Horizon Advisors Summer 2013 Market Commentary

For the quarter, which ended June 30, 2013, the S&P 500 rose 2.9%. International stocks declined with the MSCI EAFE returning –1.0%. Bond returns were also negative for the quarter with the Barclays Aggregate Bond Index returning –2.3%.

In the most recent quarter, U.S. equity markets extended their first quarter gains, bringing the total return for the S&P 500 for the first half of the year to 13.8%. This is an impressive start; in fact, it is the best first half since 1998 when the return was 17.7%. The strong start in ‘98 led to full year return of 28.6%. The S&P 500’s return has only been above 10% for the first half of the year twice since 1998. In 1999 it was 12.4%, and in 2003 it was 11.8%. The total returns for those years were 21.0% and 28.7%, respectively.

While positive, the stock market experienced some turbulence during the quarter when the Federal Reserve hinted that the economy may finally be strong enough for them to begin “tapering” their stimulative bond buying program. The mere suggestion that the Fed might consider scaling back their efforts sent the market into a brief swoon, which some have dubbed, a “taper tantrum.”

Perversely, some investors now consider positive economic news as bearish for stocks since an improving economy could motivate the Federal Reserve to scale back and eventually end their stimulative programs. We prefer the more traditional view that good news for the economy is also good news for stock market investors.

The negative reaction by the stock market to the Fed’s “tapering” talk was relatively mild compared to the violent reaction in the bond market. The benchmark yield for the 10-year U.S. Treasury bond increased from 1.85% to 2.48% over the quarter, and nearly all of this rise occurred after Federal Reserve Chairman Ben Bernanke’s “tapering” comments following the Fed’s May meeting.

The negative effect of increases in rates on bond returns was dramatic and widespread. The Barclays Aggregate Bond Index declined by 2.3% in the second quarter; the largest quarterly decline since the second quarter of 2004. This brought the return for the bond index for the past year to -0.7%. This represents the first trailing 12-month decline in the bond market since June of 2006.

The bond market’s adverse reaction to Ben Bernanke’s comments suggests that investors do not intend to wait for the Federal Reserve to change their approach before they begin their exit from bonds. We feel that at this point, yields are more likely to move higher than lower. With this in mind, we have positioned our clients’ bond allocations towards less interest-rate sensitive areas of the bond market, such as low duration and higher yielding bonds.

While the market’s negative reaction to the Fed’s “tapering” comments is somewhat disheartening, the improved economic outlook responsible for motivating these comments is encouraging. Recent months have provided increasingly strong reports on employment, economic growth, and residential real estate. Although the stock market has risen at an impressive pace, we maintain our cautious optimism. Stock valuations remain reasonable and corporate profits continue to strengthen.

Thank you very much for your continued confidence in our service and advice. If you would like to discuss our opinions, outlook, or your portfolio in greater detail, we would be happy to schedule a meeting or a conference call at your convenience.

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