Is the Federal Reserve driving the bus or just along for the ride? The stock market rally is the result of both an accommodative Federal Reserve and improving market fundamentals. The Fed is working the bus’s accelerator pedal while the market has control of the wheel. Easy monetary policies delivered through a variety of Fed programs under the banners of Quantitative Easing (QE) and Operation Twist (OT) has definitely bolstered stock prices. Look at a graph of the expansion of the Federal Reserve balance sheet and the price movement of the S & P 500.

One can easily conclude Federal Reserve policy is having a positive impact on the equity market. This conclusion is further supported if you notice that the mini price corrections during this bull market occurred during short breaks in the Fed’s monetary expansion. While the Fed has given the market a supportive tailwind, the market is also recognizing better fundamentals. Corporate earnings are strong and continue to get stronger. Corporations are lean, employees more productive and profits are at record levels. The U.S. consumer has deleveraged, become more confident, and is spending once again. Housing is still well below pre-recession levels, but the current trend is positive. While the bearish investor will point to the chart above and claim this rally is just smoke and mirrors, the bullish investor will look at the chart below and tell you stock prices are driven by fundamentals such as the earnings per share of the S&P 500.

As this bull market approaches its fifth anniversary the debate continues; is this a Fed induced asset bubble or is an improving economy driving prices higher?

Our view is the Federal Reserve has created an environment for corporations to maximize their success, but ultimately it is the success of the companies themselves that will dictate the future direction of stock prices. We firmly believe the stock market is the best wealth creation machine ever invented, but it takes time and patience to generate wealth. It’s never a straight line and hurdles are already in place for 2014: government shutdown round two, debt ceiling debate, Fed tapering decisions, mid-term elections, geo-political events, and the future of Obamacare to name a few.

Regardless of the cause, stocks continued to run higher in November. The S&P 500 set new record highs twelve times and the NASDAQ reached the 4,000 level for the first time since 2000. November’s performance numbers were a microcosm of the trailing twelve months. U.S. Stocks lead the way, international stocks underperformed, investment grade bonds and municipal bonds posted small losses, high yield bonds were up and commodities declined yet again. For the month, the S&P 500 gained 3.05%, , NASDAQ Composite 3.79% and the MSCI Europe, Asia, Far East (EAFE) 0.43% MSCI Emerging Markets -1.46%.

Bonds gave back some of their October gains. The Barclay’s US Aggregate Bond Index returned -0.37% for the month and -1.61% for the trailing twelve months. Once again, high yield was the best monthly performing bond sector with a 0.51% return. Commodities continued their struggle as the Dow Jones Commodity index fell 0.80% during November.

Washington tried to scare the financial markets this October, but the markets did not flinch. Those classic horror picture reruns are not quite as scary the second time around.

October started with the first government shutdown since 1996 and the market yawned. It has been a while, but the market experienced fourteen government shutdowns during the ten year period ended in 1988, so the old timers have seen this show before. The second picture in this double feature was the debt ceiling crisis. The U. S. self-imposed debt ceiling limit has been approached fifteen times since 2000 and every time the story ends with the debt ceiling being raised and the crisis averted. In addition to these headlines, the market also took bad economic news (a weak September employment number) and twisted it into good news. The collective wisdom deduced the Federal Reserve’s tapering plans will now be delayed well into 2014. The pending departure of Federal Reserve Chairman Bernanke and the nomination of his current vice-chair, Janet Yellen, were much anticipated and the markets climbed higher. A new round of quarterly earnings releases also kept price momentum positive.

Stocks and bonds each had a positive impact on your portfolio in October. The S&P 500 set new record highs on numerous occasions and the NASDAQ reached levels not seen for thirteen years. Even the bond market rallied. For the month, all the majority equity markets indices had returns around 4.00%. The S&P 500 gained 4.60%, MSCI Emerging Markets 4.86%, NASDAQ Composite 3.98% and the MSCI Europe, Asia, Far East (EAFE) 3.36%. The Barclay’s US Aggregate Bond Index returned 0.81% for the month and minus 1.08% for the trailing twelve months. Once again, high yield was the best monthly performing bond sector with a 2.51% return. Commodities continued their extended struggle with another down month lead by declines in oil prices. The Dow Jones Commodity index fell 1.48% during October.

The spring bond market sell off ended quickly and interest rates have now stabilized. Yields on the 10-year U.S. Note rallied from a 2013 high water mark of 3.00% in September and fell back to 2.48% intra month and finished October yielding 2.55%. Assuming Janet Yellen becomes the next Federal Reserve Chairwoman; expect short-term interest rates to remain low well into 2014. It appears the new 2.50%-3.00% range on the 10-year Treasury has replaced the policy induced 1.50%-2.00% range of the past few years. While the twelve month returns from investment grade bonds are still in negative territory, the recent strength is inching the bond market back toward unchanged for the year. High yield bonds continue to ride the coattails of a strong equity market.

As we begin looking ahead to the 2014 markets our advice to investors is to set realistic expectations and remain invested. If you are a 2008 doomsayers, it’s been five years now and it is time to move forward. If your perception of the financial markets is, “the glass is half empty”, it may be time to view the 2014 market in a different light. Let market fundamentals, not breaking news, drive your opinion of the market. While twenty percent annual returns in the stock markets are not sustainable over the long haul, five to eight percent returns can be achieved. Stocks today are fairly valued based on next year earnings estimates and projected price/earnings ratios. This coupled with stable economic growth creates an environment which can produce positive single digit equity returns in the years ahead.

A successful third quarter in the financial markets has ended and the hype from Washington is once again the number one story in the land. We have heard these stories before: a government shutdown, debt default and raising the debt ceiling. The debt ceiling in the United States has been raised fourteen times in this thirteen year old 21st century. A fifteenth increase is a safe bet. As the media spotlight shines on Washington’s fiscal issues, investors will become more concerned and market volatility will increase in the weeks ahead.

The political nature of the debt ceiling debate and a potential government default will receive full coverage by all the media outlets, but there are other key stories occupying the front page that will impact the fourth quarter financial markets. Uncertainty regarding the next chairperson of the Federal Reserve, questions about Fed policy and future tapering plans, geopolitical instability, economic growth, unemployment rates, and a new corporate earnings season will influence future of stock and bond prices. Before we look ahead, let’s review what happened.

International stocks had a huge month taking the lead role after many months of weaker performance. The MSCI EAFE Index jumped 7.39% and the MSCI Emerging Market Index gained 6.50% for September. U.S. equity markets posted attractive gains for the month ranging from up 2.27% on the Dow Jones Industrial average to up 5.14% on the NASDAQ Index. For the trailing twelve months, if you invested in stocks you should be gratified with returns near twenty percent. For the doom and gloom investors who moved into gold and commodities a year ago it was a different story. Gold is down 25.0% over the past year and commodities in general have fallen by 14.35%.

The bond market crashed in May and June as the Federal Reserve hinted at ending their accommodative policies. Yields on the 10-year U.S. Note moved from 1.70% to 3.00% very quickly. The “taper” is now priced into the bond market and September marks the third consecutive month where bond investors are getting accustomed to a new trading range. It appears a 2.50%-3.00% range on the 10-year Treasury has replaced the unsustainable 1.50%-2.00% range of the past few years. While the twelve month returns from investment grade bonds are in negative territory, the higher current interest rates give bonds a more compelling relative value moving forward. High yield bonds continue to shine reflecting strength in the both the equity markets and lower quality corporate credit.

If you own bonds in your portfolio, remember why. Bonds provide for capital preservation, income, stability and low correlations to equity returns; important components for successful long-term portfolio strategies.

The fourth quarter and particularly October tends to be a stern test of investor resolve. Our long-term view is stocks can still move higher in 2014 as fundamentals like corporate earnings, consumer confidence and global economic growth will move prices upward. Even though stock prices are near all-time highs, they are still reasonably priced relative to other asset classes. Stock gains in the fourth quarter though will likely remain muted as volatility increases and investors digest the stories of the moment.

Our best advice to all investors is to not let yourselves get trapped into thinking today’s breaking news is tomorrow’s end of the world. Years matter – days, weeks and months are irrelevant in the bigger picture. We may experience some headline induced turbulence in the fourth quarter; fasten your seatbelt, sit back and enjoy the ride to your financial destination.