1st Quarter Update for 2015

Three Strikes and You’re Out?

I recall the wisdom relayed to me by a prominent weatherman for one of the local TV stations. He told me that no matter how hard he worked on his forecast or how strong his convictions were about the computer forecast, “I always stick my head outside and look at the sky before I go on the air!” In a similar vein, before writing these updates, I always go back and read what I wrote in prior months and years. I do this for three reasons. I want to confirm that what I spoke about then was relevant, I check to see if the prognostications I made were correct, and, finally, I look to inspire myself to write updates with fresh content. To my surprise, the past two March updates talked about preparing for the coming stock market correction. Our current bull market in U.S. stocks is now in its seventh year and the S&P 500 Index has finished higher for nine consecutive quarters. My concern is that my repeated calls for preparation (mentally and fiscally) every March for a coming stock market correction are beginning to sound like Chicken Little’s cry that the sky is falling. So, to avoid being wrong three years in a row, this update will be more factual and less editorial.

Laissez Les Bons Temps Rouler

The headline above is French for “let the good times roll,” and so they have for most investment categories in the beginning of 2015. Large-capitalization domestic stocks, as measured by the S&P 500 Index, were up 0.95% to start the quarter. (This is a total return number and all the calculations that follow assume dividends were reinvested for the period.) Mid-sized domestic stocks, as measured by the S&P 400 Index, were up 5.31% for the quarter. Small-cap domestic stocks, as measured by the Russell 2000 Index, were up 4.32% for the quarter. Developed country international stocks, as measured by the MSCI EAFE Index, had a total return of 4.88% for the quarter. Emerging markets also started the year well, with the MSCI Emerging Markets Index climbing 2.22% in the quarter. In general, bond investments continued to rally even with interest rates at historical lows. The broadest measure of US bond performance, the Barclays US Aggregate Bond Index, was up 1.61% for the quarter. In another area of note, real estate continued to do well, with the FTSE Nareit Equity REIT Index increasing 4.88% for the quarter. The one standout in terms of negative performance for the start of the year was most any investment category tied to energy or commodities. Although good for gasoline buyers, the swift and severe fall in oil prices was bad for oil investors and related companies in the short term. The S&P Goldman Sachs Commodity Index fell 8.22% in the first quarter of 2015.

Don’t Put All Your Eggs in one Basket

The conclusion drawn from the numbers above is that for the first quarter of 2015, diversification added value to our portfolios. For the past two years, with perfect hindsight, investing solely in the S&P 500 Index would have produced the best returns. Every other asset category you added to your portfolio (bonds, mid-cap stocks, small-cap stocks, international stocks, etc.) lagged the return of the S&P 500. So, although we know instinctually that it is not good to have all your eggs in one basket, that instinct did not work out in those years. So far in 2015, we can see the reverse is true. Adding almost any asset category (except energy) to the mix of investments has not only diversified your portfolio, but incrementally added to portfolio returns versus an all S&P 500 stock portfolio. Diversified portfolios are designed to reduce risk and add some comfort by offsetting the volatile mood swings, like those the S&P 500 Index has had so far this year. As an example, between February 18 and March 27, the S&P 500 never had two days in a row of back-to-back gains. Every other trading day was either up or down. That has happened only two other times since 1957. In fact, since around Halloween, the S&P 500 Index has essentially been stuck in a trading range between 2,000 and 2,100. The big question is not when we break out of the range, but in which direction!

On the Horizon

There are some interesting events that could move the markets in the near term. Domestically, the biggest financial event is our current march towards the first potential Fed interest rate increase in six years. The Fed thinks they have clearly signaled this event to the markets and most pundits claim we are ready (and some think past due) for the rate increases to start. Since stock markets are supposed to be forward-looking, this near-term event should be priced into current market averages. Unfortunately, I doubt that is truly the case. My concern is that many investors are playing a version of poker, trying to remain calm and fully invested in their current hand, showing no signs of weakness or “tells” to their playing opponents. But, when the rate increase comes, they might be willing to fold their hands very quickly. In Europe, the European Central Bank (their Fed equivalent) is just now starting a bond buying program similar to the one the Fed has recently concluded. In the short term, this move in Europe has been good for their equity markets. The resulting U.S. dollar strength and euro weakness has made many European companies more competitive on an export basis. Globally, the shake out from falling oil prices is still being sorted out. In the short term, the joy felt by consumers of oil has been more than offset by the pain being felt by the drillers, producers and countries to which oil is a lifeline (Saudi Arabia, Russia, Venezuela, etc.). Of course, we always have war in the Middle East, terrorism, Greek debt, Puerto Rican debt, student loan debt and a few other things to worry about; all the more reason to stay diversified and cautious for the third year in a row. Enjoy the change in seasons. Mike.

Mike Kauffelt

Chief Investment Officer
Bill Few Associates, Inc.

Data source: The Wall Street Journal