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July 2013 Investment Journal: "Bounce Back" 


With the exception of high grade US bonds, almost all major markets recovered smartly from prior downswings in June:
Over the last three years and year to date, US stocks have strongly outperformed all other asset classes:
The summer swoon that sometimes occurs in the stock market has not taken hold, although some observers see big pauses or even declines coming in August and September as a result of various cycle work and studies. Others say that stocks are still the only game in town with T-Bill rates at zero.
Stocks have clearly had quite a run, and sentiment is bullish. The charts below track the level of the average investors' appetite for stocks, and it is very high, a bearish signal from a "market psychology" perspective:


Price momentum is still favorable for stocks, however, so any pause or near term decline may be another time to add.

As we discussed in our May Journal, the bond market is not as favorable from a momentum perspective, having entered a "bearish" phase, so many investors have shortened their average maturities to combat principal loss. The municipal bond market had a particularly rough June and July, with Detroit's fiscal woes and push for bankruptcy front and center.

Amidst all the fuss and furor over what the Fed is going to do next, the graph below may help put some perspective on the trade-off between risk and reward. GMO produces a widely read Seven Year Real Return study, which exhaustively maps out the permutations and combinations of all assets to present their "best guess" as how various assets will perform "after inflation" for the next seven year holding period:

Source: GMO 2Q 2013 Letter, Ben Inker & James Montier

From a bond investors' perspective, notice how high yield dominates the other fixed income alternatives of cash, TIPS, and US Governments. It is not perfect, but it suggests investors still are getting paid to take on the additional "risk" of owning less than investment grade bonds. This bond asset group is also the only one with a positive price momentum trend.

As August gets underway, most of Europe and a large part of America will be vacationing. Germany is likely to be the focus as we get into the fall months, with a Federal election set to occur on September 22nd that, by all counts, will serve as a referendum on the continuing monetary union of the Eurozone. We'll report back in our next Journal shortly after Labor Day. Have a great month!


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