Ask a CFA: A Review of 1st Quarter 2014
Today’s CFA: Marshall Bolden, CFA
Vice President & Chief Investment Officer
CapSouth Partners
Q: So Marshall, describe for us the first quarter of 2014, and specifically address the topic of volatility.
A: The first quarter of 2014 was an interesting one from many perspectives. Stocks were volatile, commodities finally had a positive return, Russia and Ukraine grabbed plenty of headlines, and interest rates actually fell. The result of all of this was nearly positive returns across the board for the quarter; emerging market equities were the only major exception. Of these topics, I’m going to spend the most time discussing volatility in the stock market.
Stock Market Volatility
I believe the relatively calm U.S. equity markets of the last two years, paired with nice gains, have probably made a lot of investors more comfortable than we should be. As evidenced by the chart below, 2012 had volatility that was a little below average, and 2013 was one of the most placid years of the last 34. The grey bar is the S&P 500 return for each calendar year, and the red dot and number indicate the worst decline experienced during the year. So for 2013 the return was 30% while the largest pullback was 6%.
The chart indicates the average intra-year drop is 14.4%. Of the 34 years shown, 19 had a pullback of at least 10%. The 6% pullback of 2013 was very low; only two years (1993 & 1995) saw a maximum decline that was smaller. We’ve had two calm years now, but you can see there were other calm periods that lasted even longer (1991-1996 and 2004-2007).
| These facts were the most interesting nuggets I got from the chart. I point them out not to scare anyone but to set realistic expectations going forward. U.S. stocks cannot have much less volatility than we saw in 2013. And while the volatility could definitely remain low going forward there is really only one direction it can go…up.You may have noticed lately that stocks have seemed more volatile so far in 2014. As the chart shows, we’ve had a 6% pullback already this year, equaling last year’s worst. It would be my “educated” guess that volatility remains a little more elevated this year. Simply having such low volatility last year is the first reason. The other ties in the theme of last quarter’s commentary that U.S. stock valuations look a little high and the fact returns were so strong in 2013. I just believe we might have a little more back and forth this year.It would not shock me to have a 10-15% pullback this year. As we’ve already seen, this would just make 2014 a more “normal” year, and I don’t believe it would be anything to get concerned about. As long as corporate earnings continue to rise and the economy continues its slow growth, my position is that any decline of this magnitude would probably be a buying opportunity. We are definitely not going to attempt to time (get more conservative in anticipation of) any increased volatility or market pullback. There is no guarantee any larger pullbacks will occur this year, and we certainly don’t know when it will be if it happens. I just want everyone to be aware that volatility may increase going forward, that this would be normal and that market fundamentals still appear to be fairly strong.Russia & UkraineI’ve had a few questions concerning this situation lately and thought it would be good to share my thoughts. At this point the Crimean peninsula is most likely going to stay Russian. Russia has troops on the Ukraine border, Ukraine rebels are causing some issues, eastern Ukraine is pro-Russia, and civil war is a possibility. While humanitarian issues could certainly arise from all this, these issues alone should not cause much impact on the U.S. investment markets. The Russia/Ukraine issue would have to morph into a much larger issue to begin having a long-term economic impact in the U.S. and the rest of the non-European world. There is some potential for market or economic impact on Europe, and, as we currently have some European investments in select strategies, we will continue to monitor the situation and to evaluate any changes and their potential impact.
Portfolio Thoughts We did not make any changes to our Risk-Based or Genesis portfolios in the first quarter. Both the Market Opportunity portfolio and the CapSouth Value portfolio had a couple small changes. At this point I still do not anticipate any major changes in the short term to any of our portfolios. We are still positioned pretty neutrally in regard to our splits between stocks and bonds. Until some area of the market begins to either look cheap or overpriced, we will keep our current allocations pretty steady. I could still see us tweaking some things over the next few months, but these would just be minor adjustments. In conclusion, I hope this commentary has been informative and worth your while. I generally get some feedback each quarter from readers and always love to hear your thoughts and/or questions that arise from these updates. So please feel free to contact me or someone else at CapSouth with any questions or feedback. And, as always, thanks for the trust you place in me and CapSouth; we’re honored to have the opportunity to work with you!
Marshall Bolden, CFA |
|
<!– –> |
