After a steady rise for much of 2013, market volatility picked up significantly in June, with broad weakness across most major market indices. Through Monday, the S&P 500 declined 3.4% during the month (down almost 7% from its peak) and emerging markets, as measured by the MSCI Emerging Market index, is down 11% in June (and 19% from their peak).
The declines were not limited to traditional “risk” asset classes like equities. As interest rates have risen on concerns of the Federal Reserve “tapering“ its quantitative easing program sooner rather than later, the Barclays Aggregate Bond index fell 2.5% in June and is now down 3.4% in 2013. Times like these create anxiety in even the most seasoned investors. As we have articulated in prior communications, we have been expecting increased volatility and possible weakness for quite some time and have taken proactive steps over the past few months in an effort to dampen the impact to client portfolios. While downside volatility is never pleasant, we do expect risk markets (stocks and bonds) to operate outside the “norm” periodically. Additionally, while uncomfortable, we believe that market weakness does create opportunities for attractive investments.
Even with the negative returns in the month of June, U.S. equity markets remain solidly positive year-to-date and continue to be the best performing asset class in the world. Crestwood portfolios have benefited from this as our largest growth-oriented asset class exposure is in large cap U.S. equities. Additionally, as markets rallied higher in the first part of the year, we actively reduced overweight exposures to stocks approaching our target valuations. Now as markets pull back, we hope to have the opportunity to purchase high quality companies trading at more attractive valuations.
The more significant sell-off in emerging markets is the result of a convergence of negative factors including a stronger U.S. dollar, geopolitical tensions, a slowing Chinese economy, concerns over future central bank policies and a general retreat from riskier assets. These risks are always amplified for this asset class and why emerging markets continue to be a more modest weight in client accounts, relative to U.S. equities and fixed income. Today, many emerging markets trade at valuations near previous crisis troughs (i.e. 2008), which we believe amply represents the confluence of risks noted above. While we anticipate emerging market investments to continue to be volatile, we believe that these economies will continue to be the primary engine of global growth in the years ahead and that they remain attractive investment opportunities. As with many of our investments, we’ve emphasized dividend income within our emerging market exposure as this has historically offered stronger and smoother returns for long-term investors.
Perhaps the most dramatic movement this month was the sell-off in bonds and the corresponding rise in interest rates. Significantly, the benchmark 10 year Treasury yield rose over 60% since early May, from about 1.6% to over 2.6%, as investors reacted to concerns of diminishing bond purchases from the Federal Reserve. We’ve long articulated a view of higher future interest rates and over the past few years have focused on building shorter-duration portfolios to mitigate interest rate risks. In addition to our short-term focused core U.S. bond portfolios, our investments in floating rate debt, mortgage bonds and emerging market bonds have enhanced opportunities for total return and helped keep the duration of client’s portfolio well below that of the broader bond benchmarks, lessening the sensitivity to rising rates. While emerging market bonds have suffered recently on the strength of the U.S. dollar, we continue to believe in the investment opportunity and client bond portfolios have generally benefited by our diversification and positioning.
Despite the significant decline in gold prices to start the year, we continue to hold a relatively small position to hedge the risk of holding fiat currencies in an era of unprecedented money printing by central banks around the world. Gold has traditionally struggled at interest rate inflection points but, with inflation percolating in many parts of the globe, we remain firm in our conviction that gold is a worthwhile investment longer term.
We have taken several actions over the past few quarters to protect client assets in what continues to be an extremely uncertain environment. While cash is the only asset that offers complete protection when asset values decline, we believe the mix of assets in client accounts is the right mix not only to protect in times of volatility but also to provide appropriate exposure to the growing sectors of the global economy. We remain vigilant on the exposures in client portfolios and are constantly evaluating alternatives that may help to further protect and grow client assets.