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Q3 2014 Institutional Market Commentary

A Little Divergence Creeps In

Eric Freedman
CAPTRUST Chief Investment Officer

Following the first half of 2014’s rather uniform march higher across major asset classes, the third quarter witnessed several asset classes decouple from early year momentum.

The U.S. stock and bond markets delivered positive total returns in the year’s third quarter, with the U.S. stock-focused S&P 500 up 1.1 percent and the Barclays Capital Aggregate Bond Index eking out a 0.2 percent gain. Other major and sub-asset categories did not fare as well. U.S. small-cap stocks fell over 7 percent, international developed stocks (as measured by the MSCI EAFE Index) fell almost 6 percent, and emerging market stocks reversed their course, falling 3.4 percent in the third quarter. Real estate cooled off following a torrid start to 2014, losing 2.5 percent for the quarter, although the asset class is up 13.4 percent for 2014. Commodities continued their downward move, dropping nearly 12 percent on the quarter and 5.6 percent for all of 2014 through the end of September.

Central bank activity remains the key driver across the global capital markets, and this quarter’s mixed performance reflects a world with highly varied central bank policies across major economies. In the U.S. and the United Kingdom, policy makers are moving away from programs such as open-market bond purchases designed to lower interest rates and promote growth. Meanwhile, Japan is trying to overcome years of economic stagnation, stubbornly low prices, and deflation, while Europe is showing symptoms of similar problems. To combat these issues, their central banks are adopting pro-growth policies, including asset-purchase programs, and signaling to market participants that interest rates will stay low for the foreseeable future, while their American and U.K. counterparts have indicated interest rates could move higher in coming quarters.

With a mixed growth and policy picture, investors faced uncertain developments that accelerated adverse reactions through the third quarter. First, the U.S. dollar rose considerably relative to some of its major trading partners, including the pound, yen, and the euro. As noted, this had a negative impact on commodity prices, which are quoted globally in dollars and, therefore, become more expensive to foreign buyers as their currency depreciates relative to the dollar. While lower commodity prices could benefit consumers in the medium term, for now, their weakness signals growth concerns outside of the U.S. Second, while U.S. interest rates were relatively flat in the third quarter, European interest rates continued their descent. With bond yields in some of Europe’s largest economies hitting all-time lows, investors associated these sharp declines with lower prospective growth.

What will investors need to consider in 2014’s final quarter? Diversification with an emphasis on quality will likely be an investor’s ally in this uncertain global environment. We continue to see the glass half full with respect to the global economy’s forward prospects, but with the U.S. ending its pro-growth policies and potentially moving to more restrictive ones as early as this winter, investors should keep abreast of global dynamics. While the U.S. economy still has some underlying momentum, without economic relief from China, Japan, and eventually Europe, the U.S. will not be able to carry the global economy alone. Again, we remain optimistic about the current investment landscape, but we do not expect returns to happen in a straight line. 

For more expanded commentary, please download the full version below.

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