My F&M

Market Commentary 1st Quarter 2015

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In recently reported data, the U.S. economy grew at a tepid 2.2% rate in the last quarter of 2014.  A few early indications point to an even weaker first quarter.  For the past five and a half years, economic growth has been positive but weak.  Interest rates remain low (negative in some countries).  Generalized inflation has been extremely low, helped by a strong dollar.  On the other hand, the same strong dollar hurts U.S. exports.  Low oil prices hurt the previously booming domestic oil industry, but help consumers.  An economic backdrop of weak but positive growth, low interest rates, and low inflation is not bad for stocks going forward.  

Total returns in the first quarter were 1.7% for the taxable bond index, 0.95% for the S&P 500 Index, and 4.0% for the REIT index.  Last year, U.S. large stocks performed significantly better than either small U.S. stocks or international stocks.  The first quarter of this year experienced a not unusual reversal, a “reversion to the mean”, in which the best performing stocks were established international markets, up 4.9%, followed by small U.S. stocks, up 4.3%, emerging international stocks, up 2.2%, and lastly, the S&P 500 Index, up 0.95%.  There are certainly times (like last year) when diversification hurts.  There are also other times (like this year so far) when it helps.  More importantly, in the long run, diversification has provided both risk reduction and return enhancement, and we see every reason for that to continue.      

Median price/earnings multiple, NYSE stocks

Looking ahead, we see plenty of evidence that return expectations should be tempered.   Short-term investments yield essentially zero, 10-year Treasuries yield less than 2%, and other bonds don’t offer much more return.  At the same time, stock valuations are high by most measures.  This chart shows the median (not market-cap weighted) trailing price-to-earnings ratio for NYSE stocks (source: Wells Capital Management, used with permission), and on that measure, stocks are more expensive now than any time in the past 64 years.  That implies very little regarding short-term return expectations, but as we just passed the 6-year anniversary of the last bear-market low, we note that there has not been a meaningful market correction, let alone a bear market, since March, 2009.  As corrections reverse excesses, we may be “due”.  

We process the above and conclude we should remain fully invested but also stay defensive and very well diversified, with extra emphasis on seeking “uncorrelated” returns – that is, returns not dependent on stock or bond returns.  We have just completed a broad initial purchase of a new investment (All Asset Variance Risk Premium Fund) that we expect to exhibit near zero correlation to stocks and to bonds over periods of a year and more, and we intend to look for opportunities to expand exposure to such investments.