Market Commentary: August 2005
Three consecutive months of gains in equities came to a halt in August, as US markets lost ground across the board. The good news? After declining relatively steadily throughout the month, a late rally revived returns, softening the losses for most investors.
The S&P 500 Index slipped 0.9% for the month to pace the US market. For the trailing three months, however, this large cap indicator has still provided a 2.9% return. By long-term standards, the last quarter would still be better than average. Smaller companies, which have fared better during the recent rally, were hit harder than the blue chips; the Russell MidCap and 2000 Indexes lost 1.1% and 1.5% respectively for the month. Despite the losses, quarterly returns for these smaller, more volatile issues remained strong. Positive news for equity investors came from international markets, which shrugged off negative sentiment in the US to provide a solid 2.5% gain for the month. The EAFE Index of international stocks continues to trail only the Russell MidCap Index for the year.
Bonds rallied during August with long-term bond yields heading lower, notably reversing course from their July spike. The Lehman Aggregate Bond Index returned 1.3% for the month, virtually matching its prior year-to-date return. The 10-year Treasury yield fell almost 30 basis points to end the month at just over 4.0%. The Fed continued its steady mantra of rate increases; on August 9, it announced another quarter point hike in the Fed Funds rate to 3.5%. Moreover, the committee’s language continued to suggest that more increases could be reasonably expected. Spreads between short-term rates and the 10-year Treasury have dipped to about 50 basis points, compared to a long-term average in excess of two percent. There remains relatively little benefit to becoming more aggressive in one’s core bond allocation. While a “normal” yield curve can be generally expected to reward investors with additional yield for longer term bonds, the current environment provides limited incentive to do so. In the absence of perceived “fat pitch” opportunities in the domestic fixed income markets, international bond markets have not disappointed, with a 4.6% return year-to-date as measured by the Citi World Government Bond Index Hedged.
As we move into the closing months of the year, year-to-date capital market returns remain moderate by historical standards. Given the outlook at the beginning of the year for both fixed income and equity investments, returns appear to be generally on par with expectations. A rising interest rate environment is generally challenging for fixed income investors. The dearth of yield among equity investments and gradually declining valuations which remain on the high side of long-term averages were expected to place some drag on returns. Nonetheless, investors should be pleased that the returns of major sub-asset classes all remain positive through eight months. Attentiveness to investment costs, opportunistic rebalancing, and tactical portfolio reallocations become even more meaningful in a low return environment. In the coming months, we will seek opportunities to further enhance your returns by focusing more specifically on tax motivated transactions such as tax swaps or loss harvesting techniques prior to January 1.
