The Cornerstone Investment Commentary: 1st Quarter 2015
What a topsy-turvy first quarter … down in January, up in February, down again in March. If there’s anything to say in its aftermath, one theme would be that it clearly illustrated the benefits of diversification.
Here’s why. In broad terms, we allocate your portfolio among eight major categories: For equities – U.S. large company, U.S. small company, foreign developed countries, foreign emerging markets, real estate and commodities; in fixed income – both intermediate-term and short-term bonds. No matter the time frame, especially with the equities, some always do better than others. (Put another way, there are always some we’d have done better without – the ‘curse of diversification’!) A key is whether (one believes) predicting the ‘winners’ matters. For people who do the things well that they can control – like living within their means, saving for the future, doing savvy tax planning and preparing for life’s unknowable but inevitable contingencies – it does not. We call this planning-done-well. And it doesn’t require a crystal ball.
Last year, your largest equity category – though not 100% – was also the ‘winner’. (The smallest allocation – zero – was to the biggest ‘loser’.) So far, this year’s ‘winners’ – including foreign equities which gained about 5% – were in last year’s bottom half. How has 2014’s winner, the S&P 500, fared? Solidly in 5th place of the 6, gaining less than 1% so far. Why is this?
Partly, it’s a victim of its own success. U.S. market levels, propelled to record highs and valuations by record profits, need these to at least be sustained to spark further gains. Furthermore, despite low energy prices, a stronger dollar has put a damper on profit growth. We’ve even seen announcements of layoffs popping up again. (Here in Minneapolis, Target Corp. recently announced such a major restructuring.) Of note, U.S. small-cap stocks, which generally don’t do as much business overseas, fared better this quarter.
And foreign stocks? It’s all about the dollar making their goods less expensive in dollars (plus lower energy prices, the bond-buying program of their central bank, more attractive stock valuation levels and a growing recognition that ‘austerity’ hasn’t helped.) In sum, profitable companies trading at good values.
As for bonds, conditions of below-target inflation paired with the slack remaining in the labor market bodes well for your holdings of ~80% short-term corporate bonds (which pay a bit more interest) and ~20% intermediate government bonds (which do well when both interest rates and stock markets fall).
In short, we believe your portfolio is well-positioned given the environment at-hand. And as always, we both welcome and look forward to any thoughts or questions you may have. We wish you a pleasant lead-up to this year’s summer and as always thank you for the continuing opportunity to work together.