Weather Dominated 1st Quarter 2014

Construction Impeded
This past quarter saw severe weather in most parts of the United States. The weather had an impact on many sectors. One of the effected sectors was home construction. New home construction took a dive. In addition, construction of new malls and shopping centers was negligible.  This was not good for the overall economy, but it did have a positive impact on real estate investment trust earnings and growth. Due to the lack of construction, the value of existing commercial properties in some areas rose, with demand exceeding supply. This also created an opportunity to continue to raise rents. The result of the combination of rising value and rising income gave this sector of the market a remarkable gain for the quarter.

Fuel Consumption
Because of the severe cold in many parts of the country consumption of heating oil, natural gas, and propane was higher than normal. This was bad for consumers and they spent more on heating and less on other goods and services. As consumption grew, demand outstripped supply and prices rose. As an investor in natural gas and oil this meant enhanced value. The resulting increased valuation of energy and pipelines was due in large to higher income.

Job Growth
The quarter brought greater job growth. The number of people filing first time claims for joblessness was greatly reduced. The unemployment rate dropped to 6.7%. Many more jobs were created as service industries and manufacturing were hiring. The hiring was similar across all size companies.

Rising Wages
It appears we are finally coming out of the massive recession that began in 2008. With hiring up, it is forcing wages up. Congress is finally talking about raising the minimum wage. The minimum wage went unchanged from 1997 until July 2007 when it was raised, from $5.15 to $5.85, with two additional increases in 2008 and 2009. This brought the minimum wage up to the present $7.25. Some states have raised it above this minimum since 2009. Part of what is happening is that part time jobs are becoming full time jobs. As there are more hires, increasing wages, and a greater sense of stability, consumers will increase spending. Since the consumer accounts for about two thirds of our economy, this change should be good for the overall expansion of the economy.

Federal Reserve Impact
The Federal Reserve (FED) had been buying about $85 billion of mortgages and bonds until January. In January they began to reduce the buying by $10 billion and reduced it again by the same amount in February. At their March meeting the FED decided to reduce it by an additional $10 billion, bringing the targeted buying to about $55 billion for April. It is clear the FED is getting out of the business of propping up the low mortgage rates and low 10 year Treasury rate. Mortgage rates, since last year, have gone up by a little more than 1.25% and the 10 year Treasury from about 1.65% to about 2.7% today. The next big task is to raise the discount rate, which is currently at 0% and controls short term interest rates and inflation.

Market Performance
After a blistering pace in 2013 the stock market rise slowed down. The reaction to increasing bond rates appeared to be overblown and the return on bonds went up for the first quarter.

The stock market, as measured by the S&P 500, was up about 1.44% for the quarter. As so often is the case this belies the actual performance during the quarter. Near the end of January the market began a descent that continued until the beginning of February. At its high point on January 15th the S&P was at 1848. By February 3rd it was at 1742, or a drop of 106 points (5.75%). Whoops! That did not feel so good. The market then continued to rise until March 27th when it was back to 1849. Thanks to a strong last two days of the quarter, the market rose to 1872. It was not a smooth ride. Then again the stock market is rarely a smooth ride.   

The stock market moved based on what it thought was going on both domestically and internationally. On the international front the situation in Ukraine was troubling. Ukraine being next door to Russia allowed the Russians to amass a large army on the eastern border then use their strategic naval presence in Crimea to annex Crimea and threaten eastern Ukraine. Western Europe and the United States were left with few choices. Once military intervention was ruled out the stock market went back up.

The stock market is still very uncertain about the new Chair of the FED, Janet Yellen. In her first press conference, following the March 19th FED meeting, she gave mixed signals about when short term interest rates would be allowed to move up. Short term interest rates are what the FED uses to control inflation. Any increase to short term rates, which are currently targeted at 0%, would signal that the FED is concerned about inflation. As mentioned earlier, wages are beginning to rise. As the unemployment rate drops there are fewer qualified people for jobs. Supply and demand takes over and wages begin to go up quickly. The FED is therefore looking at wage inflation and the unemployment rate to determine when they will begin to raise the discount rate. We saw short term market rates going up during the 1st quarter in anticipation of this possible change.

High quality bond values moved up during the quarter. This seems in large measure to have occurred because of an overreaction to increasing rates in the prior quarter. As the FED has moved out of their purchases of bonds and mortgages the markets have remained stable. The concern was that this reduction in purchases by the FED would result in reduced bond values and higher interest rates. This has not happened.

Conclusion
The first quarter of 2014 was impacted by bad weather, the move by Russia to take over Crimea, the actions of the FED, increasing jobs, decreasing first time jobless claims, and increasing manufacturing activity. One of the big areas of construction growth is the continued development of oil and gas pipelines, needed to move the increasing supply to markets and refiners.

Once again during this quarter, it was clear that diversification makes a difference. We saw many diversified portfolios do better than either the stock or bond markets did individually.  It is likely that managed investments will be more important than ever. There are good spots in the markets and bad spots. Staying on top of which you want to own is going to be very important.

Ed Mallon