On behalf of the Altium Investment Committee;
We certainly hope that you and your family are well and off to a good start in 2015. We are writing to wish you a very prosperous New Year and to thank you for your business and support. We also want to give you our perspective on the investment markets in 2014, an idea of what we are keeping an eye on in 2015 and an update on what we are doing at Altium to serve you better.
U.S. STOCKS SHINE, OUTPERFORMING THE REST OF THE WORLD
What really impressed us last year was the performance of the U. S. stock market. Despite some dips and scares along the way, the market as measured by the S&P 500 posted a third straight year of 10%-plus gains, the first “hat trick” of that magnitude since the bull market of the 1990’s (it rose 11% in 2014, building on a nearly 30% gain in 2013 and a 13% rise in 2012). The rally was fueled by an improving economy driven by the creation of more than 2.5 million new jobs, unexpected declines in long term interest rates and the price of oil and the continuation of healthy corporate profitability. These factors offset a number of fears about the Federal Reserve’s pulling back from its market-friendly stimulus, as well as geopolitical and economic worries from abroad. 2014 was significantly more volatile than the last 2 years as investors experienced 5 “pullbacks” during the year. Most notably a “ 6%’er” right at the start after last year’s rip-roaring gain and a more serious dip in October-November of 9% driven by global growth fears, Ebola and pro-democracy protests in Hong Kong. The market, however, re-affirmed its upward momentum late in the year rising again to new highs. Only the energy stocks, given a dramatic decline in the price of oil, were not invited to the celebration.
While stocks performed well in the U.S., they did not in most of the rest of the world. Driven by weakening economies, international equities were down 7% on average. Europe and Japan battled a lack of demand, high levels of indebtedness and unemployment and deflationary fears. China faced a tug of war between monetary and fiscal authorities as its export and investment-led growth model weakened in the country’s transition to a more consumer-oriented economy. The emerging markets had both demand and supply issues, which were intensified by the year-long weakness in commodity prices and the increasing strength of the U. S dollar.
(VTI; Vanguard US Total Stock Market ETF. VEU; All World ex-US ETF. BND; Total Bond Market ETF)
BONDS ALSO DO WELL DRIVEN BY THE DECLINE IN INTEREST RATES
The 10 year U.S. Treasury bond yield was over 3% as 2014 began and most everyone expected it to go higher in response to an improving economy over the course of the year. For a variety of reasons, most notably continuing monetary ease, demand from foreign governments and fearful investors, Treasury yields fell significantly. Reflecting their weaker underlying economies, foreign government bond yields fell even further. As a result, domestic high quality bonds performed well (up 3%) – the higher the quality and the longer the maturity, the better the performance was. The only sector left out of the bond rally was the lower quality, high yield sector (down 4%), where investors grew fearful of creditworthiness in the face of sluggish growth and the decline in the price of oil.
CAN U.S. STOCKS OUTPERFORM AGAIN? WILL THE 'DECOUPLING' WITH THE REST OF THE WORLD CONTINUE?
The U. S. stock market as measured by the S&P 500 closed 2014 near a record high. Citing an underlying economy that they expect to continue to outperform the economies of the rest of the world, market pundits are calling for another year of good performance for the S&P in 2015. They argue that interest rates will in all likelihood remain near historical lows (even if the FED begins the process of raising them), that inflation is likely to remain subdued (the decline in the oil price almost guarantees it) and that corporate profits are likely to increase. “What’s not to like here?” After all, stocks are the “only game in town” given how low bond yields are and the “U.S. is the best house in the neighborhood” given the weakening outlook for the rest of the world’s economy.
What’s missing from this analysis? More cautious observers point out that the valuation of U.S. stocks is at historically very high levels (The S&P 500’s cyclically adjusted price-earnings ratio (aka the Shiller CAPE ratio) is 27 times -meaning that the index is priced at 27 times the 10 year average earnings of its constituent companies, a level reached only 5% of the time in the 134 year time period covered by the ratio. They also point out that P/E’s using current earnings estimates are based on peak profit margins, which may be unsustainable in an environment of increasing cost pressures and sluggish revenue growth. On the latter point, earnings per share have grown faster than revenues due to an unusually high level of corporate share buy-backs in 2014 (S&P companies bought back $438 billion worth of their own stock, an amount equal to 93% of what they spent on capital projects during the year).
(Gray shaded lines represent recessionary periods)
WHAT ABOUT THE FED (AND SOME OTHER KEY INDICATORS WE ARE WATCHING)?
Historically, the stock market has struggled when the central bank begins to tighten monetary conditions (just as it has appreciated on the back of an aggressively accommodative policy in recent years). The consensus of market opinion is that the FED will seek to raise its policy rate from zero sometime in 2015, but observers are divided on the question of when and to what degree the central bank will do so. A lot will depend on how the employment and inflation numbers come in. But even if the FED does not find justification in the numbers, it may raise rates anyway just to get off its zero rate policy, allowing it to have room to cut rates if necessary in the future.
In addition to the FED, we will be watching the following for clues about the global investment outlook:
1. Wages. While job growth has accelerated, wage growth has not. We’ll be looking to see if the pickup in average hourly earnings in the private sector that we saw in November (+0.4%) can be sustained and produce the 3-4% annual growth rate in wages that FED officials would like to see.
2. Housing and Business (Real) Investment. Housing has not rebounded to pre-crisis levels and thus has not yet contributed meaningfully to the growth of the U.S. economy; nor has investment spending (non-M&A or share buyback related) by corporations. You’d think that in an improving economic environment, corporations making money by borrowing at no cost to invest in productive assets would be a “no-brainer”, but not so far.
3. Congress. Given the majority in both Houses of Congress that the Republicans now have, they will seek to demonstrate an ability to govern by getting together enough to be able to produce some bi-partisan results on important business issues like corporate tax reform (the absence of which drove many U.S. companies to consider moving their headquarters to more tax-friendly offshore locations in 2014).
(Real wage growth has significantly lagged the 5year growth in the CPI)
1. The politics of Europe. The persistence of near recessionary conditions in much of the Eurozone makes the outcome of upcoming elections in Greece, Spain and the UK an important new factor to keep an eye on. Are we in for another round of “euro brinksmanship”? Keeping track of German reaction to events in the rest of Europe remains an important factor in assessing the global investment outlook.
2. Will The U.S. $ continue to strengthen? The euro has declined to under $1.20 from $1.40 and is expected to weaken further, perhaps testing a 1:1 relationship as the schism between the Federal Reserve (beginning a tightening process) and the European Central Bank (considering further monetary ease) continues to develop. The yen is likely to remain weak versus the U.S. $ as Prime Minister Abe also pursues aggressive monetary ease.
3. Russia. Russian aggressiveness in Crimea was an unexpected development in 2014. The collapse of oil prices late in the year and its implications for the Russian economy and currency are an even bigger “wild card” this year.
(RSX is the Market Vectors Russia ETF)
WHAT'S OUR CURRENT INVESTMENT STRATEGY?
As you know from our client reviews and previous correspondence, we believe that investment performance is best measured over a 10 year or longer period. We also believe that diversification (the strategic use of several different asset classes in a portfolio, each with its own risk and return profile) tends to reduce volatility over longer periods of time. In the past 2 years, the benefits of diversification were overshadowed by the strong performance of the U.S. stock market. Furthermore, the increased volatility we experienced over this period did not last long enough to seriously upset investors. Yet a review of the last 10 years clearly shows that all major asset classes take turns leading the parade in terms of performance. Interestingly, international stocks, which were last year’s laggard by a large margin, significantly outperformed their domestic counterparts and bonds - finishing in first place 5 times, versus 3 for U.S. Stocks and 2 for bonds.
So we think that trying to figure out which asset class is going to outperform the others in any particular year is a fool’s game. We’d prefer to work with our clients to determine what their risk budget is and then recommend a portfolio that mixes the different asset classes based on their long term average return and risk profile in an attempt to give our client the highest possible return that is in line with how much risk he or she is willing to take. We think that doing so is in the best interest of our clients.
Having given you our view, we’d like to hear about your successes in 2014 and any major changes in your life that may have happened since we last saw you. Andrea Contreras, Manager of Client Services, will be reaching out to you in the near future to help schedule a visit and account review with us.
Altium had its best year ever last year. Our assets under management grew significantly with your support, as did our staff. We invested heavily during the year in building our client service capacity and capabilities. Our commitment to developing a “state of the art” wealth management firm remains steadfast. We recognize that investing in our people and our infrastructure (with a particular emphasis on the use of productivity-enhancing technology) will help us reach this goal.
Gregory Slater, CFA, CFP®
Chief Investment Officer
Altium Wealth Management LLC (“Altium”) is an SEC registered investment adviser with its principal place of business in the State of New York. Registration does not imply a certain level of skill or training. For information pertaining to the registration status of Altium, please contact Altium or refer to the Investment Adviser Public Disclosure web site (www.adviserinfo.sec.gov).
The information contained herein is provided for general informational purposes only, reflects the opinions of Altium, and should not be construed as personalized investment advice. Past performance is no guarantee of future results and there can be no assurance that any particular strategy or investment will prove profitable. This newsletter contains certain forward-looking statements that indicate future possibilities. Due to known and unknown risks, other uncertainties and factors, actual results may differ materially from the expectations portrayed in such forward-looking statements. As such, there is no guarantee that the views and opinions expressed in this newsletter will come to pass. Additionally, this newsletter contains information derived from third party sources. Although we believe these third party sources to be reliable, we make no representations as to the accuracy or completeness of any information prepared by any unaffiliated third party incorporated herein, and take no responsibility therefore. Investing in the stock market involves gains and losses and may not be suitable for all investors. Information presented herein is subject to change without notice and should not be considered as a solicitation to buy or sell any security. Clients should contact Altium promptly if they experience changes in their financial situations relevant to the management of their accounts.
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