After a third quarter in which markets skidded and tumbled to the close, Treasuries were in their glory. The U.S. long government bond category was the only one whose performance was in the double-digit range. It catapulted to 27.9%, zooming past the second best group, Muni California Long, which was up 4.5%. Long bets on Treasuries comprised the top three, and were up 4.3%.

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Those performances seemed to contradict a lot of gloomy predictions that all public entities - from tiny municipals all the way to federal government - had finally reached the limit on their ability to borrow and honor their debts. Investors reacted to Standard & Poor's first-ever downgrade of the United States' long-term rating to AA+ by looking around and deciding that they still had faith in Treasuries.

"This is similar to 2008, when people were looking for safe havens wherever they could get them," says David Kathman, a senior mutual fund analyst at Morningstar.

Equities struck investors as anything but safe, and dropped 15.3% on a whole, according to Lipper. Meanwhile, the S&P 500 slid 224.34 points, or 16.6%, from July 22 to Aug. 8. With all the volatility, the index stayed below 1,219 through the end of the third quarter.

"I've heard a lot of equity fund managers say, 'The market does not care about fundamentals,' " Kathman says. "Things that are perceived as depending on the broader economy are going up and down in concert."

The third quarter had one of the highest levels of stock correlation among global equities, says Omar Aguilar, chief investment officer of equities and multi-asset strategies at Charles Schwab Investment Management. Emerging market and industrial fund classes suffered as a result of investor apprehensions.

Latin America stock and China-region equity funds dropped 27.5% and 25.4%, respectively. Investors worried that demand for industrials and commodities would abate if GDP growth in emerging markets, particularly China, slowed drastically. Industrials plunged 24.5%.

"If China slows down, that would ... hurt the global economy," Kathman says. "It would make a lot of companies miss earnings expectations, and it would keep rippling around the globe."

"They were trading in tandem regardless of earnings. In an ordinary quarter, we do not see that many levels of high correlation," Aguilar says.

The investing picture looked bleak in terms of asset flows, too. Stock funds had $31 billion in net losses in July, $29.2 billion in August and $6.9 billion during September. Total mutual fund industry assets dipped below $1 trillion in September for the first time since December 2010, according to Morningstar.

As for where clients go from here, industry experts say investors will continue to hunker down in relative safe-haven assets until the volatility passes. One encouraging sign is the investment product industry is coming up with more strategies that target retirement funds, says Chris Philips, a strategist in Vanguard's investment strategy group. Those approaches tend to be more balanced.

"Investors in those portfolios do much less reacting to the market," Philips says. "There is less timing and portfolio manipulation." That's just as well, because investors - and the overall markets - have already seen plenty of thrilling fluctuations.


Donna Mitchell is senior editor of Financial Planning.

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