Q3 Investment Strategy

We held our third quarter investment strategy meeting on June 27, 2014. The key issues now for the financial markets remain primarily Federal Reserve policy, the pace of global economic growth, concerns over slowing growth in China, and geopolitical factors (Ukraine, Iraq, etc.). It appears that both the U.S. economy and corporate profits are poised to accelerate in 2H-14, currently the “consensus” opinion. This is being viewed positively for stocks and is part of the reason why stocks are rising.

We are growing more concerned about the stock market’s ability to sustain its uptrend in the near term. We are more concerned about valuation and the growing consensus or unanimity of opinion that stocks are “the only game in town”. We view current valuation as “moderately high”, not enough to create a big problem by itself, but other factors are also somewhat unsettling. What are some of these factors?

We have not had a market correction (defined as a decline exceeding 10%) in almost three years, about twice the average duration between corrections. The extended condition of certain technical indicators may be signaling some near-term excess. The Fed is in the process reducing its bond purchase program thereby reducing a source of market liquidity. And while still low from an historical perspective, inflation appears to be accelerating a bit. While we believe the stock market remains in a secular bull trend, we slightly reduced our equity exposure as “risk management” against an increased potential for a correction.

Within our equity holdings, we maintained our strategy of focusing on large cap, quality dividend-paying stocks and further enhanced these holdings in your portfolio. We also maintained holdings in both health care and technology stocks as vehicles to capture sector growth and attractive valuation. We reduced exposure to developing U.S. equity in order to take advantage of attractive valuation opportunities in emerging market equities and European large cap stocks, to which exposure was increased.

Despite the recent strength in bonds, we continue to believe interest rates are in a secular uptrend. This means as interest rates rise, the current market value of bonds declines. The conundrum facing investors with bonds is achieving decent return and income while protecting against a decline in capital. We have been reducing the duration of our bond holdings as a way to reduce interest rate risk and we are not changing this policy. We did not change any of our fixed income holdings and our allocations to fixed income remained relatively stable, with a slight increase in emerging markets bond exposure as a way to increase overall yield.