Letter to Clients: 1st Quarter 2015

Dear Clients and Friends:

Have you ever wondered what would happen to you, if something happened to me? I sure have. One of my clients was in the office preparing for retirement later this year when she asked me that very question. Suddenly I realized that while I had done a good job preparing, I had not done a good job of communicating.

The answer is there is a plan in place. I have a good friend who has also earned his CFP® designation who runs a competing firm here in town which also clears through Broker Dealer Financial Services. A few years ago we put an agreement into place so that if anything happened to either one of us, the other would take care of our clients. Broker Dealer Financial Services is aware of the arrangement and will act to facilitate the transfer of accounts and files quickly and efficiently. So, if something ever did happen to me, you will be well taken care of.

After all, should you work with a financial planner who didn’t plan for themselves?

As we fully transition to 2015 and enter “tax season”, it is an excellent time to review your financial accounts and do some house cleaning.  We would like to remind you that we strongly believe in taking every precaution to protect your identity.  We have a commercial shredder service for our office. If you have documents you would like to have shredded, just bring them into the office. We will add them to our secure shredder box where they  will be destroyed in an eco-friendly way.

Also, if you ever have documents which need to be witnessed by a notary, we are happy to provide that complementary service for you as well.

A look back to 2014

In some ways 2014 seemed predictable yet it was not without some interesting surprises.

The U.S. economy picked up steam throughout 2014 and the S&P 500 Index racked up another double-digit gain following 2013’s 30% advance. The economic forecast was reasonable. Though a call for another double-digit advance may have seemed to be a bit of a stretch, solid market fundamentals have yet to abate – but we will discuss that in a moment.

Who would have forecast utilities, which are normally a defensive sector, would lead the way if the S&P 500 Index had posted a double-digit gain? Credit the higher dividends they offer and falling bond yields. Speaking of bond yields, there has been the rally in Treasury bonds and high-grade corporate debt. Weren’t we supposed to see a continuation in the upward drift in bond yields? At least that was the consensus.

Finally, few could have predicted the outright collapse in oil prices. We began the year near $100 per barrel and ended just north of $50 per barrel. When and where oil will stabilize has yet to be determined (we believe prices will increase around 3rd quarter), but the decline in crude is responsible for the 10% drop in the S&P Energy sector. It was the worst performing of the 10 industry groups that make up the S&P 500 Index.

All of this serves as an example as to how markets can, and do, baffle the best minds. It also highlights why diversification among and between asset classes is such an important principle to successful long-term investing.

Market Performance 12/31/14

There were times in 2014 when we hit patches of volatility but the fundamentals quickly reasserted driving stocks to new highs. Fundamentally we saw:

  • Acceleration in economic activity which led a pickup in earnings growth. S&P 500 earnings improved from a modest increase of 5.6% in Q1 to a solid 10.3% by Q3, according to Thomson Reuters.
  • A pledge by the Fed to keep short-term interest rates at rock bottom levels for a “considerable time.” Without drowning you in the tedious details of discounted cash flows, low interest rates make equities more attractive than most debt investments.
  • Stock buybacks by corporations continue to rise. According to S&P Dow Jones Indices, combined dividend and buyback expenditures set a new record of $892.66 billion for the 12 months ended September 30, with stock repurchases representing 62% of the total. Stock buybacks reflect confidence as well as real demand for shares.

Jeremy Siegel is a professor at the highly respected Wharton School of Business and is often a featured guest on CNBC and other national news outlets. He noted at year’s end, “The last three, four years, I thought this was easy. I mean, it was a slam dunk. The market was so undervalued with the interest rates so low, and earnings momentum going up. … Earnings momentum is going up, but we are closer to fair market value.

At this time last year Siegel projected that the Dow Jones industrials would hit 18,000 by the end of 2014; the index cracked that milestone on December 23. Of course, it’s easy to be a Monday morning quarterback when you’ve accurately called the game, but his analysis is spot on. Looking ahead he sees 20,000 on the Dow as a possibility but he’s quick to point out, “We’re close to fully valued…it gets hard.”  His reasoning, “Interest rates are going to be…lower than what the Fed thinks…going forward.

It’s fair to point out that Siegel was relatively bullish on stocks as part of a panel discussion that was published by Business Week in May 2000 and highlights diversification between and among asset classes is critically important. No one has a crystal ball. No one can accurately foresee the unexpected events that may derail the most thoughtful forecasts.

Looking ahead into 2015

The fundamentals that have fueled equity gains in recent years remain in place. Even though the Fed ended its controversial bond-buying program last October, the fed funds rate is expected to remain at historically low levels through at least the end of 2015 and possibly beyond. Moreover, the European Central Bank has announced its own quantitative easing program as it battles a disinflationary environment. In the past, central bank generosity has been a tailwind for stocks.

But let’s not get carried away. Let’s keep a balanced approach. We should only adjust our approach when changes in your personal situation or goals are no longer in line with your investment strategy.

While strong fundamentals remain in place risks never disappear, even in a diversified portfolio. We can manage but not eliminate risk. Prudence leads to the next question – what may be some of the events that could create volatility in 2015?

  • The year ended with oil near $50 per barrel. A recent story in Reuters that noted $150 billion in energy projects around the globe face the axe. That means there will be winners and losers at current prices though the net gain to the economy should be positive.

Meanwhile, Russia is undergoing a wrenching adjustment as its energy-dependent economy must adapt to the new reality. The Russian ruble has fallen sharply and Russia’s central bank said its economy could shrink by as much as 4.7% in 2015 if oil averages $60 a barrel.  A 1998-like crisis that briefly walloped stocks doesn’t appear to be on the horizon, but any contagion that seeps out of Russia could create volatility at home.

There has been a steep selloff in junk bonds tied to the energy sector. While Treasury and investment grade yields fell last year, high-yield debt rose. Some of the rise can be blamed on expectations the Fed will eventually raise interest rates which could crimp some highly-leveraged borrowers, but a big part of the increase is from default fears in the energy patch amid a re-pricing of risk in high-yield energy bonds. If concerns were to seep into other sectors of the junk bond market, we could see a spillover into stocks.

  • Greece elected a new president in January and while the new political leaders favor staying in the euro-zone, they want to renegotiate the terms of the Greek bailout. Markets rarely enjoy grappling with an added layer of uncertainty.
  • Slowing growth in China and Europe’s tepid recovery could dampen growth at home, but the odds are fairly low since the U.S. simply isn’t dependent on overseas demand to drive its economy. So far, U.S. growth has accelerated in the face of global jitters.
  • Will we get volatility around the Fed’s first rate hike in nearly a decade? There are no guarantees when it comes to Fed policy but if U.S. employment and economic growth continues at the current pace, the Fed has signaled rates will start rising in 2015. Although it is doing its best to telegraph its intentions, markets could get jittery in the interim.
  • Emerging market anxieties. A stronger dollar and a Federal Reserve that is expected to begin raising rates could pressure developing countries that have sold bonds in greenbacks instead of their local currencies, forcing them to repay loans in more expensive dollars. Foreign reserves (akin to a rainy day fund) could minimize any pressure, but it’s something that bears watching.
  • Liquidity is like oxygen to the market. A brief surge in U.S. Treasury prices and the steep but short-lived stocks selloff in October can be partly blamed on a temporary lack of liquidity. Some cite well-intentioned regulations put in place after the 2008 financial crisis.
  • Cyber-attacks. North Korea’s alleged attack on Sony quickly comes to mind. It’s impossible to forecast, but the outside chance of a big event can’t be discounted.
  • Geopolitical fears. War or geopolitical instability has historically caused short-term losses. Whether the Arab spring, Russia’s incursion into Ukraine, or the rise of ISIS (ISIL) in Iraq, heightened uncertainty is not a friend of investors.

Bottom line

We have always stressed the importance of being comfortable with your portfolio. When we meet, my goal is to help you create a plan which fits not only your needs and goals but your comfort level as well. You must understand and be comfortable with the level of risk you’re taking as we set out to meet your objectives. If you are not, let’s talk and recalibrate.

Stick to the plan. Markets rise and markets fall, but unless there have been changes in your circumstances or you’ve hit milestones in your life, such as retirement, stay with the plan. By itself, a record high in stocks isn’t a good reason to bail out of stocks.

Rebalance. Last year’s rise in equities may have knocked you out of alignment with your target allocations. Now may be the time to take profits on winners and selectively re-allocate proceeds.

We hope you’ve found this review to be educational and helpful. Our job to assist you! If you have any questions or would like to expand the discussion, please feel free to give us a call or schedule a meeting.

As always, I’m honored and humbled that you have given me the opportunity to serve as your financial advisor.


Art Dinkin, CFP®