1Q 2015 Commentary
by Richard Siegel, CFP®
Both the U.S. equity and bond markets eked out small gains for the quarter amid increased volatility. During the period, the stock market struggled to find direction and the fixed income market continued to overreact to “Fed-speak.” The following themes are a carryover from 2014 and should remain prevalent for the near future:
- Lower oil prices
- Strong U.S. dollar
- Increasing likelihood of the Fed raising interest rates during 2015
- Global monetary policy continues to be favorable for stock prices
- Geopolitical risks remain troubling
In addition to these items, 2015 is already brimming with political news around the possible nominees for the next presidential election along with the U.S.’s relationships with Israel and Iran.
One of the financial metrics we are keeping a very close eye on is corporate earnings. Even though the economy as measured by GDP is growing at an acceptable rate, corporate earnings growth has leveled off and may even temporarily contract. According to Factset, the year-over-year earnings for the S&P 500 for Q1 are projected to decline by 4.6%. If the index reports a year-over-year decline for the quarter, it will be the first time since Q3 2012 (-1.0%). This is primarily attributed to the strength in the dollar and falling oil prices. That said, these two factors can be viewed as long-term positives for the economy, but have had a negative impact in the near term. We are looking for a reacceleration of earnings growth in the second half of 2015 to justify higher stock prices based on higher disposable income for consumers.
GDP is made up of many economic factors. Even though the most recent annual reading was 2.2% growth, it is worth noting that in Q4 of 2014 personal consumption rose by 4.4% at an annual rate, the highest number since 2006. We expect GDP to temporarily trend lower during the first part of 2015 based on corporate profits, harsh weather conditions, and delays from the west coast port strike.
Stock prices remained volatile over the past three months. The days of a 100 point or even a 200 point move in the Dow Jones Industrial Average being significant is now the norm. This volatility can be mitigated by employing a diversified approach across the equity spectrum. Having exposure to both U.S. and foreign stocks for example is something we have been proponents of since our inception. Not only is it important to not exclude investing in companies just because they are based overseas, we also feel it is important to have currency exposure other than just the U.S. dollar. This strategy has been a detractor from our clients’ performance over the past couple of years, but thus far is paying off handsomely in 2015.
There is no way to determine if this trend will continue, but from a valuation standpoint, foreign equities on the whole remain a better value than domestic stocks. Additionally, it is important to stress that the U.S. will soon be tightening its monetary policy while many countries overseas are just in the beginning phases of a loose money policy, which is typically stimulative for stock prices. From an allocation standpoint, approximately 20%-25% of our clients’ stock holdings are currently invested in foreign equities.
While the recent outperformance of foreign equities versus U.S. equities is compelling, the last five years shows a very different story. The S&P 500 has returned 12% per year since 2010, while the foreign markets have returned only 4% over the period, building an even stronger case for exposure outside of the U.S.
Broadly speaking, stocks are not a great bargain at these levels, but relative to cash and bond investments they remain the most attractive of the major asset classes. Until the Fed starts to aggressively raise interest rates and/or corporate earnings significantly reverse course, we will maintain our target exposure to equities in our strategies.
Fixed Income Overview:
U.S. bonds as an asset class outperformed the S&P 500 during Q1 (1.34% versus 0.44%). The chart of the benchmark 10-year Treasury yield below shows what a rollercoaster ride yields were during the period. Mixed economic data along with Janet Yellen’s Fed testimony provided plenty of fodder for volatile yields and bond prices for the period. When all was said and done, rates ended lower for the quarter, pushing bond values slightly higher.
To reiterate our position on fixed income securities, we are certainly not excited about Treasury bond yields of 1.90%, but relative to inflation and cash yields, they are worth positioning in a portfolio as a hedge against stock market volatility. Client portfolios also maintain exposure to municipal bonds, corporate bonds, and foreign bonds with higher yields and lower prices than U.S. Treasury bonds.
We expect yields to remain volatile until there is a clearer picture on the direction of the economy and the Fed’s monetary policy. While the near term is difficult to predict, we expect interest rates to normalize over the long run with the hope of a gradual grind higher as opposed to an unsettling spike like we saw in 2013 when Ben Bernanke hinted about wrapping up the quantitative easing program.
It appears that 2015 is shaping up to be a year of transition for the capital markets where good news is good news and bad news is bad news. For the last few years, the market rejoiced at poor economic metrics, knowing that the Fed’s artificial economic stimulus programs would be there to support the markets. Ideally, the U.S. economy will be comfortable standing on its own two feet without the crutches.