Summary of our 1Q-15 Investment Committee Meeting

We held our first quarter 2015 investment committee meeting on December 18. We continue to “stay the course” in maintaining a fairly full exposure to stocks. We believe U.S. stocks continue to offer the most attractive risk/reward among global markets. This is based on our positive outlook for the U.S. economy and corporate earnings and continued low inflation. Growth of the U.S. economy remains the strongest of the developed world economies. We expect U.S. real GDP growth in 2015 of about 3%, compared to virtually zero growth in the Eurozone. Both China and many emerging markets are experiencing slowing in growth. Relative growth of U.S. corporate earnings should remain a positive factor in 2015.

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.

Daily Bullets…..for October 7, 2014

·         IMF again reduces growth outlook…The International Monetary Fund today reduced its global growth outlook with most of the weakness centered in Europe, particularly Germany, Italy, and France. The announcement also had some rather alarming language pertaining to potential for a stall in the recovery, acceleration in deflationary trends, and risks of market plunge once the U.S. Federal Reserve starts raising interest rates.

What’s the point? We believe today’s announcement by the IMF is the primary factor contributing to today’s stock market weakness. As we have mentioned in previous posts, the European economy remains in a deep funk and the IMF report just confirms this. Deflation continues to be a major risk for the Eurozone economy. Japan went through a period of sustained deflation, so it can certainly happen. While Eurozone monetary policies might be highly accommodative, the mechanisms to transmit the policy to the economy (such as credit) are highly stunted to non-existent in Europe currently. A key concern for investors is renewed possibility of recession in Europe which could act as a drag on the entire global economy, and thereby slow corporate earnings growth, a key driver of stock prices. The good news is U.S. companies generally remain in excellent condition financially and are generating record levels of free cash flow. This should be an important factor in supporting U.S. stocks, along with the prospect of a strengthening U.S. dollar.

Link: http://www.reuters.com/article/2014/10/07/us-imf-economy-idUSKCN0HW15Y20141007

 

 

Daily Bullets……for September 29, 2014

·         Steady outlook for economy……..The latest National Association for Business Economists (NABE) forecast was released today. The results point to continued steady economic growth led primarily by business and government investment and growing export trade activity.

What’s the point? The NABE survey is a good one because it reflects the views of private sector economists at large businesses, and not Wall Street economists. This is good, in our view, because NABE economists are closer to what is really happening in the economy through their businesses. The article in the link discusses the outlook for various sectors, but a key point is there appear to be no big surprises in the general outlook, which is in line with our view: moderate real GDP growth of 2.5%-3%, with inflation of around 2% (what we’ve dubbed the “3+2” economy). In general, this scenario remains a positive backdrop for financial assets, particularly stocks, and is probably more neutral for bonds.

Link: http://money.msn.com/business-news/article.aspx?feed=AP&date=20140929&id=17967495

 

·         Evans comments assuring on Fed policy……Chicago Fed president Charles Evans spoke this morning at a meeting of economists and reiterated his belief that the Federal Reserve will remain patient and restrained in raising interest rates, even if it involves the risk of inflation running modestly above the Fed target of 2% for period.

What’s the point? We think Evans’ comments most likely reflect the current majority view of the FOMC, and echo recent comments of Fed Chairwoman Janet Yellen. While the U.S. economic growth does appear to be accelerating somewhat, as the above comments on the NABE survey indicate, moderate growth is still expected and Europe remains in a severe funk with deflationary implications. The Fed thinking is probably that the economy gives them the latitude to keep monetary policy more loose than they otherwise might at this point in an economic recovery and, in fact, this may still be of necessity. The point for financial markets is essentially “more of the same”: an accommodative Fed policy is positive for stocks, in particular. The big questions concerning investors now are “how fast does the economy accelerate?” and “to what extent does the Fed accelerate the reduction of accommodation?” Our thought is gradualistic changes in policy accomodation, which we expect, should not be overly disruptive to the financial markets. Under this scenario valuations should hold up if not increase somewhat.

Link: http://money.msn.com/business-news/article.aspx?feed=OBR&date=20140929&id=17968890

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.

 

Daily Bullets…..for September 11, 2014

·        Retirement study supports slower growth…..The Federal Reserve recently issued its highly regarded triennial Survey of Consumer Finances (SCF). With respect to retirement preparedness, the picture is  troubling due to widening income gap, declining home ownership, and drawdowns or liquidations of retirement accounts among lower and mid-income categories.

What’s the point? The survey results are further confirmation of what we have been hearing for several years now: retirement savings is under pressure and general preparedness of the baby boomers for retirement is looking terrible. The economic implications of this would support the slower secular growth thesis due primarily to significantly lower discretionary income available to the boomers. While certain segments of the economy are doing OK, a large segment of society (the baby boomers) will have far less resources for discretionary spending and will likely need to rely more on government programs for support during retirement. On a macro basis, this places more pressure on the tax base to fund significant increases in entitlement spending, and reduces resources available for investment and savings and discretionary spending, which represents a significant portion of U.S. GDP. We believe these factors most likely would contribute to lower secular real growth in the range of 2-3%, compared with 1950-2000 average of about 3.5%.

Link: http://money.msn.com/business-news/article.aspx?feed=OBR&date=20140911&id=17925601

 

Daily Bullets ….September 10, 2014

·        Fed considers change to rate guidance…News out this morning that the Federal Reserve is considering a change in the way it issues guidance on interest rate policy. The idea would be to move from guidance based on specific time periods to guidance based on economic developments or “outcomes”-based.

What’s the point? The Federal Reserve has a huge impact on the global financial markets. Its formal guidance, press releases, speeches, open market operations, and other forms of communication can have a major effect on financial market trading and financial asset valuations. We are encouraged that the Fed is grappling with the issue of improved communication on policy. Why? Because through better communications and focus on visible, understandable goals, it should help to reduce policy uncertainty in the financial markets and thereby help to reduce speculation and trading volatility. While volatility (and speculation) are normal aspects of the financial markets, we believe lower volatility around Fed policy would be a benefit to all market participants.
Link: http://www.bloomberg.com/news/2014-09-10/fed-weighs-change-to-rate-guidance-for-added-flexibility.html
 

·        Long-term care insurance, good or bad?....This article provides a very good discussion of the pros and cons of long-term care insurance. Whether it is “good or bad” for an individual or couple depends on their individual situation and goals.

What’s the point? The issue of long-term care insurance comes up often in developing financial plans for clients. Long-term care is a major consideration for most people and, of course, fraught with unknowns: “will I pay the premiums for years and never use it?” The financial planning analysis is also not easy, as it depends on a mix of the client’s goals, financial position, ability to pay, optimal use of assets, legacy issues, etc. We believe pure long-term care insurance is not only expensive but also in most cases not a good “risk-reward” proposition. That said, there are many folks who are in a position where it can improve the outcome of a financial plan and can provide peace of mind. The article discusses some of the new insurance products, such as single premium life with a long-term care rider. We believe these new products are a step in right direction and offer a better risk-reward trade off for the client.

Link: http://www.usatoday.com/story/money/columnist/brooks/2014/09/09/retire-long-term-care-insurance-baby-boomer/14968081/

 

 

Daily Bullets…..for September 9, 2014

·         Job openings at new highs…..Labor Dept out this morning with report that number of job openings at end of July were at a 13-year high and that companies have stepped up hiring to the fastest pace in seven years.

What’s the point? Obviously this is positive news for the economy and suggests the economic recovery remains on track. One problem noted is that while job openings are up 22% in the past 12 months, actual hiring is only up 8%, which suggests companies are still having problems finding workers with appropriate skills. The “skills gap” has been one of the reasons for the unusual slowness of employment growth we’ve seen in this recovery. Other reasons for slowness in jobs growth have been demographic factors, decline in labor force participation, and technology advancements which have accelerated the substitution of capital for labor.

Link: http://money.msn.com/business-news/article.aspx?feed=AP&date=20140909&id=17917584

 

·         Survey detects global gloom…..A newly published Pew Research survey of 46,000 people worldwide reflects downbeat assessment of economic prospects, with 60% of those surveyed saying their country is performing poorly.

What’s the point? Not to focus on the negative, but what is disconcerting about this survey is the pervasiveness of it across virtually all regions. The study notes that only in low-income developing economies, such as China, is there a slight majority (51%) calling economic conditions “good”. Is this a new version of a “depression”? One could call it that. The only “good news” in this is generally consumer sentiment is behind the actual curve of the economy. Our assessment is global growth will remain sub-par for the foreseeable future due to moderate growth (2-3%) in U.S., slower growth in China, and essentially no growth in Europe. The implications for investments and financial planning are: 1) continued low interest rates resulting in poor returns on bonds; 2) continued emphasis on stocks for both growth and income; 3) continued emphasis on sectors of the markets that can grow at an above average rate, such as health care, technology, and certain financial and industrial sectors.

Link: http://money.msn.com/business-news/article.aspx?feed=AP&date=20140909&id=17917751