Market Summary – Q3 2013

Posted by on Nov 4, 2013 in MFA Quarterly Commentaries

The Royal Swedish Academy of Sciences announced on October 14, 2013 that Eugene Fama, Professor of Economics at the University of Chicago will share in this year’s Nobel Prize for Economics.*  We congratulate Gene Fama on the recognition he has achieved.  It was his research and teaching along with co-author and collaborator Professor Kenneth French ( Dartmouth) on efficient markets and Small Cap and Value investing that provided the insight and inspiration to David Booth who went on to found Dimensional Funds Advisors (DFA).  Dr. Booth earned his PhD under Professor Fama in the early 1970’s.  Gene Fama serves on DFA’s board of directors and Investment Policy Committee.  Over the past ten years we have had the privilege of participating in numerous meetings with him and other noted academics, and we’ve learned a lot from this association. 

Professor Fama might describe the Stock market as a continuous pricing machine, incorporating investors’ judgments of the future prospects of the companies they invest in.  In mid August it was reported that the 17 country Euro zone’s economy grew by 0.3% after six straight quarters of contraction1.  The news appears to have lifted investors’ moods, as the Index for International Stocks2 provided nearly double the return of stocks in the US and Emerging Markets.  We have been commenting on the relatively attractive values of stocks outside the US3.  We can’t predict the timing but by rebalancing (buying more of) unpopular asset classes when they are shunned and priced at relative discounts, we participate in the upside when it arrives.  It is said they don’t ring a bell to let you know the recession has ended or the market has shifted.  The rebound last quarter of Euro zone Stocks (The Greek and Spanish stock markets both gained over 25% in three months!) is reminiscent of the unexpected rebound of US Stockssince the last recession ended in 2009.

We often observe that markets hate uncertainty.  But let’s not restrict the love of the predictable to the markets.  Who doesn’t enjoy a sure thing?  The removal of Larry Summers as a candidate and the nomination of Janet Yellen to succeed Ben Bernanke as chief of the Federal Reserve were two events well received by the stock markets, likely because it suggested little change of course in the Fed policy of keeping interest rates low to restore full employment.  Hard negotiations between the Senate and the Congress with a looming debt ceiling caused many government services to shut down October 1st.  Stock markets swooned as the prospect of an extended shutdown and possible default, then soared ten days later as news of a potential compromise surfaced.

As of this writing, the debt ceiling issue is not yet resolved.  A default by the US Government on its debt would put us into unchartered territory (since 1790, anyway) and certainly qualifies as a world class source of uncertainty.  We would expect extra volatility to be part of investing until an acceptable long-term resolution is achieved.  The essential question is “does the presence of doubt dictate a course of action?”  On this the record is pretty clearly “no”.  Markets (representing ultimately people making choices) are quick to react to news, but not particularly good at predicting the news.  Even if one gets the prediction right, it is hard to know how markets will respond.  When the credit rating on US Treasury Debt was downgraded in 2011, Treasury bond prices rose, the opposite of what economic theory would predict.  The ongoing negotiations over the federal budget and debt ceiling are constantly covered in the news and, we expect, mostly reflected in current prices.

We look forward to discussing your investments or touching base on other topics that affect your financial well being.