The unusual continues…as usual


The movement of the Dow and S&P stock indexes would lead one to believe the economy is doing great one day then collapsing the next.  We have seen volatility in this particular area of the equity markets like never before.  Any good news on the economy leads to a down day.  The reverse is true for any bad news.  The motivation for the seemingly contradictory movements resides in the future course the Federal Reserve will take on interest rates.  If the economy is performing poorly, the investment world believes the Fed will keep interest rates low for a longer period of time.  The opposite occurs on good economic news.  While the bond buying plan known as “quantitative easing” ends in October, the outlook remains for low short term interest rates well into 2015.

The equity markets have fallen in line with our thoughts going back over a year.  The large cap US stocks have done very well.  This can be seen by looking at the P/E ratios for the S&P index.  The norm for this index is a price/earnings multiple of approximately 15.  The current ratio is near 25.  We believe this is because of investors need for return going back to early 2013 when CD rates were, and still remain, quite low.  The small investor decided to look for 2 – 3% dividend return with the potential for growth versus any purely interest bearing holding.  This is reinforced by the fact that the rest of the US equity market is relatively flat this year.  The divergence between large cap US stocks, up nearly 10%, and mid to small cap stocks, which are near zero this year, is quite unusual.  We have been selling portions of client large cap positions and moving to smaller cap indexes as this disparity should eventually close.

One other area of movement has been in the emerging market indexes.  We made a move to balance out our equity exposure to a more equal level between domestic and international several years ago.  This was due to the fact that 60% of the world economy occurs outside the US.  We also moved a little more aggressively toward the emerging markets for long term investment growth.  This is currently paying off as the emerging markets have gained nearly 10% this year.  While domestic growth has increased, many emerging market economies are growing at 2 – 3 times our growth.

The interest rate picture remains murky.  Chairwoman Yellen is continuing to push for low short term rates as her perception is that the domestic economy is still on shaky ground.  We have seen a slight uptick in the longer term rates but nothing that will pull investors away from dividend stocks.  We remain relatively short in interest bearing maturities, looking for reasonable yield until the rates move higher.  While most of us see inflation on a daily basis, the tools used by the Fed and the government to report real inflation are manipulated or excluded, as in food and energy, so that their definition produces a lower figure.  This is the justification for maintaining low rates.  With that being said, we would also point out that, in the history of the Federal Reserve, they have never tightened credit either too soon or on time.  We believe history will probably be repeated.  In addition, they have stated that their new method of tightening, whenever it occurs, is new and totally untested.  With six years of the great Keynesian monetary expansion experiment and an untested control mechanism for the future, it is difficult to have a great deal of confidence in their ability to produce stable and sustainable growth.

We have mid-term elections coming soon.  Regardless of political persuasion, everyone should be urged to vote.  This is our individual expression of how we believe the US should be governed.  It is a privilege not accorded throughout the world and part of a great democracy.  We appreciate your business, are here to help every client meet their financial goals and are available to assist with any questions you may have.

Sincerely,

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Larry Miller


Third Quarter 2014

Q3 2014 Q2 2014 Q1 2014 Q4 2013
S&P 500 1.13% 5.23% 1.81% 10.51%
MSCI EAFE -5.88% 4.09% 0.66% 5.71%
Barclay’s US Agg Int Term Bond 0.03% 1.62% 1.20% -0.14%

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