by Ron Veld

In the second quarter of 2014, equity markets across the world continued the bull market that started in March 2009. After a slow start to the year, with mediocre equity returns in the first four months, equities rallied sharply in May and June. As a result, investors have been rewarded handsomely year to date, despite lingering concerns regarding the overall pace of recovery of the developed world’s economies and the weakness in emerging markets, particularly in China.

All equity markets gained in the second quarter and are also up for the year. The S&P 500 was up 4.14% for the quarter, international stocks were up 3.4%, and emerging markets were up an impressive 6.06%.

After a weak 2013, the bond market and most commodities continued their rally from the first quarter of 2014. The overall bond market was up 0.92% for the quarter, and gold was up 3.58%.

Economic Outlook

Looking ahead, we remain moderately optimistic regarding economic growth around the world. We expect the U.S. economy to improve modestly in 2014 and 2015. As a result of housing prices (up 13% in the last 18 months) and higher equity markets in the past several years, U.S. households have become wealthier. We believe that will lead to more consumer spending, which remains the largest engine of the U.S. economy. In Europe, the fragile economic recovery remains on track, as well. The political unrest in Ukraine needs to be watched; if the conflict escalates, European economies will be impacted, with the potential for declining financial markets.

On the bond side, we have been surprised by the year-to-date fall in interest rates. As long as the U.S. economic data doesn’t disappoint, however, we expect the Fed to continue to slowly reduce its bond-buying program in 2014, leading to a gradual rise in interest rates. In particular, we doubt the Fed would want to become too aggressive because rapidly rising mortgage rates would threaten the recent improvements in the housing market, and that could impact a broader-based recovery in employment.

Market Outlook

In the short term, we expect volatility in the equity and bond markets, especially after the strong U.S and European equity markets in 2013 and the first half of 2014. Recently Large Cap equities have outperformed Smaller-Cap stocks. That could be a precursor to a 10% or larger decline in most equity markets, which hasn’t occurred in more than two years. Longer term, the most likely scenario is that the U.S. economy will continue to improve gradually, and equity markets should allow for attractive returns for investors