The Top 10 Surprises Of The First Quarter

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From Nick Colas of ConvergEx

Q1 2014 – Top 10 Surprises

U.S. stocks are like a duck, floating on a quiet pond – calm above the surface, but lots of furious churning invisible to the naked eye.  The S&P 500 looks like it will end the first quarter within a hair of the 1848 level where it started the year, but that doesn’t mean everything else is all stasis and light.  Today we offer up a quick ‘Top 10’ list of surprises from the last 90 days.  Gold, for example, is back from the grave, up 7.3%.  So is an imperial Russia, with the biggest land grab since the building of the Berlin Wall.  Mutual fund flows are ahead of exchange traded funds by a factor of 5:1.  And most of those ETF inflows are into bond funds, not the “Great Rotation” we all expected into stocks.  The 10-year U.S. Treasury yields all of 2.67%, and bonds have bested U.S. stocks consistently in 2014.  First quarter 2014 may not have been a long trip, but it certainly has been strange.

The number 1848 is synonymous with revolution.  Starting in France early in February 1848, populations in scores of countries from Latin America to Poland rose up, sometimes even overthrowing long established monarchies, with calls for greater democracy.  There was no Twitter back then, of course, or any of the other technological enablers we now consider essential for a truly modern uprising.  These were old-school revolts, but no less effective in their impact for want of a YouTube channel or Facebook page.

Fast forward to the current year and relocate the conversation to Wall Street, and the number 1848 is a good deal more benign – even boring.  We started the year at 1848.36 on the S&P 500 and 85 days later we are at 1849.04.  Excluding dividends, that is a 0.04% increase, and a negative return when adjusted for inflation.  Yes, we are coming off a strong 2013, but that lack of follow through is a notable shift from expectations just three months ago. 

That got me thinking about capital markets ‘Surprises’ generally, and it wasn’t too difficult – with the help of some ConvergEx capital markets professionals – to come up with a “Top 10” list.  Yes, I know Jimmy Fallon is beating the Worldwide Pants off David Letterman, but a series of “Thank you” notes didn’t seem to capture the “Spirit of 1848” in quite the right way. 

Here’s our list of Q1 2014 capital markets surprises:

  1. Geopolitical Headline Risk is Back – and No One Cares.  If you had told 100 traders at the end of last year that Russia would annex the Crimea and amass a sizeable military force on the Ukrainian border, 101 of them would have laughed in your face.  And then they would all have sold their risk assets.  Yet, even with this event now in the history books, U.S. equities are flat and European stocks are catching a bid late in the quarter.
  2. Gold Beats U.S. Stocks.  The yellow metal is back with a vengeance, up 7.3% year to date.  Yes, it is well off its 2011 highs of +$1,800, but rumors of its demise in 2013 were greatly exaggerated.  All the more impressive is the fact that this move comes with worries of European deflation and new Fed Chair Janet Yellen’s “Six month” doomsday clock to interest rate hikes. 
  3. Bonds Beat U.S. Stocks.  Look at any wide measure of performance for the fixed income complex – high grade corporates, their high yield cousins, or aggregate bond indices – and you’ll see YTD performance of +1.3 to +2.5%.  That’s much better than the stuck-in-neutral U.S. equity market.  Domestic stocks, in fact, have lagged their bond market competition in all but 5 days of 2014 when looking at YTD returns. 
  4. Mutual Funds Get Their Groove Back.  The aftermath of the Financial Crisis was especially cruel to the mutual fund industry, as retail investors reduced risk from 2007-2013.  Now, in 2014, total mutual fund flows as measured by the Investment Company Institute are +$85.7 billion through March 19th.  Of that total, equity funds got more than half, or $51.9 billion.  Domestic stock mutual funds may see their first 3 month streak of inflows since 2009 if the last half of March just holds flat for money flows.
  5. CBOE VIX Index Begins to Trend Higher.  Over the last few years, the only activity at most volatility desks on Wall Street was the occasional tumbleweed rolling through town.  The “Bernanke Put” made stock investors fearless, pushing their demand for options-based insurance dramatically lower.  Now, with the Federal Reserve talking up the need to start lifting rates, volatility is creeping back into stock markets.  We continue to believe that the VIX will grind its way higher in 2014 and average 15-20 as we move through Q2. 
  6. U.S. Treasuries – What, Me Worry?  The 10 year started 2014 at 3.03% and currently sits at 2.67%.  Everyone talks about how the horrid weather this winter hurt the U.S. economy; no one mentions that the weakness seems to have helped Treasury yields by dampening fears of accelerating economic growth and inflation.  Throw in some asset allocation trades from institutional investors anxious to lock in their 2013 stock market gains, and you have a measurable rally in the most hated asset class out there – bonds.
  7. Utilities Beat Tech – and Everything Else.  The top sector with the S&P 500 is Utilities, up 7.8%. With a 3.6% dividend yield, this group is the closest thing an equity investor can get to bond exposure in all-stock portfolio.  So, for 2014: Widows and orphans: 1, momentum investors: 0.
  8. Jan Brady (MidCaps) Finally Get a Date.  Of the three closely followed S&P market cap indices, mid caps rule the roost, up 0.6% in 2014.  One explanation: they are not as risky as small caps (down 1.0% in YTD) and not as international and heavily super-cap as the S&P 500 (flat). 
  9. Miss PIGSy Gets Her Frog.  Exchange Traded funds focused on Portugal, Italy, Greece and Spain are pulling in assets, to the tune of $1.0 billion year-to-date.  That’s especialy impressive considering their total asset under management are just $3.1 billion. 
  10. No Great Rotation.  The old saw that “Convention wisdom is always wrong” lives on in 2014.   This was supposed to be the breakout year for stocks, full of revenue growth, synchronized expansion in developed economies, and rising interest rates.  Yeah… Not so much.  Money flows into fixed income ETFs of $10.4 billion YTD outnumber those into equity products, with just $1.3 billion.  Interest rates seem well grounded, as noted previously.  If you had a flashback to high school History class at the top of this note, consider the following: “The Great Rotation is neither ‘Great’ nor a ‘Rotation’.  Discuss.