We held our Q3-17 investment strategy meeting on June 28.
The most significant changes we made following our deliberations were, in the
equity area, an increase in our exposure to international equities, more
specifically Europe; and within the fixed income area, a very slight reduction
in our allocation to short term bonds.
We continue to remain positive for the outlook for the
global economy. We see the U.S. economy accelerating somewhat this year and
next in the range of 2.5% or a bit higher in terms of real GDP growth with the
potential for stronger growth in 2018. This is positive for corporate profit
growth, the primary driver of stock prices. What has been driving the stock market higher of
late, in our opinion, is rising corporate profits. In the first quarter of 2017,
corporate profits rose at an annual rate of about 9% and are currently forecast
by Factset to grow at about 10% for the full year in both 2017 and 2018. The trend of rising corporate earnings should
provide support for higher stock prices assuming valuations remain steady.
One problem or “issue” for U.S. equities currently is
valuation. The U.S. stock market as reflected by the S&P500 is currently
trading at around 18.5x this year’s expected earnings. This is approaching the
upper end of the market’s long-term valuation range of around 12-20x. This does
not imply that the stock market cannot go higher; we believe it can based on our outlook for the
economy and rising corporate earnings. However, it does reflect an element of
risk for equities that needs to be considered in our investment policy and risk
management.
There are several ways in which we manage risk in your
portfolios. One is through diversification of your investments by asset class
(e.g., stocks, bonds, commodities, real estate, etc). This helps to dampen
portfolio volatility while providing a more stable long-term return. Other ways
in which we manage risk are through changes in tactical strategies following
our quarterly meetings and through our selection of securities holdings that we
believe will best serve you in implementing our strategies. One of the ways we
are currently mitigating the risk of higher U.S. stock valuations is through
allocating more equity investments towards international stocks such as Europe,
which currently have lower valuations than U.S. stocks. Another way we are
actively seeking to mitigate portfolio risk is through a relatively high
exposure to “value” stocks, which tend be dividend-paying and less volatile
than growth stocks. The goal is delivering the best risk-adjusted return we can
and an important element in achieving this goal is reduction of portfolio
volatility.
Within the fixed income area, there were no major strategic
changes. We continue to remain underweight in the long-maturity sector because
we believe interest rates could continue to rise based on Fed policies of
normalizing the Fed funds rate and reducing its bond holdings built up during the
period of “quantitative easing”. We maintained a normal/neutral weighting in
the intermediate bond area and continue with our overweight of short maturity
bonds. These allocations are intended to keep your effective duration at a below
average level. We expect a below average duration should help to mitigate the
capital impact of further increases in interest rates.
Robert E. Toomey, CFP, CFA
