Turn the Page

2014 has come and gone and it was a good year to own stocks.  The S&P 500 closed out the year up a respectable 13.69%.   For the most part, stocks continued their multi-year trend higher.  There were only four down months and, in my opinion, four points in time when one could “buy the market.”  For example, January 2014 saw prices drop 3.4% making early February an attractive buy point.  Similar entry points presented themselves in early August, mid-October and finally early December.  In the end, if you were a patient buyer, there were opportunities to make money in stocks.

Back in 2013, stocks put on a clinic in “high” returns, with the S&P 500 producing a total return of 32.4%.  Interestingly, most other asset classes faltered.  Portfolios with the highest allocations to stocks performed the best.  In 2014, we saw a balanced contribution from all asset classes.  To the surprise of many, fixed income (particularly municipal bonds) had a strong year.  We also saw solid contributions from REIT’s and MLP’s, two other asset classes we regularly utilize.  Quite unlike 2013, balanced portfolios performed the best.

Utilities, health care and technology were the most consistently positive sectors, month over month, all year.  Telecom and energy were the biggest disappointments, and if it were not for a late year rally, consumer discretionary would have come in much worse.  Generally speaking, large cap growth names did well, as did stocks with higher P/E ratios.  At the same time momentum (highly owned) names did poorly as did stocks with large percentage of international revenues.

For 2015, I expect the volatility in stock prices, that began to ramp up late in the year, to escalate further.  This undercurrent of change has been creeping back into the marketplace after several placid years.  There has not been a notable “correction” in prices since August 2011 and I think it prudent to prepare for some rougher seas.  I do not think the current bull market is over, but I do think it will antagonize investors and bait many to sell and go home.

The US economy is performing better than any time since the financial crisis.  It is also head of the class when compared to economies around the globe.  GDP, a useful measure of economic growth, is currently 2.8%.  There is a strong relationship between GDP and consumer confidence, and a further healthy relationship between consumer confidence and stock price movements.  The U.S. index of consumer confidence jumped to a two-month high of 92.6 in December.  Consumer spending makes up @ 70% of GDP and is the main driver of economic growth.

Though the backdrop is favorable, there is a lot for stocks to overcome if they are to perform well in 2015.  For example, the recent drop in oil prices is a conundrum, and it’s unclear how this will impact the broader markets.  On the positive side, it may well boost our economy by lowering input costs and bumping up consumer confidence.   Conversely, it may lead to sharp cuts in industrial capital expenditures, cuts in analyst earnings forecasts and the possibility of fallout among countries around the globe highly dependent on oil exports.

The surging US$ may also become an issue.  Again, it is unclear whether a strong dollar is a positive, or a negative.  A few scenarios are as follows.   First, as far as earnings go, a higher US$ hurts companies that repatriate high levels of foreign earnings.  Second, there is considerable talk of the deflationary effect of the strong dollar, driving down commodity prices and flattening the yield curve.  Some prognosticators are pointing to a US 10-year Treasury below 1% yield.  Finally, the potential for an emerging markets currency/debt crisis looms, as the surging US$ could force an un-wind of the global carry trade.

Other concerns as we move into the new year relate to the jobs market.  The unemployment rate is in the 5.8% range, and on the surface things look favorable.  Yet the Civilian Labor Force Participation Rate has fallen to 62.8%, well below its pre-crisis level of 66%.  Along with productivity, labor is a key GDP ingredient and if people are exiting the labor markets, this is a sure headwind to future GDP growth.

Finally, geopolitical issues are pervasive.  From ISIS to Russia, there is no place to hide.  China is difficult. Cyber warfare is becoming a regular event.  And at home, Washington DC and our congressmen, adept at brinksmanship, may continue to favor their own political advancement above common sense fiscal policy and their obligation to serve their country.

So, as the book on 2014 is now closed, we can be thankful for a good solid year in the financial markets.  At the same time, we ought to be conscious of the multitude of issues in play that could raise their ugly heads.  In my opinion, there is good reason to remain well invested, but there does not appear to be as much upside (expected return) and there does appear to be an increased level of risk.  I expect the next chapter to read more like an action-thriller than the young-adult drama we’ve been immersed in.  Please let me know if you have concerns.  I am happy to review your portfolios with you and make adjustments to your asset allocation.

 Bruce Hotaling, CFA

Managing Partner

The views and opinions stated herein are those of Bruce Hotaling, are as of this date, and are subject to change without notice. Information contained in this report was received from sources believed to be reliable, but accuracy is not guaranteed. Investments are subject to market risk, including the possibility of loss of principal. Past performance does not guarantee future results. The S&P 500 is an unmanaged index of 500 widely held stocks. Investors cannot invest directly in an index. The PE ratio (price/earnings) is a common measure of relative stock valuation. This note contains forward-looking statements, predictions and forecasts (“forward-looking statements”) concerning our beliefs and opinions in respect of the future. Forward-looking statements necessarily involve risks and uncertainties, and undue reliance should not be placed on them. There can be no assurance that forward-looking statements will prove to be accurate, and actual results and future events could differ materially from those anticipated in such statements.

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