Published: 2014.10.16 09:46 AM

Economic growth in the U.S. jumped to 4.6 percent in the second quarter bringing year-over-year growth to 2.6 percent. ISI Strategies notes that this expansion has been the worst in history, with real GDP growing at 2.2 percent annually over the past five years.

They believe that slow and steady increases the odds that the expansion continues as imbalances have not built up. Maybe the slow expansion will turn out to be one of the longest on record?

The Federal Reserve is doing all it can to help by keeping short rates near zero. That will probably end by next summer. However it looks to be ending its monthly bond buying QE (qualitative easing) program this October. Most central banks throughout the world remain dovish; especially Europe and Japan, where some analyst believe rates will stay at rock bottom levels for the next five years.

Given soft global growth and well known geopolitical disturbances its not surprising that market performance was lackluster in the third quarter. Yes, the U.S. stock market hit new highs but after all was said and done the S&P 500 closed at 1972, up 1.1 percent for the quarter and 8.3 percent year to date. Smaller stocks in the S&P 600 lost 6.7 percent and are down 3.7 percent year-to-date.

After trading sideways for the first half of the year, the U.S. dollar gained roughly 7 percent against a basket of foreign currencies (DXY) last quarter. That suppressed the dollar returns of foreign stocks and bonds. For example the Japanese Nikkei stock index gained 7.3 percent in yen, but -0.9 percent in dollars. The Euro Stoxx index was up 0.9 percent in euros but -6.9 percent in dollars.

Bond markets in the U.S. tread water with the 10-year treasury trading in a narrow range around 2.5 percent. Recall it was just over 3 percent at year-end. The Barclays Aggregate bond index posted a 0.2 percent total return over the quarter. However, high yield junk bonds were particularly volatile. The Merrill Lynch High Yield index lost 1.9 percent and now yields 6.2 percent. Thats a spread of more than 4 percent over Treasury notes.

Inflation: Missing in action

Inflation has been remarkably tame here in the U.S. and around the world. The CPI inflation rate is 1.7 percent year over year. Its 0.3 percent in Europe, and only 2.0 percent in China. Sluggish growth and slack in the labor markets are the main factors, but there are other reasons.

Bumper crops around the world have driven agricultural prices lower especially grains like corn, wheat, and soybeans. Corn prices have fallen over 60 percent in two years and wheat prices are at a four-year low.

Oil prices have reached their lowest levels in two years despite various civil wars and violence in the Middle East. The domestic shale boom is part of the answer increasing supply, but demand has been soft owing to more fuel efficient cars and slowing economic growth out of China and Europe.

A stronger dollar has also kept a lid on import prices. That dollar trend may continue given the favorable interest rate differentials towards the U.S. For example, the 10-year Treasury yields 2.5 percent and looks to be a relative bargain compared to 0.5 percent in Japan and 0.9 percent in Germany.

In addition many commodities are priced in dollars on global markets, so a rising dollar makes them more expensive for foreign buyers lowering quantity demanded and ultimately prices.

APCM bond manager Bill Lierman notes that Wall Street economists have been revising their inflation forecasts down and that inflation expectations embedded in the bond markets have softened with inflation protected TIPS underperforming nominal Treasury bonds. The market expects 1.7 percent annual inflation over the next five years.

Jeff Pantages, CFA, is the chief investment officer for Alaska Permanent Capital Management, a $2.4 billion investment management and advisory firm located Anchorage.

This page requires javascript. It seems that your browser does not have Javascript enabled. Please enable Javascript and press the Reload/Refresh button on your browser.