Investing Insights: January 2014

Thursday, January 30, 2014

Sustained drop in stocks not likely despite uncertainties, global worries

By Robert C. Doll, Chief Equity Strategist and Senior Portfolio Manager at Nuveen Asset Management

There is growing investor anxiety about the strength of global equity markets following their strong run in 2013, especially in light of a slightly lackluster economic backdrop. Many equity investors are questioning the efficacy of monetary policy, the level of profit margins and valuations, the threat of Fed tapering and geopolitical risks. Five years after a harrowing economic recession, equity investors still appear largely focused on risk.

Fourth-quarter earnings season announcements are showing stronger signs. Thus far, 68% of companies reporting 4Q 13 earnings beat consensus expectations. Approximately 25% of S&P 500 companies have reported earnings.

Severe weather across much of the U.S. will likely impact economic data in January. Once temperatures return to normal, a bounceback could unfold.

The Federal Open Market Committee announced it will cut its monthly asset purchases by another $10 billion. Despite concerns about emerging markets and a weak December payroll report, the Fed will reduce its purchases to $65 billion per month, and leave the interest rate forward guidance unchanged.

A correction in equities may be under way. A price correction would be natural after the substantial increase in prices over the last few months. Potential areas of concern include the squeeze in China's shadow banking system, increasing currency instability in several emerging-markets countries and a renewed spike in interbank borrowing rates in the eurozone. Nevertheless, none of these issues are likely to significantly unsettle the global economy.

Bear markets have almost always coincided with economic recessions.

Today, the developed world has barely recovered from the 2008 financial crisis, and it is not probable that another recession will emerge soon. If this conclusion is correct, the bull market should remain intact. Investors seem to be more upbeat about the world economy and prospects for stocks than they were 10 months ago, but signs of a bubble are not yet prevalent.

A forward price to earnings (P/E) ratio of 16 for the S&P 500 is not viewed as extreme, compared with a 10-year U.S. Treasury yield of 2.75%. We believe the sweet spot for equities is when the underlying economy remains weak but recovering, and monetary policy is stimulative.

We have been in the sweet spot for some time, and it is likely to continue.

Profit growth is about to accelerate. The eurozone is coming out of a recession and the U.S. economy remains below its potential. Also, inflation rates in G7 countries are below central bank targets. Overbought conditions and periodic worries about the impact of Fed tapering, particularly in emerging markets, is causing near-term choppiness. While the current turmoil may not be over, current conditions do not suggest a sustained decline in equity prices.

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The views expressed here are that of myself or the cited individual or firm and do not constitute a recommendation, solicitation, or offer by myself, D2 Capital Management, LLC or its affiliates to buy or sell any securities, futures, options or other financial instruments or provide any investment advice or service. D2, its clients, and its employees may or may not own any of the securities (or their derivatives) mentioned in this article.

The Jacksonville Business Journal has ranked D2 Capital Management in the top 25 of Certified Financial Planners in Jacksonville. The Firm is also a member of the Financial Planning Association of Northeast Florida, the Jacksonville Chamber of Commerce, the Southside Businessmen's Club, and the Beaches Business Association.

More Volatility Ahead

By Russ Koesterich, CFA, Chief Investment Strategist for BlackRock and iShares Chief Global Investment Strategist.

After a rocky first few weeks of the year, U.S. equity markets fell sharply last week. The media blamed much of the decline on market turmoil in emerging markets. China reported some surprisingly weak economic data, and financial turmoil in Argentina and Turkey led to a sell-off in EM currencies.

But while EM volatility certainly contributed to investor angst, I believe last week’s equity market sell-off had more to do with two other factors, as I write in my new weekly commentary.

1. Stretched Valuations. Last year’s gains were powered mostly by multiple expansion – investors were willing to pay increasingly more for a dollar of earnings. In fact, 2013 saw the largest single-year increase in market valuations since 1998. In addition, not only did stocks become more expensive, but bonds became cheaper. As a result, many large institutions are rotating back into bonds, contributing to pressure on equities.

2. Domestic issues. Last year’s rally was largely an act of faith that the economy and earnings would improve, justifying higher stock prices. While the economy does appear to be mending, the improvement has been modest and gains are not yet evident in earnings numbers. It’s still relatively early in the fourth-quarter reporting season, and to date, the results have been respectable, but hardly inspiring. The percentage of companies that are reporting better-than-expected results is actually below the four-year average.

Investors’ growing frustration with earnings results is evident in recent flows. U.S. equity funds have been seeing outflows, while European and global equity funds have been attracting assets.

So what does this mean for investors and their portfolios? While I still think that stocks will post gains this year, those gains are likely to be more muted and accompanied by more ups and downs. As the Federal Reserve tapers, market volatility is likely to revert back to its longer-term average. As such, investors should consider preparing their portfolios for the rockier road ahead.

In addition, in a week when much of the news was negative, Europe surprised to the upside with a big surge in manufacturing. So, for investors that have focused on the United States, I advocate looking to increase international exposure to the other large developed economies, specifically Europe and Japan. In fact, I now hold overweight views of both markets.

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Wednesday, January 29, 2014

Equities market 'the best in our lifetime,' but hold on tight

By Jeff Benjamin, Investment News

Don't be surprised if the stock market corrects by as much as 10% this year, but don't even think about giving up on the secular bull market.

That's the bottom line message from Liz Ann Sonders, chief investment strategist at Charles Schwab & Co. Inc.

Speaking at the Inside ETFs conference in Fort Lauderdale, Fla., on Tuesday, Ms. Sonders stressed that from both valuation and sentiment perspectives, there is no reason to walk away from the equity markets at this point.

“There is a slightly elevated risk of a 10% correction this year, but I don't think the secular bull market is over,” she said. “I have some short-term concerns, but I personally think the bull market we're in now will be the best is our lifetime.”

Some of the driving forces she identified include the fact that U.S. businesses “are sitting on a huge hoard of cash, which is at a level not seen since World War II,” she said. “We know the capital is there, but we haven't had the animal spirits to put it back to work yet. But this is the year we'll probably see increase in [capital expenditure] spending.”

Inflation is not a threat at this time, she explained, because “there is no velocity of money.”

“The money is not multiplying and that has held inflation in check, but it has also kept economic growth low,” Ms. Sonders said. “You don't get an inflation problem when you have no velocity of money, but if we start to see velocity pick up, then I think we could start to change the thinking around future [Federal Reserve] policy.”

The current spread between bank deposits and bank lending, which Ms. Sonders said has never been as wide as it is today, could narrow this year as lending picks up.

“But we're still a long way from the point where lending matches deposits,” she added.

Another area of potential fuel for the U.S. economy is one of Ms. Sonders' favorite themes, the U.S. manufacturing renaissance.

“We're at an inflection point,” she said. “For the first time in post-World War II history, U.S. manufacturing is up three years in a row, but keep in mind it is coming off a very low base and it is still only 13% of the U.S. economy.”

In terms of equity market valuations, Ms. Sonders said she is not worried about the fact that forward price-earnings ratios are around the historic median level.

“Bull markets rarely stop at the median P/E,” she said.

In making her point, Ms. Sonders used a slide showing that the average trailing P/E of every bull market since the 1950s was 18.7, which compares to the current level of 16.6.

“We know that profit margins are at or near all-time highs,” she said. “But unless you're rolling over into a crash, it has not been historically a problem for the market coming off all-time highs in profit margins.”

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Monday, January 27, 2014

Case for Munis Still Strong, Despite Market Woes

By Ilana Polyak , Financial Planning Magazine

Pity the poor municipal bond fund managers. Every few years, they are called on to defend the sector in the face of worries about a debacle in the muni market.

This is another of those times. Among the reasons that bears are wary of the muni market: Detroit’s default last summer, Puerto Rico’s looming (as of mid-January) downgrade, Illinois’ mounting pension obligation and the Federal Reserve’s decision to begin tapering its $85 billion monthly bond-buying program. The S&P Municipal Bond Index was down 2.3% for the year that ended on Jan. 7 — ouch.

But Christopher Alwine, head of Vanguard’s municipal bond team, has seen this before. He has been managing municipal bond funds since 1991, and over that period he has witnessed some bleak times.
In 2008, the worldwide financial collapse seized up credit markets — and bond insurers, once ubiquitous, experienced credit problems all their own.

That led investors to question the creditworthiness of munis and the eventual departure of insurance from the market.

The worst fears passed — until 2011, when prominent banking analyst Meredith Whitney predicted a massive wave of municipal bond defaults. (They didn’t happen.)

By comparison, Alwine says, today’s worries are relatively modest. “When munis have a bad year, it’s not all that bad,” Alwine says of the recent dip in the sector’s performance.

RARE DEFAULTS

Although muni default rates are on the rise since the financial crisis, they are still extremely unusual. According to Moody’s Investors Service, the default rate for munis rated by the firm is 0.03% over the last five years.

And compared with corporate bonds, the recovery rates — that is, the amount of money that bondholders eventually wrangle out of the issuer after a default — looks good too: 65% for muni bonds versus 49% for corporate bonds.

In 2012, as hungry investors looked for yield advantage, munis were a natural place to get it with relatively little risk. But 2013 proved something else, amid the Detroit bankruptcy and fears about an impending ratings downgrade for Puerto Rico.

THE CASE FOR OWNING

Despite the headlines, Alwine says, the case for munis is strong. First of all, the income produced by munis is tax-free; that is especially important now that the net investment income of high-income individuals is subject to a 3.8% Medicare surtax.

And when problems do flare up in the muni market, they don’t tend to be contagious, Alwine insists. Part of this has to do with the sheer number of issuers — there are tens of thousands of them. In addition, the financial troubles in one jurisdiction tend to be unique. So, highly publicized troubles in a few locations aren’t necessarily symbolic of difficulties throughout the market.

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The D2 Capital Management Tax Free Income Portfolio is currently yielding 4.83% (Trailing 12 month Tax Equivalent Yield at 28% Tax Bracket, of 24 January 2014).

Last Week’s Selloff Isn’t a Big Deal

By Vahan Janjigian, Editor of MoneyMasters Stock Report

When stocks sell off, everybody wants to know why. Last week’s selloff is being blamed on everything from the collapse of the peso in Argentina to a contraction in manufacturing in China to disappointing Q4 earnings announcements in the U.S. Whatever the case, the bigger concern is how long the selloff will last.

Of course, nobody knows for sure how long any selloff will last. To keep things in context, keep in mind that stocks rallied about 30% last year. That’s a rather large one-year return. Over the long term, stocks tend to rise by approximately 8-10% annually. But that is just the average. Average, of course, implies variation. For example, if stocks go up 10% every year for 10 years in a row, the average return is 10%; but in this case, there is no variation. This would be a highly unlikely occurrence. On the other hand, if stocks fall 5% every year for five years in a row and then rally 25% per year over the next five years, the (arithmetic) average annual gain is still 10%. This, too, would be a highly unlikely occurrence; however, in this case, there is variation. Notice also that in the second case, even though the average is 10%, there was no actual year in which stocks rallied 10%.

The point is that selloffs are inevitable. As Warren Buffett has said, long-term investors should welcome selloffs. It gives them the opportunity to buy more shares at lower prices. No one, however, can consistently pick the tops and bottoms. When you buy stocks following a selloff, you run the risk of getting in too early.
The S&P 500 is down only about 3% since the year began. Many pundits have been calling for a 10% correction. Even long-term bulls view 10% pullbacks as healthy. We’re still a ways from that point so the selling could easily continue for a while. In 2013, the stock market rallied strongly even though the economy showed little signs of health. This year (so far), the economy is looking better. However, that does not imply further gains in stocks. To a large extent, last year’s rally anticipated an improving economy.

Right now, we are in the heart of earnings season so we can be sure to see more volatility in the days and weeks ahead. Furthermore, Ben Bernanke’s last FOMC meeting as Chairman of the Federal Reserve occurs on Jan. 30. The Fed has embarked on a course of reducing the amount of quantitative easing. The market currently expects the Fed to announce an additional $10 billion reduction in easing. That means, the Fed would continue buying bonds at the rate of $65 billion per month. One thing is for sure. If the Fed chooses some other course of action, stocks will respond very quickly one way or the other. In fact, if the past is any guide, stocks could shake, rattle, and roll even if the Fed does exactly what is expected.

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Thursday, January 23, 2014

2014 Will Be a Year of Moderation

By Max Chen, ETF Trends

The economy is moving along and the markets will continue to strengthen. However, investors should not expect a repeat of last year as growth moderates.

“We expect U.S. and global growth to pick up modestly in 2014 given stronger household balance sheets and less fiscal drag,” according to Russ Koesterich, Chief Investment Strategist for BlackRock and iShares Chief Global Investment Strategist.

BlackRock expects the U.S. economy to expand 2.5% to 2.75%, up from 2% over the past few years, while global growth could rise to 3.5% from about 3% in 2013.

However, investors should remain vigilant if Capitol Hill bickers over another budget deal. Additionally, the labor market is still slow to pick up and wage growth has been subdued, which means households will keep a lid on their wallets.

Potential Federal Reserve tightening has weighed on the markets, but the Fed is committed to low short-term rates for the time being and has tapered its monthly bond purchasing plan.

“We foresee the 10-year Treasury yield modestly climbing this year, finishing 2014 at around 3.5%,” Koesterich added.

While gains may be muted, BlackRock suggests investors should stick to stocks. Specifically, Koesterich is overweight U.S. mega-caps, Eurozone stocks and Japanese equities.

“Against this economic backdrop, we continue to advocate overweighting stocks, which remain more attractively valued than bonds and cash,” Koesterich said. “That said, U.S. equity market gains will likely be more modest this year than in 2013, and international stocks have more room for multiple expansion.”

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Fidelity 2014 Outlook

As we emerge from a blockbuster 2013 for U.S. stocks, which gained more than 30% on the way to setting all-time highs, investors have numerous opportunities to consider, along with some unique challenges.

Here are the key things to know right now, according to a range of Fidelity experts featured recently in Fidelity Viewpoints:

Stick with stocks as economic growth solidifies. Stocks may continue to outperform bonds and cash. Focus on companies with high earnings growth potential and reasonable valuations. If it is appropriate to your goals, investment objectives, and risk tolerance, consider financial, tech, and health care stocks.
Brace for some volatility. Stay diversified. If you’re a long-term investor and it is in line with your investment objectives and goals, consider using pullbacks to buy strong companies at reasonable prices. If you’re a trader and are willing to assume the risk of investing in options, consider strategies like calendar and other spreads.
Rates may inch higher, not spike. Bonds still play a role for income and diversification. The Fed could keep short rates low, and much of the change in longer rates may have already happened.
Search for income beyond conventional bonds. If maximizing income is part of your investment objectives and you are willing to assume the risk, consider a mix of high yield, floating rate, convertibles, and equity income.
Look abroad for opportunities. Europe’s economic cycle appears to be turning positive, and many foreign companies have lower valuations than their U.S. counterparts.
Watch for a transition in emerging markets. Emerging market countries, such as Indonesia, Turkey, and South Africa, could suffer from U.S. central bank tapering. However, others—such as Mexico—may benefit from the next phase of growth.

Source: Fidelity Viewpoints

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A Pause That Refreshes

By Gregory Dorsey, Leeb's Market Forecast

Stock market trading was somewhat thin this week as people across the country dealt with the return of the polar vortex. The ominous-sounding weather event blanketed the mid Atlantic and parts of New England with snow accumulations of 6 to 12 inches or more, accompanied by strong winds and extreme cold. While the thermometer drops again in some U.S. regions, however, economies globally are heating up.

The International Monetary Fund (IMF) increased its global growth forecast Tuesday, for the first time in nearly two years. The Washington-based organization is expecting the world’s economy to increase by 3.7 percent this year, 0.1 percent more than its previous estimate. The organization expects even faster growth in 2015, of 3.9 percent. Behind those numbers, the IMF sees economic activity in mature economies, led by the U.S., picking up slack from softer emerging economies.

The IMF’s prediction followed Monday’s report that China’s economy grew by 7.7 percent in 2013. Although that’s near a 14-year low, China remains in good shape. And its expansion last year was hampered by slowing exports. That headwind will be reduced in 2014 thanks to improving Western economies.

It’s worth nothing that 2014 is a midterm election year. But it’s important to remember that the stock market has a long history of producing sub-par returns during midterm election years.

Since 1900, stocks have only gained an average of 4 percent (excluding dividends) during such years. That’s about half their normal annual pace.

That’s not to say prices have never advanced strongly during midterm election years—double-digit returns are not unheard of in the second year of a Presidential cycle. But often the market has also experienced corrections in the second year of the cycle, leading to years that go down overall. In fact, since the start of the 20th century, the market has only advanced 57 percent of the time during these years. In contrast, it has gained more than two-thirds of the time for any given year and 82 percent of the time in the third year of the cycle.

It seems hard to believe but the bull market is just shy of entering its sixth year. On the heels of a strong 2013, analysts have tempered views of where stocks are headed in 2014, but on balance Wall Street strategists remain upbeat and project an 8 percent annual gain (before dividends) for the S&P 500 this year. In light of the market’s steep valuations, however, such gains are likely to be a stretch and unlikely to occur without a sizeable correction first.

A saving grace for the market and the economy is the fact that there’s still plenty of slack in the economy and that prices remain contained. Indeed, consumer prices remain below the lower end of the Federal Reserve’s target band. And with crude oil, which is by far the most important of commodities, essentially flat on a year-over-year basis, inflation will pose no threat in the near future. The absence of inflation also takes pressure off the Fed to rush to remove its current quantitative easing program. Let’s hope the central bankers don’t move too quickly to remove this stimulus, which could impede the pace of expansion.

For now anyway, the correction we anticipate could prove merely a pause that refreshes rather than the start of an ugly bear market.

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Tuesday, January 21, 2014

Stock Market Would Prefer a Seattle Super Bowl Victory

By Todd Shriber, ETF Trends

There are a plethora of effects and indicators, both legitimate and fanciful, that market observer like to reference.

On the more whimsical side of the ledge are indicators pertaining to the World Series and what country cover model of Sports Illustrated’s swimsuit issue hails from. Then there is the January Effect, the scenario where small-caps lead large-caps in the first month of the year, setting the broader market up for a (usually) positive result for the year. The January Effect has earned its stripes because of its penchant for accuracy.

The Super Bowl Theory may not have the credentials of the January Effect, but its track record is good enough that one thing is clear: Investors who are not devout Denver Broncos fans ought to cheer for the Seattle Seahawks in Super Bowl XLVIII on Feb. 2.

“The Super Bowl Predictor Theory says that the market will gain for the year if an NFC (National Football Conference) team or an AFC (American Football Conference) team with an NFC origin wins the game, otherwise the market will fall – totally irrelevant items to the market. However, the indicator has been correct 37 of the last 47 years, or 78.7% of the time, on a total return basis for the S&P 500,” according to Howard Silverblatt, Senior Index Analyst at S&P Dow Jones Indices.

This year’s game sets the NFC Seattle Seahawks against the AFC Denver Broncos. If Seattle wins the theory says that the S&P 500 will be up this year; if Denver wins the market closes down.

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Sunday, January 19, 2014

China Growth Investment in 2014

With valuations stretched for U.S. stocks, go international

By Jeff Reeves, Editor of InvestorPlace.com

There’s no doubt that China is evolving from an emerging economy to a developed one, and that evolution is going to come with growing pains.

But China just projected that its GDP likely grew at 7.6% in 2013 — above the 7.5% forecast set in March, and down only 0.1 percentage points from 2012 GDP. And while early last year we saw trouble in manufacturing and exports, those trends have started to stabilize and move in the right direction.

From a valuation perspective, China is cheap compared with future earnings. Chinese stocks have a forward Price to Earnings ration (P/E) of about 10.6, trading at a Price/Sales ratio of 0.65 for a 35% discount. Also, The Price to Earnings Growth ratio — that is, the price compared with earnings growth — is attractive. Furthermore, Hong-Kong based companies that do a lot of business in China are also looking cheap. The P/E for this neighboring nation is 10.7.

Of course, China stocks got gutted in 2013, so some investors are still leery. Furthermore, risks of opacity or corruption thanks to the command-and-control government in Beijing are very real.

So if you want to play China, I advise a broad play via the SPDR S&P China ETF (GXC). It’s reasonably cheap with expenses of 0.59%, or $59 annually for every $10,000 invested. It’s also much more diversified with only three stocks allocated at over 3% of the fund and no pick over 7% allocation.

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Disclosure: I own the SPDR S&P China ETF in my personal portfolio

The views expressed here are that of myself or the cited individual or firm and do not constitute a recommendation, solicitation, or offer by myself, D2 Capital Management, LLC or its affiliates to buy or sell any securities, futures, options or other financial instruments or provide any investment advice or service. D2, its clients, and its employees may or may not own any of the securities (or their derivatives) mentioned in this article.

The President & the Markets

By Scott Chan, Contributing Editor Leeb's Market Forecast

The four-year cycle of a president’s term is replete with historically consistent market activity. Typically, the first two years of a president’s term are not too good, with market corrections averaging 2.6 percent taking place in 16 of the last 18 terms. Of the 16 corrections, 12 of them started in the first year and four in the second. As market cycles go, the bearish aspect of the presidential cycle is about as consistent as you get. On the other hand, the second two years are almost always good. This makes sense; if corrections happen in years one or two, then, by comparison, it isn’t hard to understand why years three and four perform better. Delving a little deeper, the conventional wisdom blames these swings on political strategy—the ramifications of looming elections prod politicians to do things to ensure a that a lovely economy is visible come Election Day, while the opposite often also holds true. In a president’s first two years, there is often a need to reign in the exuberance created by the policies of the prior administration, meaning interest rates and fiscal policies tend to get tighter in the first two years than the second. We are a little skeptical that a president can turn the good times on and off with such accuracy, but there is no denying the fact that at least historically, the first two years of presidential terms typically experience corrections while the last two usually enjoy rallies.

Interestingly, when broken down into quarterly returns, it is actually the fourth quarter of the second year that does the best. It has the highest historical median return of any quarter of the four-year cycle, and has often been when the stronger performance in years three and four has begun. Conversely, quarters two and three of the second year have typically experienced corrections.

2014 is a second year. This means that according to the historical presidential cycle, odds favor a correction at some point between now and the fourth quarter, at which point a new rally would begin that would carry over into next year. Granted, much of this kind of work depends on fiscal and monetary policies being at least marginally consistent across presidential terms, which is certainly not true in this case. In fact, the current situation of continued low interest rates and significant, if shrinking, Federal Reserve quantitative stimulus means the traditional presidential cycle playbook might be totally invalid, as they are not in tune at all with where a president is in his term. Nonetheless, if the cycle’s batting average is any guide, the market will face headwinds in the second and third quarters of this year.

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Thursday, January 16, 2014

MLP ETFs Capture U.S. Energy Expansion

By Max Chen, ETF Trends

The U.S. is pumping out more black gold than ever as shale oil and gas production accelerates. As the country moves toward energy self-sufficiency, investors can take a look at master limited partnership exchange traded funds to capitalize on oil boom.

According to BP Plc (NYSE: BP), the U.S., the world’s largest producer of oil as of 2013, will be able to meet all its energy needs on its own by 2035 due to increased shale oil and gas projects, along with slowing demand, reports Brian Swint for Bloomberg.

Over the next two decades, Asia and Europe will be the main oil importers, with global energy demand to rise 41% by 2035 from 2012, slower than the 52% gain over the past two decades.

“Both oil and gas import concentration will increase massively in Asia and Europe,” BP Chief Economist Christof Ruehl said in the article. “About 80 percent of all traded oil will go into Asia.”

Meanwhile, investors can capitalize on the U.S. oil production boom through master limited partnerships.

MLPs are businesses that engage in energy infrastructure activities, including the processing, storage and transportation of minerals and natural resources. While MLPs are associated with the energy sector, they have a low correlation to energy prices, along with the broader equities markets, as the assets act like a toll-road in the nation’s energy infrastructure. Consequently, MLPs are ideally situated as the U.S. pushes around more volume.

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Global X MLP (MLPA) is a component of the D2 Capital Management Multi-Asset Income Portfolio.

Disclosure: I own the D2 Capital Management Multi-Asset Income Portfolio

The views expressed here are that of myself or the cited individual or firm and do not constitute a recommendation, solicitation, or offer by myself, D2 Capital Management, LLC or its affiliates to buy or sell any securities, futures, options or other financial instruments or provide any investment advice or service. D2, its clients, and its employees may or may not own any of the securities (or their derivatives) mentioned in this article.

Morningstar Announces 2013 Fund Manager Award Winners

Morningstar recently announced its 2013 U.S. Fund Manager of the Year award winners. The awards acknowledge managers who delivered impressive performance for the year, have shown excellent long-term risk-adjusted returns, and have been good stewards of fund shareholders’ capital. Among the winners:

The Fixed-Income Fund Managers of the Year are Daniel J. Ivascyn and Alfred T. Murata with PIMCO Income.

The fund gained 4.8 percent in 2013, boosted by its core investment in non-agency mortgage-backed securities and smaller holdings in investment-grade and high-yield corporate securities. Ivascyn and Murata’s three- and five-year trailing returns have also been in the multi-sector bond category’s best quintile, and have kept the fund’s volatility below the average of its category's peers.

Source: Financial Advisor magazine

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PIMCO Income (PONDX) is a component of the D2 Capital Management Multi-Asset Income Portfolio.

Disclosure: I own the D2 Capital Management Multi-Asset Income Portfolio.

The views expressed here are that of myself or the cited individual or firm and do not constitute a recommendation, solicitation, or offer by myself, D2 Capital Management, LLC or its affiliates to buy or sell any securities, futures, options or other financial instruments or provide any investment advice or service. D2, its clients, and its employees may or may not own any of the securities (or their derivatives) mentioned in this article.

Tuesday, January 14, 2014

Oakmark’s 4th Quarter Commentary

By Bill Nygren, CFA, Portfolio Manager, Oakmark Fund and Oakmark International Fund

Monday morning quarterbacking is a great pleasure for sports fans. In sports, as in many areas of life, decisions that produce bad outcomes are endlessly replayed, generating innumerable, unanswerable “what if” questions.

Investing shares a lot of similarities with sports. Good decisions often lead to bad outcomes and vice-versa. In order to fairly judge decisions based on outcomes alone, one needs a large sample size, rather than just a few anecdotes. Investors with long track records of above-average performance almost always employ a process that puts the probabilities in their favor.

One of the most important contributors to successful long-term investing is asset allocation. Investors evaluate the tradeoff between higher returns on riskier assets, such as stocks, and lower returns on more stable assets, such as U.S. Treasury bonds. In constructing a portfolio, they try to balance their desire for maximum returns with their ability to withstand volatility. Long-term data clearly demonstrates that stocks, though more volatile than bonds, have rewarded investors with higher returns. Statistics compiled by Ibbotson Associates show that since 1926, stocks have produced an average annual return of 10% while U.S. Treasury bonds have returned less than 6%. Long-term investors in stocks have been well rewarded for accepting the risk of short-term loss. Obviously, if one could avoid owning stocks in the negative years, one’s return would be even higher (and one’s risk would be lower) than if one used a buy-and-hold approach. With this in mind, many investors attempt to time their investments in stocks. But almost every study has concluded that trying to time the market is futile for most investors.

And yet, despite all of the evidence that stocks are the highest returning asset class over the long term and despite all of the evidence that almost nobody can time the market, the financial media usually treats bears as being more thoughtful than bulls. This is a pet peeve of mine because I believe it is a disservice to individual investors. Much like with Monday morning quarterbacking, investors need to consider the probabilities. Since the stock market has to either go up or go down, you might think this is a 50/50 proposition. However, the S&P 500 Index has had 24 down years since 1926; in other words, in 88 years, only 27% of the years have produced a loss. The probability of a down year has been about the same as the probability of an eight-point underdog winning a football game. It happens, but it isn’t a bet you’d make unless you got good odds. In short, history shows a much higher burden of proof is on the people who predict that the market will fall, rather than on those who predict it will go higher.

When we look back on the S&P 500 gaining over 30% in 2013, it will seem like owning stocks was an easy call. The market had been moving higher in preceding years, valuations weren’t demanding, and the economic recovery was still quite young. But the bears argued that it was foolish to invest after stocks reached a new high in March. They argued that slowing growth in China threatened our economic recovery and that it was too risky to invest when our government was so dysfunctional that it shut itself down. Additionally, they predicted that the Fed tapering would bring a screeching halt to the positive returns. As Gilda Radner’s Saturday Night Live character Roseanne Roseannadanna said 35 years ago, “It just goes to show you, it's always something--if it ain't one thing, it's another." There has always been something for investors to fear, not just last year but every year, yet the market has averaged a 10% annual gain and has gone up in 73% of the years since 1926.

Our message is not that the stock market is unusually cheap right now, nor are we saying that we believe it is poised for a great 2014. We don’t believe we have specific market-timing skills. Clearly, the 125% increase in the S&P 500 over the past five years was not matched by an equally high increase in intrinsic business values; so by definition, stocks aren’t as cheap as they were. However, when looking at metrics such as price-to-earnings ratios, stocks appear to be priced consistent with historic averages. And when stocks have been priced near average levels, returns have typically been near average, too. Looking at the probabilities, “average” isn’t a good reason to be bearish.

Our message is the same as it almost always is – don’t let current events keep you from following your long-term financial plan. Periodically reexamine your asset allocation and take the steps needed to put your portfolio back into long-term balance. Restoring balance won’t always deliver an immediate profit. Sometimes a kicker misses a 47-yard field goal attempt. Sometimes a field goal attempt gets returned for a touchdown. Neither is more likely than not, but they happen. In an uncertain world, all that investors can do, like good coaches, is to position themselves so that the probabilities are in their favor. And remember, the stock market bulls start the year as an eight-point favorite.

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Disclosure: Oakmark Fund and Oakmark International Fund are components of D2 Capital Management's investment portfolios. I own D2 Capital Management Investment Portfolios.

Friday, January 10, 2014

Vanguard 2014 Outlook

Vanguard’s economic and investment outlook, released earlier this week, says the firm’s experts “anticipate that the modest global recovery will likely endure at a below-average pace through a period of low interest rates, continuing high unemployment and debt levels.”

However, the U.S. may be moving toward better-than-trend growth for the first time since the onset of the global financial crisis, it says. “Our economic outlook, in short, is one of resiliency,” the group said in its report.

U.S. economic growth has been 3.2% on average from 1995 to 2007. For the next three years (2014-2016), this growth is expected to be 2.5% on average, Vanguard says.

Europe’s growth was 2.3% from ’95-’07 and is poised to be just 1.6% in the ’14-’16 period. China’s 10% growth from 1995 to 2007 is coming down to 7% for the next few years.

“Market volatility is likely as the Federal Reserve undertakes the multistep, multiyear process of unwinding its extraordinarily easy monetary policy,” Joseph Davis and a team of experts wrote. “Rather than frame this process as a negative, we view it as an indication of increasing economic strength.”

Overall, the group says it is “uneasy about signs of froth in certain segments of the global equity market” and encourages investors to “exercise caution in making strategic or tactical portfolio changes that increase this risk.”

Vanguard says its outlook for global bonds is muted, but it is boosting its 10-year median nominal return of a for a globally diversified fixed-income portfolio to 1.5% to 3% range versus last year’s 0.5% to 2%.

The group expects “the diversification benefits of fixed income in a balanced portfolio to persist under most scenarios.”

“We believe that the prospects of losses in bond portfolios should be weighed against the magnitude of potential losses in equity portfolios,” it added, “because the latter have tended to exhibit much larger swings in returns.”

Portfolios with 60% stock and 40% bond allocations can anticipate returns of 3% to 5%, adjusted for inflation over the next 10 years.

Source: ThinkAdvisor

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Will the U.S. Bull Market Continue?

By Reuters

What are the odds that the U.S. stock market's bull run will continue?

Despite last year's record rise - the S&P 500 and Dow Jones industrial average both closed at all-time highs - it does not always follow that one good year will be succeeded by another. The stock market is often roiled by irrational fears, bubblicious greed and a constantly boiling pot of earnings reports.

Yet many pundits predict that corporate earnings and the global economy will continue to expand, so stocks may have another good year. Just don't invest thinking you will see a repeat of the 26 percent return the S&P 500 Index posted last year.

A little historical perspective on 2013 may be in order. The most comparable year was 2003, when the S&P Index returned 26 percent. Going back further, you would have to revisit the nifty '90s to see better returns: big stocks were up nearly 27 percent in 1998; 31 percent in 1997 and 34 percent in 1995.

What did those years have in common? Relatively low inflation and consistent economic and employment growth. If you see these trends continuing in 2014, odds are your portfolio will benefit.

A continuing bull market will favor investors with broad-based exposure to stocks in the United States abroad.

One nagging concern harbored by market skeptics is that the rally could be interrupted at any moment by some unforeseen gremlin. Rising interest rates could be a negative influence. Since the stock market hates uncertainty, this is always a worry.

Again, history provides some guidance. The average bull market lasts for 61 months, based on market data going back to 1932, according to David Larrabee, writing for the CFA Institute's "Enterprising Investor" blog, an organization representing chartered financial analysts.

The current bull market - stretching back to March 2009 - is right around that average duration. Does that mean that when the rally hits a half-decade it automatically hits the brakes? Not necessarily.

For one thing, some rallies have gone on much longer than the current one. The largest sustained gains since the onset of the Great Depression were from December 1987 through March 2000, netting a 582 percent return over 12 years, according to Larrabee. (A distant second in bull surges was from June 1949 through August 1956. This post-war rally saw a 267 percent run-up over seven years.)

Another positive lesson from history is that most of these barn-burning rallies came after huge, gut-wrenching declines. Stocks rebounded after investors went through major bouts of discouragement - the "Black Monday" crash of 1987; the dot-com bust of 2000; World War Two; and the crash of 1929 and subsequent Great Depression. While it can be argued that we are still suffering a low-employment hangover from 2008, the market may still move ahead in a marginally improving economic environment.

The most important insight is that you can rarely predict the start or the end of rallies. Who would have thought that some of the biggest returns would have been recorded in the 1930s?

There is only one guarantee in all of this rearview mirroring: You can't reap stock returns if you are not invested or are waiting for "confirmation" of market signals. Some of the best periods to invest are when the general business news is negative - or just plain boring.

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Opportunities Emerging Markets

By Tom Lydon, ETFTrends

The developing economies have slowed down over the past year, but investors shouldn’t dismiss them just yet. Reforms and policy changes could help bolster some emerging market stocks and exchange traded funds.

Kristoffer Stensrud, the founder of Norway-based Skagen AS, which has outperformed funds run by Goldman Sachs and JPMorgan Chase over the past decade, believes that a series of elections in some emerging countries this year could led to economic reforms and stability, reports Ilana Friedman-Schroit for Bloomberg.

“There’s an election cycle starting this January in Egypt, India, Indonesia, Thailand and South Africa,” Stensrud said in the article. “South Africa is interesting because of the social unrest over the past year. They may be more committed to statutory reforms and we might see a change of policy or a change in government.”

Developing economies can still generate above-average returns as a growing middle class demands a higher standard of living. For instance, the rise in discretionary spending should help boost car sales.

“Cars in emerging markets are very interesting because penetration is low, demand is very high and affordability is rising sharply,” Stensrud added. “This gives these companies fantastic possibilities of growth.”

ETF investors can gain broad exposure to the emerging markets through the Vanguard FTSE Emerging Markets ETF (NYSE: VWO) or the iShares MSCI Emerging Markets ETF (NYSE: EEM).

“Emerging markets fundamentals are actually stronger now than they were in the past, and they are certainly stronger than developed-market countries, especially if you factor in the policy room for maneuver,” Stensrud said.

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S&P SPDR Emerging Markets Dividend (EDIV) is a component of the D2 Capital Management Multi-Asset Income Portfolio.

Disclosure: I own the D2 Capital Management Multi-Asset Income Portfolio. I also own Vanguard FTSE Emergeing markets (VWO) in my personal account.

The views expressed here are that of myself or the cited individual or firm and do not constitute a recommendation, solicitation, or offer by myself, D2 Capital Management, LLC or its affiliates to buy or sell any securities, futures, options or other financial instruments or provide any investment advice or service. D2, its clients, and its employees may or may not own any of the securities (or their derivatives) mentioned in this article.