As I write in my new weekly commentary, the third quarter played out largely to script, although there were some plot twists along the way. On the market front, while fears over tapering and uneven data hurt stocks in August, September was a surprisingly strong month. Investors were relieved by the Federal Reserve (Fed)'s decision not to taper and a temporary downgrade of the tensions in Syria.
From an economic perspective, other than a Fed-induced rise in rates, the overall economic backdrop remained broadly the same as the first half of the year: positive, but uninspiring, growth. Real rates rose modestly, economic growth was still soft and inflation stayed low. And the key U.S. economic theme remained a continued resurgence in manufacturing and a mixed jobs and consumption picture.
The third-quarter calls I got right:
- Overweight stocks. Stocks easily beat bonds.
- Underweight the utilities & consumer staples sectors. Cyclical stocks generally beat defensive ones – and utilities and consumer staples struggled.
- Increase international exposure. The equity rally broadened out with international stocks, including emerging markets, beating U.S. stocks.
- Overweight credit. Credit outperformed Treasuries.
The third-quarter calls I got wrong:
- Underweight the consumer discretionary sector. Retailers and other consumer discretionary companies continued to perform well, despite the weak labor market.
- Overweight mega and large caps. Small caps continued to outperform their larger peers.
Looking ahead at this quarter, I'm sticking with a few broad themes. The fourth quarter looks to be a decent one for the economy (assuming the economy is left to its own devices) and I still expect that stocks can finish 2013 higher. In particular, I'm advocating taking on a bit more cyclical exposure, something that investors who are harvesting tax losses and are looking for new places to allocate may want to consider.
However, Washington remains a wild card and a risk to my views. While I still expect that a deal to avoid the debt ceiling will be struck prior to the October 17th deadline, given the prevailing level of acrimony, it's hard to imagine a broad or long-lasting deal. Instead, it's likely that Washington will produce another temporary patch, meaning markets are likely to remain volatile amid continued policy uncertainty.