Q4 Investment Strategy Meeting: More “3+2”

We held our Q4 investment strategy meeting on September 16, 2014. The environment for the financial markets has not changed significantly since our last meeting in June and we believe the stock market outlook remains favorable for the longer term.

Economic growth in the U.S. remains steady and, while we expect the pace of growth to accelerate, we do not expect a level of growth that would cause significantly higher inflation or interest rates. The bond market has confounded predictions this year, with 10-year Treasury yields actually declining about 20% due to slower than expected growth in Europe and emerging markets and foreign capital seeking higher returns in U.S. bonds. The European economy remains weak which is contributing to slower-than-expected global growth.

Within this backdrop, we believe Federal Reserve policy will continue to remain accommodative. This was confirmed at the Fed’s recent FOMC meeting in which the Fed voted to maintain a “highly accommodative” monetary policy and reiterated its guidance to maintain very low interest rates for an extended period. Fed policy continues to be a positive for financial assets.

U.S. stocks remain in a stable uptrend. The current “3+2” environment (3% GDP growth, 2% inflation) is favorable for U.S. stocks which we believe remain positioned for further gains over the longer term. In the short term, we remain of the view that risks of a market correction are elevated due to increased bullish sentiment, narrowing breadth, and increased valuation. We have taken actions following our past two strategy meetings to hedge this risk by slightly reducing our equity exposure.

With respect to investment strategy, there were no major changes in our sector allocations following the meeting. Within equities, we slightly increased exposure to large cap stocks. Within this sector, we continue to favor quality dividend-paying stocks as well as health care and technology due to their strong secular growth prospects. Our exposure to developing equity (small and mid-cap stocks) remained essentially flat and slightly underweighted due to high relative valuations. Our exposure to international equities was reduced slightly in favor of a higher U.S. allocation, while exposure to REITs and natural resources remained virtually unchanged.

Our allocations within fixed income were essentially unchanged. We remained at the low end of our allocation with respect to long bonds as these remain most sensitive to a rise in interest rates. We increased our exposure to intermediate maturity bonds, mostly through increased utility stock exposure. Our exposure to short-term bonds remains above normal due to increased risk of an increase in interest rates or unexpected change in Federal Reserve policy.