The Federal Reserve continues to remain accommodative of
economic growth. While we expect the Fed to begin raising interest rates in
2015, we expect this increase will be a) later in the year and b) gradual and
well telegraphed. We do not share the concerns of some that a change in Fed
policy will cause a significant upset to financial markets, particularly if inflation remains low and
corporate profit growth remains sound, both of which we expect as of now.
With respect to recent stock market volatility, we note that
volatility is a normal element of all financial markets. The mid-December
pullback in the stock market was about 5% and well within the normal range of
day-to-day, week-to-week volatility going back many years. It seemed worse
because of the coincident plunge in oil prices. That said, we think the
cyclical bull market is maturing and we do not expect stock market returns
going forward to be as strong as the past 5-6 years. Valuation, for one thing,
is now above the long-term average and will not be the tailwind it has been for
the past six years. We expect market growth going forward will mostly be driven
by earnings.
We spent more time this quarter in deliberating our bond
investment strategy. As we’ve explained previously, the conundrum (balancing
act) facing bond investors is maintaining income in a very low rate environment
while protecting against capital risk associated with rising interest rates. We
have implemented a structure that underweights the long end of the curve and
overweights shorter duration while also holding bonds or bond substitutes (such
as utility stocks) that support portfolio income. With respect to equity
investments, within U.S. exposure, we increased our weightings to large and
mid-cap value (higher dividend-paying) stocks and also increased exposure to
real estate. We slightly reduced aggregate exposure to international stocks and
held steady our exposure to commodities, primarily in the areas of energy and
forest products.
