This Year Proved to be a Difficult One


Posted in: Economics, General, Stock Market, Thought of the Week

Financial markets took investors on another wild ride this year, thanks to several pockets of volatility in both equities and fixed income. Despite these ups and downs, it appears as if the S&P 500 will add to its bull market run as our economy continues to grow at a slow and steady pace.

This year proved incredibly difficult to meet the “consistent return” objective, while preserving capital at the same time, because of three reasons:

  1. Avoided Bonds: We expected the weakness in bonds in 2013 would amplify due to the Fed’s exit from the market, along with a continued improving economy. Instead, the demand for U.S. debt surged and expectations for interest rates to rise are now pushed back even further.
  2. Stock Selection: Our Conservative Income Portfolio (CI) uses stocks that are cheap and pay good dividends, and these stocks were hard to come by this year. We also sold winners too early due to valuation, yet they kept climbing higher as investors took on even more risk to obtain yield. Lastly, most stocks in the S&P 500 don’t pay dividends and/or are far too volatile for CI.
  3. Elevated Cash Balance: Cash is deployed only when opportunity presents itself, and we do not feel pressure to stay fully invested or chase performance like most mutual funds. CI’s cash balance was elevated this year because few securities screened cheap until October when markets began to put stocks and bonds on sale.

 

Let’s go back to early April, when some of the more popular internet and biotech stocks came under severe pressure. Many of these stock prices were cut in half in a matter of days as traders rotated out of high momentum names because their valuation could no longer be justified. There was no warning and certainly no catalyst, and investors who were caught flat-footed were forced to endure the excruciating pain of a valuation-led correction.

Timing these events with any level of consistency is impossible, so we try to keep our investors safe by avoiding overvalued stocks. The unfortunate reality of this strategy is that we occasionally sell our winners too early and screen out sectors/stocks that continue to defy gravity.

Simply put, performance was impacted this year because we anticipated volatility that never arrived, and although we were ultimately wrong, we would much rather be safe than sorry.

As we look to 2015, consensus is no longer easy to spot, and herein lies the opportunity. For example, there are those who believe that the recent drop in energy prices reflects a weakening global economy. Our Investment Committee strongly disagrees, and any short-term pain caused by panic selling will most likely result in long-term gains for patient investors as consumer spend less at the pump and more in the economy.

In regards to the future of interest rates, it’s hard to say when they will rise. The events of this year have dramatically impacted the Fed’s outlook for inflation, and the anticipated actions from central banks in Europe and Japan will most likely keep our interest rates lower for longer. Therefore, we expect risk-adjusted income to continue to remain under pressure for the next several months and urge income seekers to be patient and avoid the temptation to go further out the risk curve.

Keep in mind that your investment plan is likely one that spans over several years. One period of underperformance, or even outperformance, rarely alters a long-term trend. Think about professional athletes within this context. They almost always endure a few games where things do not go their way, but over the span of their careers, they achieve success because they remain focused on what really matters.

Lastly, one of the easiest ways to lose money in investing is to maintain the same strategy over time because markets are constantly evolving. Investment managers must adapt in order to protect and profit, and our Investment Committee is currently making changes in our portfolios, given our views of where they see opportunity for our investors in 2015 and beyond.

However, what will not change is our strict focus on capital preservation and avoiding overvalued securities. Markets may be fueled on speculation and emotion in the short run, but valuation always rules in the long run.

Read this week’s Thought of the Week to get a more in-depth review of the market in 2014.

Click Here for the Weekly Thought

As an Investment Advisory Representative working in conjunction with Global Financial Private Capital (GFPC) we are provided weekly thoughts on what is happening in the economy and the market. Written by our investment committee at GFPC we find these thoughts to be informative and interesting.