Market strategists around the globe started 2015 with a dose of humility as last year surprised many that try to predict market direction and movement. As many lamented, 2014 ended with interest rates having fallen during the year (thus benefitting interest rate sensitive assets) and the US stock market in particular dominating all other stock markets. Recently, articles touting the “death of diversification” have been published as the benefits of owning different assets haven’t been seen the last few years. However, similar to Mark Twain’s quote, “The reports of my death have been greatly exaggerated”, the reports of diversification’s death may be premature, as this first quarter has shown.
2015 started with a backdrop of a fairly healthy U.S. economy, a potentially healing European picture, and a slowing, but reforming Emerging Market picture. The Federal Reserve, which controls short term US interest rates, has remained fairly dovish. While rates may be increased sometime this year, most think that the Fed will be slow to do so, as to not derail our economic growth or overly appreciate the dollar. The European Central Bank (ECB), however, has just started its Quantitative Easing (QE) program and is driving interest rates lower across Europe in an effort to revive those economies and spur European banks to lend. This divergence between the Fed and the ECB has caused quite a move in currencies (strengthening the US dollar), but generally these currency differentials and their impacts smooth out and self-balance over time. With this, there may likely be some volatility in the markets as they find their way.
With the short news cycle and access to unprecedented amounts of data and research at our finger tips, the natural reaction is to try and predict or adjust to everything that we see and hear. This can be very unfruitful and even dangerous when it comes to successfully investing over a lifetime. Pursuing short-term and long-term investment results at the same time is like chasing two rabbits; you won’t catch either. Our approach is to be very conscience of the risk we take, while aiming to be rewarded appropriately for the risks we choose over the long-term.
U.S. Stocks: America has been the place to be in the stock market over the past several years and, while the bull market is now over 6 years old, bull markets don’t die of old age. However, it is important to look at our stock valuations, which are edging higher than historical averages and into the “more expensive” realm. Trees don’t grow to the sky and stock valuations don’t either, but given the low interest rate environment, valuations could go higher, especially if the earnings picture continues to remain strong and the alternative (bonds) continues to be low returning. One headwind to U.S. earnings is the stronger dollar which causes our exports to be more expensive. This has put pressure on large U.S. companies during the first quarter with the S&P 500 earning a modest 0.95% growth. The smaller U.S. companies, represented by the Russell 2000, did slightly better with 4.32% growth due to less currency pressure.
International Stocks: It wasn’t long ago that everyone was worked up over Mr. Putin and his actions in Ukraine. While these issues haven’t gone away, the market can only focus on a few things at once, so the attention on Russia has dissipated for the time being. The eyes of the world and the “smart money” (institutional buyers) have been on European markets as the ECB has joined the Fed in the world of “extraordinary measures” with its bond buying program to reduce interest rates and spur economic growth. The weakening Euro has also been a tailwind to European exporters. All of these factors have led to a 4.88% rally in the EAFE index this first quarter, while Emerging Market stocks were up 2.24% (quite a different result than last year).
Bonds: The one “sure thing” last year for most market seers was that interest rates would rise as the U.S. economy gained strength and in anticipation of the Federal Reserve raising rates. This, as we now know, turned out to be false, as the U.S. bond market seems to have linked itself, to some degree, to the foreign bond market with falling rates. So, while it is still important to understand the risk of rising interest rates on bonds (as this could happen, and may over time), the near term, including this first quarter, has actually driven rates slightly lower. More importantly, if going forward, this link between European bonds and U.S. bonds continues, then we could be in a very low interest rate environment for a long period of time. The Barclays Aggregate bond index rose 1.61% in the first quarter, and Barclays Capital 1-3 Yr. Credit was up 0.70%.
Diversifying Strategies: This term refers to strategies that seek to perform in a different manner than traditional stock or bond managers, whose funds are typically tied to a particular asset class. In a world where nearly all assets, including stocks and bonds, are relatively expensive by historical standards, and where new geopolitical risks emerge daily, we use Diversifying Strategies as a means to reduce our total portfolio risk, but not substantially impact our long-term return potential. It is this part of the portfolio which strives to not act exactly like the rest of the stocks, nor exhibit exactly the same characteristics or risks of bonds, that when paired together with the rest of the portfolio, seeks to equal something that is greater than the sum of its parts. While diversification has not been return enhancing in the past several years, we feel that the absence of volatility is not the absence of risk and that over time it will be beneficial to carefully plan and construct portfolios. Using these 3 pillars – stocks, bonds, and diversifying strategies – can provide the opportunity for a greater diversification with potential to both reduce risk and enhance returns over the long-term.
Today’s markets provide a challenge to clients and professionals alike; how to grow wealth over time while being conscience of risk. We believe that the thoughtful and careful construction of a globally diversified portfolio tailored to the risks our clients are willing and able to take is the prudent answer. In some shorter time frames, diversification seems unnecessary and chasing returns seems appealing, but we choose to stick to our guiding principles as we take our role as stewards of our clients’ finances very seriously.
We appreciate your trust in us as your partners in working towards your goals. Please let us know if you need anything.
Source: Blackrock/Bloomberg
This commentary is provided for information purposes only and does not pertain to any security product or service and is not an offer or solicitation of an offer to buy or sell any product or service. Any opinions expressed are based on our interpretation of the data available to us at the time of the original publication of the report. These opinions are subject to change at any time without notice. Bridgeworth, LLC does not undertake to advise you of any changes in the views expressed herein. Unless otherwise stated, all information and opinions contained in this publication were obtained from sources believed to be accurate and reliable as of the date published or indicated and may be superseded by subsequent market events or other reasons.
Risks include, but are not limited to, liquidity, credit quality, fluctuating prices and uncertainties of dividends, rates of return, and yield. Past performance does not guarantee future results. Investors should consult their Financial and/or Tax Advisor before making any investment decision.
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