1Q 2015 Market Commentary

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Market Commentary
By The Deighan Team

In the late 1960’s I used to race home from school to watch my favorite show, the serial Dark Shadows. While it was a far cry from classy Downton Abbey, I loved it. It was a cheesy drama filled with constant surprise and impossible leaps of faith in plot. The screen writers must have had a ball coming up with the story line. Today, as testimony to its shallowness, I cannot recall even the barest detail of the story line, but I do recall the excitement of wondering “What will happen next?” Sometimes as I report the quarterly goings on in the world markets, I wonder if clients and friends have the sense of watching a serial. While I know I can’t compete with Downton Abbey, certainly there are enough twists and turns in the quarterly market story to keep us engaged.

In the spirit of a true serial, here is a brief re-cap of the previous episode. In 2014, we experienced plenty of market ups and downs, but overall, we hailed a recovering US economy as evidenced by solid returns for US stocks. At the same time, we cast worried eyes across the pond at negative market returns and continued economic strife in Europe. Wringing our hands we wondered, “Would the Eurozone woes and worldwide lethargy spread and derail our recovery?” We hoped not. Perhaps as a measure of our strength, the US dollar soared against most other currencies in 2014, but it hit our statements hard driving the returns of most foreign securities further into negative territory. On the fixed income side, despite record low interest rates, and a strong indication from the Fed that rates would be heading up, the ten-year US Treasury note defied gravity and delivered strong results for the year. This was a curious result since rising interest rates will mathematically result in lower bond prices. Apparently, this did not matter to investors worldwide as they plowed their funds into what appeared to be the safest place possible: US government securities, driving up bond prices. Meanwhile, back at the ranch, New Englanders were cheering the falling oil prices while the US western oil boom was under serious pressure due to oil price drops. How would this affect our US growth prospects in 2015? Would consumers find more discretionary income in their pockets due to lower gas and home heating fuel prices and spread the wealth? Or would the inevitable layoffs that must follow the dip in US energy firm revenues take a greater toll on the economy?

Let’s fast forward to March 31, 2015! First, stock market volatility continued to provide alternate groans and gasps throughout most of the first quarter giving way to new trends for 2015. The chart below is a continuation of the chart shown in the 2014 year-end Market Commentary with a column added showing investment results for the first three months of 2015. Note the strong first quarter showing of Mid-cap and Small-cap US equities versus the larger US companies, many of which are large multinationals that have business holdings worldwide. Perhaps the balance sheets of those multinationals were negatively impacted by the strong US dollar. Further, note the strong comeback demonstrated by international stock indices. Remember, the first quarter 2015 results cover only a three month period compared to an entire year’s result. Furthermore, since these results are converted to dollars instead of reported in local currency, the international index results are stronger than they appear. The point is, markets move quickly and yesterday’s underdog can become tomorrow’s star, hence asset class diversification remains key.

Asset Class Representative Index 2014 Return 1Q15 Return
US Large Cap Equity S&P 500 Index 13.69% 0.95%
US Small and Mid-cap Equity Wilshire 4500 Completion 7.94% 5.28%
Developed Int’l Equity MSCI EAFE (Net) -4.90% 4.88%
Emerging Int’l Equity MSCI EM (Net) -2.19% 2.24%
Alternative Equity HFRX EH Eq Mkt Neutral 3.63% 1.69%
Hard Assets Bloomberg Commodities -17.01% -5.94%
Broad Fixed Income Barclays US Aggregate 5.97% 1.61%
Cash Equivalents BOA/Merrill Lynch T-bill 3mo 0.03% 0.00%


So, what’s next? Continued growth in the US stock market is generally considered likely, but given the energetic run up of 2014, US stock valuations are somewhat high. The MSCI US Composite shows a quarter-end normalized price to earnings (P/E) ratio of 23, far above the mean P/E ratio of 16.3 from 1969 to date. Thus, it is best to temper our expectations to slower growth in the US stock market. On the other hand, valuations of developed foreign equities excluding the UK were far less puffy with a P/E of 18.4 compared to a mean of 15.6, and the UK appeared even more approachable at 12.9 right on the mean P/E of 12.9 for the same time period.

The global disinflation triggered by the immense drop in oil prices in 2014 will continue to cut two ways. Importing countries such as China and the US will benefit from reduced energy costs for consumers and businesses. Exporting countries such as Russia, Brazil, and Venezuela are negatively impacted. Similarly, the strong dollar has winners and losers. The US consumer has more international buying power, but large multinational companies will continue to see downward currency adjustments on their foreign operations.

We’ve seen a dramatic decrease in US Treasury yields with the ten-year Treasury Note dropping from 2.73% to 1.94% from March 2014 to March 2015. US Corporate bond yields dropped from 3.10% to 2.91% while US high-yield (lower grade) bonds inched up from 5.23% to 6.18% over the same time frame. Meanwhile, the Fed has wrapped up the first part of their pledge to return to interest rate normalcy (a faint memory in the distant past), and has stopped the quantitative easing program. An active increase in the Fed Funds rate is in the forecast for this year. While the Fed has promised to be patient and to avoid raising rates until they believe the US economy can stand it, we will likely see a rate hike in June or September of this year.

The recent disappointing jobs report was an interesting exercise in market reaction to the push pull of news. When the report became public, the stock market dipped several hundred points. Foreign markets followed suit as they worried we may be slipping out of our recovery mode. Then, over the Easter weekend, the news was digested and calmer views prevailed. The lower numbers could have been the effect of the brutal Northeast winter, the likes of which we are all hoping we will not see again for a while! However, the bad jobs number could have been the effect of lower oil prices causing layoffs in the mid-western and western energy companies. Whatever the reason or combination of reasons for the bad jobs number, the Monday market rebound was swift. Apparently the perceived silver lining of the bad jobs report that caused the rebound was a consensus that the Fed would now delay a rate hike until September. Eventually, higher rates will prevail, and we must be prepared for it.

As I look back over this market commentary, it occurs to me that some might ask, “Wait, is this a re-run?” In some respects it may appear to be as the over-arching themes relative to investing remain constant: diversification, rebalancing to maintain diversification, valuation analysis for security selection, avoidance of market timing, expecting volatility, and holding firm over the rough patches. Truly, there is nothing new under the sun. However, the timing of the predominant themes is difficult to predict, and thus we remain engaged as the stories unfold. And so dear reader, that’s the way it is… until next time!