U.S. equity returns modestly increased during the first quarter of 2014 following an outstanding 2013. Investors were rewarded last year with 20 percent plus market gains regardless of market capitalization or investment style choices. So far this year, we have seen some divergence in performance among sectors and industries, and by company size. Mid-and-smaller-cap securities have performed quite well relative to their larger counterparts. Moreover, there are discernible sector/industry differences. Last year ended with Telecom and Utilities as underperforming sectors. We took advantage of the underperformance and began to allocate dollars to some strong utility businesses trading at reasonable valuations. These companies provide stable (and in some cases growing) dividends, and are generally very well capitalized. Utilities collectively performed quite well during the first quarter.
With no notable interest rate movements during the first quarter, prices of fixed-income investments moved slightly higher. However, during her first news conference, new Federal Reserve Board Chairwoman Janet Yellen implied that the Fed may raise rates six months after it finishes its "quantitative easing" (QE) program. Those comments alone drove the 10-year Treasury price down and raised the yield 15 basis points in one day, reflecting just how sensitive fixed-income investments are to changes in interest rates.
Our longer-term thinking regarding bond investments remains the same. While the timing is unknown, it is inevitable that interest rates will rise. As rates move higher, bond prices will fall as the relative value of current coupon payments declines versus newly issued securities. We expect fixed-income investors will find themselves earning meager (if not negative) real rates of return in the meantime. For this reason, we have largely avoided fixed-income investments and will continue to do so until interest rates rise, which will lower the inherent price risk and improve the total return characteristics of bonds.
Richard E. Pyle. PHOTO PROVIDED.
International equities moved modestly lower during the first quarter. We continue to see value among international equities for investors with long time horizons -- particularly in emerging markets where valuations have become quite attractive relative to their domestic counterparts.
In addition to a very strong 2013, U.S. equity markets concluded an outstanding five-year period with double-digit annualized returns. As bull markets endure over longer periods of time, the natural tendency is to believe that the next five years will look much like the previous five. While we certainly believe there is substantial upside for equity securities moving forward, it is important that we temper our expectations. For example, a reversion to long-run average rates of return seems quite plausible, meaning we should expect stock market performance to average closer to 7-9 percent per year in a healthy economy, as opposed to the above-average returns we were pleased to earn over the past several years.