One of more significant considerations at our meeting was
the recent decision by the Federal Reserve to postpone its long-anticipated
increase in its Fed funds target range, a decision which has numerous implications.
The primary reason for the Fed’s “non-move” was concern over the pace of global
growth, which does appear to be slowing due to the slowdown in the Chinese
economy. The implication of this is that both interest rates and inflation may
remain lower for a longer period than we and other investors expected. In its
deliberations, the Fed also reduced its forecast for inflation, estimated
global growth rates, and pace of future interest rate increases. All of this
implies further continuation of what some have dubbed the “new normal”, a
euphemism for an extended period of low growth and low inflation. Other key
considerations in our meeting revolved around relative exposure to “growth”
versus “value” sectors of the market as well as U.S. versus international
exposure.
We now expect an increased level of volatility in the equity
markets over the near term primarily due to heightened concerns over global
growth, risk of associated slowing in corporate profit growth, and lingering
uncertainty over Federal Reserve policy. We believe these factors have
increased the near-term risk of some further downside in the stock market and
we have taken action to address this risk, discussed below. We continue to
remain positive about the long-term outlook for the U.S. economy and stock
market and we do not believe this derails the secular bull thesis; however, we felt
it prudent to make these adjustments in managing risk in your portfolios.
With respect to changes in your portfolio, we reduced equity
exposure by about 5%, on average, reflected in a lower allocation to all equity
sectors, both domestic and international. Within equities we raised our
allocation to growth stocks versus value stocks because we believe growth
companies can maintain stronger relative earnings growth in a slower economy
and maintain a higher relative valuation. Our real estate and commodity/natural
resource exposures were also reduced slightly; however within natural resources
we increased exposure to energy (primarily oil) as we believe it offers good
relative value. We maintained exposure to health care, financials, and home
builders as we believe they still represent attractive secular growth opportunities.
Within the fixed income sector, we slightly increased our overall exposure
while increasing our effective duration (time-weighted average maturity). As we
now believe rates will stay lower for a longer period than we previously
expected, we believe this implies better returns for longer-maturity bonds than
we previously expected warranting some lengthening of duration.
