Domestic
stock and bond markets were essentially flat in the first half of this year as
investors continue to sort out prospects for higher interest rates, Greek and
Puerto Rican defaults, and what has now become a bear market in Chinese stocks. While developed international stocks were
virtually flat in the second quarter, they have been the best performing asset class this year with a total return for EAFE
(Europe, Australia and Far East stock index) of 5.5%. Recall that, last year, this was the worst performing asset class. On the other hand, last year’s best performing asset class (REITs -
real estate investment trusts) has been this year’s worst performer with a total return of -5.4%. Such reversals in performance usually catch
most investors by surprise, which is why broad diversification and disciplined
rebalancing (hallmarks of our investment strategy) add value over time.
Our
strategy emphasizes dividends, because in the long run, dividend-paying stocks
have produced significantly better returns than non-dividend payers. However, there are periods, as we have
experienced over the past two and a half years, when dividend-paying stocks
have underperformed. In fact, stocks
that do not pay dividends (which we generally avoid) have outperformed
dividend-paying stocks (on which we focus) by more than 6% year-to-date,
creating significant headwinds for our investment strategy. We take comfort that these periods have
historically been followed by sharp reversals.
Economic
growth has continued at an anemic pace, and inflation has yet to become an
issue with the CPI (Consumer Price Index) nearly flat over the past 12 months.
Investment
opportunities have not changed much from the first quarter or even from the end
of last year. Low dividend yields and
high valuations leave stocks with generally below-average prospects for
long-term returns (with emerging market stocks looking like the best of the
lot). Bond yields are very low (the
10-year Treasury note only yielded 2.3% at quarter-end). Cash yields remain near zero. In light of these market conditions, we have
been expanding your holdings in market risk hedges by adding truly
non-correlated positions. Of course, we
continue to execute our process of rebalancing your portfolio with
discipline.