2014 is looking smooth right now for stock and bond investors. The year didn’t start off that way with a fairly steep decline in February, but like all the dips of 2013, it was ultimately another buying opportunity for those able to look past the noise. Just this past Wednesday, Janet Yellen reiterated the Federal Reserve’s intent to end quantitative easing by this Fall – removing the economy’s training wheels – and even talked about reducing the economy’s longer term “target interest rate” to 3.75% from 4.00%. That’s good news for stocks and housing, and hopefully for the unemployed as well.
On the equity side, my expectation is for more gains between now and the end of the year. While the economy may chug along at a more modest pace than some would like, I think the stock market can get comfortable with that, as it has been for a while. My strategy with clients continues to be taking extra caution when it comes to owning broad market indexes since some of those indexes may be getting a bit frothy due to multiple expansion and decreased fund flows into bonds. I like to screen for stocks that are either deeply valued and generating yield, or fast growing and doing so organically with cutting edge technology and visionary management. Utilizing an individual stock strategy may help weather the market if the broad indexes trade lower for an extended period of time.
On the bond side, I think prices may remain high (and yields low) for the remainder of the year. Every few months I get a call from someone who says “interest rates have to rise and then bonds will crash, right?” to which I reply that it’s not that simple or that sudden. Supporting the “low rate” thesis is good (but not great) economic growth here in the US, the potential for quantitative easing in the Euro zone, and slow growth in China. The story may continue to be taking on credit risk over interest rate risk when it comes to building out your bond portfolio. Triple B bonds have been a sweet spot this year and with reasonably low volatility.
Internationally, we’re seeing some areas play catch up. European equities are slightly outpacing the US so far this year after several years of underperformance. If Europe follows in the footsteps of the US in terms of easy monetary policy, that could give their equity markets continued momentum. I’ve found several Europe-based companies, specifically in the food and drink and retail sectors, which appear undervalued. Some investors may not fully appreciate how exposed many European firms are to the US and just how much that helps their business. Related to that, there exists a mysterious discounting process which affects some stocks just because of where they’re headquartered and which exchange they trade on.
Chinese equities reflected by the China Large-Cap Index have lagged the US for past 3 years and I believe that may continue through mid-2015. China has growing government debt, a still broken financial system, and a housing slowdown to grapple with.
It should be noted that making money via stocks has been more challenging this year than last. In 2013 volatility was very low, interest rates were consistently low, and inflation wasn’t a real concern. While those are still semi-present themes in 2014, all three of those facts may change by next year. Because the market likes to act ahead of change, the asset classes we’re looking at are changing as well. We expect that commodity prices may rise (that has been an awful asset class in terms of performance over the past couple of years) and Emerging Markets may get some attention as well now that valuations are more attractive. We’re also keeping an allocation to alternative that may provide some non-market correlation and high yields.
It is important to always consider your own time horizon and tolerance for risk when building your personal portfolio. I like to explain to people that you shouldn’t only view the performance of your accounts against broad market benchmarks such as the S&P 500. In an effort to avoid downside risk, you may only be aiming for a 5% return on your money, in which case owning broad market indexes or a portfolio of just stocks would present too much risk.
As always, feel free to call or e-mail me with questions and comments.
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Investing involves risk including the potential loss of principal
The S&P 500 is an unmanaged index which cannot be invested into directly. Past performance is no guarantee of future results.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Performance referenced is historical and is no guarantee of future results.
The economic forecasts set forth in this commentary may not develop as predicted and there can be no guarantee that strategies promoted will be successful.