The first half of 2014 ended on a high note for most investors with stocks, bonds and commodities all posting relatively strong returns over the first two quarters of this year. Investors seeking income and gains set aside concerns over rising geopolitical risks and pushed stock market averages up to new highs while keeping a bid on bonds.

The year started off on uneasy footing when Russia squandered the goodwill credits it earned from hosting the Winter Olympics by invading Ukraine and annexing Crimea. Equity markets fell briefly in late January, but investors quickly overlooked this unnerving incident and soon pushed markets briskly higher. Other equally disturbing events such as the Sunni invasion in Iraq last month did little to offset the prevailing ‘risk on’ environment. Markets quickly recovered after each temporary sell-off, marching steadily upwards.

In terms the major equity markets, the US once again led developed world bourses. For the first half of 2014, the S&P 500 gained 7.1 percent, while the more global MSCI World Stock index advanced by 6.6 percent. This latest three month period marked the sixth consecutive quarter of positive performance for both indices.

Global equities fared well during the first half of 2014, but economic forecasters were perhaps most surprised by the rally in bond prices as longer term interest rates tumbled from year-end levels. Bond prices move inversely to interest rates and thus the decline in yields since last December boosted fixed income prices across most sectors of the bond market.

At the end of last year, the consensus had been for longer term interest rates to rise, not fall, on the premise that the global economy would continue to stabilise and as America’s commitment to steadily reducing open market bond purchases or ‘tapering’ monetary stimulus was also predicted to help push rates higher. Surprising many economists, however, bond yields began to fall again this year as growth faltered and newly appointed Fed chair Janet Yellen reiterated her commitment to keep interest rates low for a long stretch ahead. Meanwhile, policymakers in Japan and Europe have been even more committed to easy money programmes. In early June, the European Central Bank (ECB) cut its benchmark interest rate from 0.25 percent to 0.15 percent and lowered the deposit rate to an unprecedented negative 0.10 percent. Clearly, deflation remains a greater risk than inflation in some of the world’s most important regions.

Also coming as somewhat of a surprise, last year’s investment pariahs, commodities and emerging markets began to rebound this year. Emerging markets, as a group, outperformed developed markets in Q2 and gold posted a posted a positive return of ten percent for the first six months of 2014.

On the macroeconomic front, the severe winter weather which sent Northeastern America into hibernation made the economic tea leaves much harder to read. Throughout Q1 and even into Q2, economists debated how much of America’s reported growth slowdown was attributable to the inclement weather. Concerns rose to a crescendo in late June when the Commerce Department reported a 2.9 percent quarterly decline in US output, a level typically associated with recession.

Even though America’s GDP reports have been surprisingly punk so far this year, other data pointed to further expansion in the world’s largest economy. For example, US manufacturing continued to experience an ongoing renaissance as domestic energy production continued to lower costs for key industries. This trend was apparent in the ISM manufacturing survey reports which remained strong for all of this year. We see the steady rise of factory output, increasing domestic oil and gas production and an ongoing improvement in the housing sector as healthy indicators that the US will continue to recover and lead global growth.

In addition to the weather-related slump in the US, China showed signs of slowing earlier in the year, albeit from exceedingly high levels. Realistically, China’s ‘slowdown’ is meaningful only in comparison to its highly prolific past. Economists are presently mulling a drop to ‘only’ 7.4 percent growth in the latest quarter versus an average compound annual growth rate of over 9 percent throughout the past decade. By comparison, the US has grown less than two percent. Nevertheless, China has become addicted to supercharged growth and the deceleration has consequences.

China safely retains its position as the world’s second largest economy having trumped Japan just a few years ago and remains an important driver of global growth. Going forward, we do not see a return to the heady days of double-digit progress for the still emerging Chinese economy, but neither do we see a so-called ‘hard landing’ scenario. More importantly, under the new leadership of Li Keqiang, the country is intent on rebalancing the composition of its growth away from spending on fixed asset investments and towards increased domestic consumption. Rome was not built in a day and neither will China be rebuilt in short order.

In terms of equities, we remain generally constructive on the markets but have become increasingly more selective. We see the advance in stock prices driven somewhat more by an expansion in valuations rather than a widespread improvement in fundamentals. On the other hand, we are not overly concerned about a sharp sell-off given that the present ultra-low interest rate environment provides few reasonable alternatives to equities. Moreover, this year’s climb to record equity prices has occurred in an environment characterised by modest economic growth and low inflation.

Historically, stocks have done well during periods of slow but steady growth, low inflation and low interest rates. Although valuations of some individual companies have become increasingly stretched, value can still be found through diligent research. We continue to build positions in shareholder-friendly companies possessing strong fundamentals and trading at reasonable valuations. On a sector basis, we are overweight the healthcare and industrial industries.

In fixed income, we like ‘riding down’ the positively sloped yield curve and see longer term interest rates rangebound for the balance of the year. We are staying with higher quality bond issues which are easy to trade, allowing us to cash out of positions at a profit when bids are strong.

Bryan Dooley, CFA is a senior portfolio manager at LOM Asset Management Ltd in Bermuda. Please contact LOM at 441-292-5000 for further information.

This communication is for information purposes only. It is not intended as an offer or solicitation for the purchase or sale of any financial instrument, investment product or service. Readers should consult with their Brokers if such information and or opinions would be in their best interest when making investment decisions. LOM is licensed to conduct investment business by the Bermuda Monetary Authority.