Q3 2013 Market Commentary
David Y. Sun, CFA®

It appears the third quarter was just an extension of the second quarter; domestic equity markets continued to touch new & recent highs and the yield on the 10 year note continued its rise, reaching almost 3%. As mentioned in the previous commentary, we felt equity markets were trading at premiums based on 2013 earnings estimates and the bond market was oversold. We also mentioned the DJIA should be around 13,800 (support level) based on current year earnings estimates, but we can also note that the DJIA should be trading around 15,400 based on 2014 earnings estimates. We continue to monitor earnings adjustment trends to see if there is either continued upside or possible downside potential in the various targets we establish. Note that out of the 30 DJIA components, a vast majority are exhibiting flat earnings adjustment trends at this time.

Economic reports remain mixed, but have proven sufficient in creating a positive landscape for stock prices. The one hiccup that weakened equity markets near quarter-end was also the main culprit in driving the yield on the 10 year note to a recent high of 2.98%. The guilty party would be the highly anticipated announcement from the Federal Reserve regarding a possible tapering of the recent round of quantitative easing. It seems that markets were taking a binary perspective on this announcement which caused the volatility we recently experienced. Many of the discussions involving the tapering were along the lines of extremes, without any middle ground. This behavior is very typical of the media and those in our industry who enjoy being in the media.

After the announcement that tapering would not occur immediately, equity markets responded in a positive way and the yield on the 10 year note started to come down, currently in the 2.6% range. With the Fed announcement still in our rearview mirror, we immediately come upon a significant pothole, the government shutdown. Our challenge at this time is gauging the shutdown’s impact on the economy. Will it take us on a detour off the expected road to recovery? As we try to figure out domestic affairs, at least the global outlook is a little brighter with the positive news coming out of China and it appears that Europe may now have an economic pulse. Emerging markets have also started to recover, as expected, due to more attractive valuation relative to U. S. markets.

We recognize the recent run-up in interest rates was driven by the uncertainty surrounding the Federal Reserve’s announcement and not inflationary factors. As expected, bond prices have started to recover from being oversold. Even though inflation may not be an immediate concern, we are seeing a greater possibility that it will be in the future. We feel that recovering bond prices at this time will present opportunities to continue with further adjustments towards a more defensive portfolio in anticipation of a rising interest rate scenario based on inflation.

The market environment remains challenging with many possible traps for decisions made based on emotional reactions. We are hoping to schedule another Roundtable Session in the near future to discuss the various issues we address at our Investment Committee Meetings. In the meantime, should you have any questions, please reach out to your consultant. Please visit our website, www.ellisinvestmentpartners.com, for more information on our newest team members.

Download Q3-13 Market Commentary