Given where the markets are, the geopolitical uncertainties, and the need for future planning we thought we would share with you some of our thoughts.
This year started off exhibiting not only a strong market, but a good economy that justified it. While unemployment has been declining at the slowest rate in recent memory, that is in part due to the fact that business was forced by the “Great Recession” to tighten the belt and learn how to run far more efficiently. That “lean and mean” approach enabled good businesses to survive in the face of meltdowns that threatened the auto industry, the near collapse of the European Union, a U.S. legislative branch that thought (and perhaps still thinks) their political gamesmanship is more important than jobs, the economy, or the markets, etc. Because the markets had weathered all of that, optimism had pushed the markets to record highs by mid-year. But that efficiency has also meant that fewer workers were needed as the economy recovered – that’s the downside.
For the past several weeks, the market has been more volatile. The S&P dropped around 3.5%, then jumped back up a bit. Who knows what the future will bring. Yet with the churning of the markets the past several months, PIN made a decision in early July to rebalance our Conservative Portfolio to be a little more cautious (as explained in our email at that time). Nonetheless, as we study our most trusted sources of economic information, we foresee
- continued strength in the U.S. economy
- weakness in the European economy, only in part due to the standoff between the EU and Russia
- continued stimulus by China’s central bank as part of its effort to convert to a more consumer oriented economy
- a brightened outlook for Japan
- rising potential for inflation
- rising pressure for the Federal Reserve to increase interest rates; our most trusted source believes the Fed’s Quantitative Easing will end by October and that they may begin lifting the Federal Funds Rate by around March
So, where does that lead us in our investment strategy? Continued U.S. economic growth provides upward pressure on the equities markets. Potentially adding to that upward pressure could be rising interest rates that could trigger a flood of money out of intermediate- and long-term bonds next year. Where would that money go? Potentially into equities. On the other hand, the European situation could place a damper on the U.S. economy. Between Europe, threats of terrorism and the fact that the markets are near record highs, taking an all-out growth stance might be too aggressive. We expect the current volatility to likely continue. Any major geopolitical incident could trigger an equity sell off. Hence, we’ve chosen to take a moderate position, anticipating a continued long-term up market, yet hedging our portfolio to protect against serious harm if the market decides to dip. Since the date of our rebalance, July 11, 2014, our benchmark (the average balanced fund) experienced a peak to trough loss of 2.5%, whereas PIN’s flagship Conservative Portfolio declined only 1.7% net of fees (the broader market, as measured by the S&P 500, lost 3.9%). PIN’s expertise in managing risk of loss continues to benefit our clients. Of course, there is no guarantee that any investment strategy will ensure a profit or protect against losses and past performance is not a guarantee of future results. The information provided is general in nature and shouldn’t be considered investment advice or recommendation to buy or sell any securities or security product.
The market subsequently offset its losses such that (from the July 11 date of the rebalance through August 25) the benchmark is now up 0.9%, whereas PIN’s Conservative Portfolio is up 1.2% (net of fees).
How are we responding to the risk of rising inflation and interest rates? Rising inflation and interest rates primarily impact “interest-sensitive” securities such as intermediate- and long-term bonds, utility stocks (and other stocks owned largely for their high dividend yield), real estate and anything else that reacts negatively to rising interest rates.
On the other hand, instruments that can be useful during periods of inflation or rising interest rates include
- short-term bonds,
- adjustable rate bonds,
- inverse bond funds that behave as a mirror image of longer-term bonds, rising (rather than falling) in value as interest rates rise, and
- managed futures funds (that can take the “contra” side of bond and interest-rate transactions to also benefit from rising interest rates).
In summary, PIN feels the U.S. economy will continue to strengthen, inflation will soon begin to make itself felt and interest rates will continue to rise (which actually started in May 2013). We have already taken some action in anticipation of these changes and will remain vigilant and prepared to act as the markets adapt to changing conditions.