

What Upset the Markets Last Week?

In case anyone missed it, the markets got the jitters in response to Federal Reserve Chairman Ben Bernanke’s remarks that the Fed could slow its quantitative easing program. Over the last several years, it has used various means to pump money into the economy to lower rates and encourage economic growth. The fact that markets have known that the Fed can’t continue an easy money policy forever didn’t seem to reduce selling of both stocks and bonds. Other previous safe havens, like gold, also declined.  Many overseas markets were thrashed as well. There really wasn’t much of a place to hide besides cash.

Barron’s pointed out that John Williams, head of the Fed’s San Francisco branch, had said something similar only a month ago, but markets had climbed instead. In both cases, investors knew the Fed wouldn’t keep easing at this pace forever. Perhaps this time it was the fact that it came straight from the chairman himself that made the difference.

Mr. Bernanke also said that the amount of tightening would be data-dependent (meaning based on readings of economic growth, inflation and unemployment, among other things). This doesn’t sound like a steady march upward in rates, especially considering that inflation is very moderate and employment still has some ways to go before it hits Fed targets. But the markets overlooked that, too, and what appeared to be indiscriminate selling happened both here and abroad.

Of course, the press is filled with plenty of commentary, both positive and negative on the future direction of markets. What to make of all the conflicting opinion? While history does not repeat itself, at times like these, I really like some good hard, data. If nothing else, it helps filter the noise from the press and put commentary in context.

How bad are Rising Rates for Bonds?

A fellow named Andy Martin published an article earlier this month called  “Bursting the Bond Bubble Babble.” Andy Martin is president and co-founder with Craig Israelson, Ph.D. of 7Twelve Advisors, LLC. While I don’t fully embrace the firm’s overall approach to portfolio management, the professionals there have studied historical data very thoroughly, and I think their points on bond portfolios are well taken in today’s environment.

The short version of this article is that in rising-rate environments, total returns for bonds generally have not been negative, if history is any guide. As defensive moves, Andy recommends shortening maturities and diversifying the types of bonds in your portfolio as much as possible. (This should sound familiar if you read my April 2013 newsletter and/or are a client of mine.) Importantly, they recommend equal weighting of various bond strategies.

Some of the data he examines to reach this conclusion include the worst periods ever for bonds. Were there some negative returns? Yes, but they were modest and far short of the disaster that many prognosticators would have you believe. Many of those comments assume that investors only own 30-year Treasury bonds, which in fact are owned by relatively few investors.

Why should diversified bond portfolios hold up as well as they do? Andy theorizes that it is because as rates rise, demand for bonds increases. In other words, they respond to supply and demand just like stocks.

If you are interested in a copy of the article, please drop me a note at It is reassuring reading that it is possible to play defense with bonds.

Are Rising Rates Bad for Stocks? 

Barron’s recently interviewed Vadim Zlotnikov, the chief market strategist for Bernstein Research on this topic. The answer: it depends on the context of the rate increase. But the bottom line is that there has been no direct historical relationship between rate increases and stock market direction.

Zlotnikov mentioned that in a study of US market returns and rates going back to 1871, they observed that rising rates do not necessarily lead to bear markets. In scenarios where real interest rates (meaning net of inflation) were below average and rose 130 basis point (1.3%) or less, the stock market return was an average 11.1%, and 4.7% in real terms (again net of inflation). So if inflation is more or less benign and rate increases are moderate, the market can rise.

But when rate increases were sharp and sudden, the market return was 5.6%, but -2.3% in real terms.

So stocks tend to shake off rate increases, unless they are sharp and unexpected, and/or accompanied by high inflation.Barron’s goes on to point out that anything is possible, but those conditions seem to have little in common with today’s environment.

These results confirm studies done years ago by Steve Leuthold, the now retired researcher who founded Leuthold Weeden Capital Management (full disclosure: I hold shares in the Leuthold Core Investment Fund). Steve started out as an institutional researcher who produced voluminous histogram charts of market history on everything you can conceive of.  Those charts clearly showed the same relationship.

How to Cope with Volatile Markets

So once again, some of the longest term data we can find leads us again to basic investment and planning tenets. While I would never minimize market volatility or economic concerns (today’s issue is China’s monetary tightening), there are some things we can do to help ourselves ride out market fluctuations.

1. Define Your Cash Needs and Keep a “Cash Stash”
When developing financial and investment plans, I recommend that clients keep some level of cash reserves on hand. The amount may vary depending on your needs, upcoming plans, lifestyle and stage of life (working or retired). But having that reserve is important, as it means you can ride out tough markets without withdrawing money from your long-term portfolio if the unexpected happens.  Think of it every time the market experiences volatility or you happen to be confronted with screaming headlines.

2. Build Diversified Portfolios
Diversification is essential. Based on the information we just reviewed, we learned that rate increases don’t have to be a total disaster for the bond portion of your portfolio, and the stock portion of your portfolio may actually rise. Not only do you want to have both asset classes in your portfolio, but within each segment, maximize your diversification to ride out tough markets. Other types of assets may add even more diversification to your portfolio.

3. Consider Averaging into Investments
If you are faced with putting cash to work during tumultuous markets, you may want to consider staging your investments. In other words, you can dollar cost average into your plan over time, instead of placing all your money at once and then feeling bad about any declines that happen.
If your portfolio stays invested over a sufficiently long time horizon, most of the benefit of this approach is psychological, rather than monetary. But if it eases your mind and makes you more comfortable executing your investment plan, then it is definitely worthwhile. Just make sure to give yourself a deadline so that you actually get your investments completed. Also buy a cross section of your entire portfolio, so that you are holding something diversified. If you try to cherry pick investments and get too cute with timing their purchases, you could end up with an undiversified portfolio which could be vulnerable because it is unbalanced.

4. Think about and do something else!
Once you have done what you can with portfolio design and implementation, assuming you have your cash stash and some sort of financial plan, then you have really done all you can. We can’t control the markets through worry, so then it is time to focus on something else.
I hope this has been helpful so that you, too can survive the emotional roller coaster of investing!

Investment advisor representative of an investment advisory services offered through Garrett Investment Advisors, LLC, a fee-only SEC registered investment advisor. Tel: (910) FEE-ONLY. Kulig Financial Advisors may offer investment advisory services in the state of Massachusetts and other jurisdictions where exempted.