A Rough Start
The new year got off to a rough start. US economic growth slowed and employment data disappointed, prices fell in the Eurozone again and there are concerns that it may start to lose members, and several large emerging markets are struggling. In 2014, the growth of the US economy helped to drive global growth, but investors recognize that is not sustainable. With the US dollar getting stronger and European demand drying up, US companies are finding fewer foreign buyers for their goods and services.
The European Central Bank (“ECB”) is concerned about declining prices and economic stagnation in the Eurozone. In particular, falling prices are a negative sign for the Eurozone economy. Lower prices sound like a good thing, but they are accompanied by lower wages, smaller profits, and debts getting more expensive. In January, the ECB followed the lead of the US Federal Reserve and, more recently, the Bank of Japan, and announced a stimulus program of bond buying that is supposed to last until September 2016. While investors expected the ECB to take action eventually, this program was more significant than they expected and the European stock markets saw a small boost as a result.
As a whole, the Eurozone is struggling to pull itself out of an economic slump, but those countries that were bailed out in recent years (e.g. Greece, Spain, Portugal, etc.) are still suffering much worse. Greece finally decided that its economic condition was unbearable and elected the leftist Syriza party, which promised to renegotiate the terms of the country’s bailout. Syriza’s landslide win made it clear that the Greek people are united behind this plan, but the European Union and the ECB are assuming a tough stance in the negotiation. While the terms of the Greek bailout were harsh and could be relaxed without assuming too much risk, would the other bailout countries decide to pursue similar renegotiations? At this point, analysts think that Greece will get a small concession in the negotiation—just enough to keep it from leaving the European Union—but not enough to encourage the other bailout countries.
Oil and gas producers are still struggling with prices stuck below $50 per barrel. While the largest producers are making sensible cuts and preparing for an extended period of diminished profitability, smaller producers find themselves in a more difficult position. Many of these smaller producers borrowed heavily to finance their growth. That may have been a sound strategy when oil was selling for more than $100 per barrel, but the current price means that their profit margins are perilously thin. In the US, only one of these companies has defaulted in the past six months, but 19 companies have been downgraded by the ratings companies and that number will increase in the coming months. If more of these companies default on their debts, the financial sector and bond holders will feel those effects too.
Emerging markets started to stumbled last summer and have not regained their feet. Obviously, Russia is still suffocating under the economic sanctions imposed after its aggression in Ukraine, but Brazil and China are also in difficulty. Brazil is on the verge of a recession and announced that it will run its first budget deficit in more than a decade, and China is still sorting out its credit crisis and its manufacturing is at its lowest output in nearly 3 years.
In January, US Stocks have changed direction by pulling back nearly 3%. It is easy to start expecting the strength in stock returns to continue and lose sight of the potential risks for this volatile asset type. Conversely, the majority of our portfolio models held their ground, with the lower risk strategies actually making small gains in this difficult market. Months like this demonstrate the importance of using other investment types to balance risk and return. Some of the more specialized assets that we utilize have provided gains that would not have been available in a “traditional” portfolio of stocks and bonds.
- Our allocation to US Small (VB) and Mid cap stocks (VO) was beneficial as these investments fell less than Large Caps (IVV)
- Internationally, stocks were much more resilient than in the US offering stability in our portfolios during January.
- US bonds benefitted from the decline in US stocks. With the exception of high-yield bonds (SJNK), the rest of the US bond category posted gains in January.
- High-quality and long-term bonds were the strongest performers for the month, where US corporate bonds (VCIT) and US TIPS (TIP) did exceptionally well. Our decision to focus on high-quality bonds continues to serve investors well.
- Foreign bonds were not so fortunate. The ECB’s announcement did not encourage the European bond markets. We reduced our exposure to foreign bonds at the beginning of the month and that limited the impact of these declines.
- Hard Assets were lifted by precious metals (GLTR) and real estate (RWO). As the top performing asset classes in January, they were able to balance out commodities (DBC) and master limited partnerships (AMJ), which continue to struggle along with low oil prices. Our increased real estate exposure continues to provide benefit to the portfolios.
- Hybrids managed to hold their ground in January. Convertible bonds (CWB) saw a small decline, which we would expect in a month when stocks fell, but Preferred Stock (PFF) posted a considerable gain for the month. Hybrids have been consistent performers in the portfolios and helped to manage the volatility in January.
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