June 30, 2013
The second quarter was a cruel period, inflicting losses on investors whether they clung to gold, cowered in bond funds they assumed were safe, or took chances on stocks, stock funds, risky bonds or commodities.
It was a period of harsh lessons. It demonstrated that people can lose 4 percent of their money in three months by investing in mutual funds that invest in safe Treasury bonds. It showed that people can lose 25 percent of their money in a gold fund, and it made a mockery of the belief that gold is always safe. And it made clear that the brainiest of investment professionals can't protect individuals in bond funds when interest rates start rising, destroying the value of both safe and risky high-yield bonds.
To make matters worse, investors will see when they start perusing statements from 401(k) funds and individual retirement accounts for the period that ended June 30 that there are times when virtually nothing will spare an investor from losses. While diversification — or buying a combination of stocks and bonds — usually provides protection, there are times when everything gets battered. That was the story of the second quarter, and especially the last month of it.
Yet, despite a nerve-racking six-week period late in the quarter, investors gained so much early in stocks this year that they are still sitting pretty. The average U.S. stock fund remains up about 13 percent. And the panic that hit the market late in May eased last week, although analysts don't expect the carefree attitude that typified the beginning of the second quarter to return this summer.
Investors came into the second quarter feeling cozy. The Federal Reserve was buying bonds in an attempt to keep interest rates low and stimulate the economy. The idea was to make low-interest mortgages available so people would buy homes, and low-interest business loans available so companies would expand and hire people. Whenever the Fed is trying to keep interest rates low, investors buy stocks, and they did it with zest early in the quarter — before fear set in. There's an old Wall Street adage that says, "Don't fight the Fed." In other words: Buy stocks when the Fed is providing low interest rates.
But late in the quarter, Chairman Ben Bernanke sounded like he was going to change the rules of the game, or start taking the punch bowl away. He said the Fed later this year would consider pulling back some of the bond-buying stimulus.
And with that comment, investors panicked. They dumped bonds, knowing bonds lose money when interest rates rise. They dumped stocks, knowing other investors would probably do the same if they expected interest rates to rise and perhaps cool a lackluster economy.
"Investors and financial markets responded by stampeding towards the exits," said EPFR Global, which tracks the flow of money in and out of funds. Investors broke records pulling money from bond funds — everything from municipal bonds to emerging market bond funds. And they pulled billions from stock funds, too, especially funds that invest in dividend-paying stocks. Stocks that pay dividends are often hurt most when interest rates rise because investors figure they will be able to get income from bonds after rates rise, and then will shun stocks because they are riskier investments.
Utility stocks declined about 12 percent from the beginning of May to June 21, but investors who have been holding them throughout the quarter have seen them climb about 3 percent. Given the sharp rise they made early in the quarter, losses for the second quarter are not extreme. The average utility mutual fund tracked by Lipper has declined about 1.5 percent for the quarter. Real estate, or REIT funds, have also lost 1.5 percent.
While the Standard & Poor's 500 stock index declined about 6 percent from late May to June 24, it recovered somewhat last week. For the year the index is up 12.6 percent. And the average U.S. stock fund, after gaining sharply early this year, retains a gain of 13 percent for the year and 3 percent for the last quarter.
Funds that invest in stocks outside the U.S. continue to show sharp losses, however. Emerging market funds, which invest in China, Brazil and India, lost about 8 percent for the quarter. The funds were hit by worries over China, continued weakness in Europe, and the fear that speculation in emerging markets would slow along with exports to China and the rest of the world as interest rates rise.
Latin American funds have been particularly hard-hit, with a loss of 15 percent, according to Lipper. European stock funds lost 4.25 percent for the quarter.
Although commodities have been a popular investment for the past few years as China has been busy buying everything from food to oil and copper, a slump in China's growth — plus the fear that China along with the Fed will stop stimulating the global economy — sent commodities plunging. Funds that invest in metals such as copper, aluminum and nickel dropped 11 percent for the quarter.
But the harshest reaction was to precious metals — particularly gold and silver. The SPDR Gold exchange traded fund declined 25 percent for the quarter, and the SPDR Silver exchange traded fund plunged 35 percent. It must be a shocking loss for investors who thought gold would always keep them safe.
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