Stevens Foster Investment Updat e
Stevens, Foster Financial Services, Inc. Registered Investment Advisor
7901 Xerxes Avenue South, Suite 325, Bloomington, Minnesota 55431
www.stevensfoster.com
stevensfoster@stevensfoster.com Ph: 952.843.4200
Toll Free: 877.270.4200
2014 THIRD QUARTER MARKET PERFORMANCE
The U.S. economy has re-emerged as a growth leader, while the rest of the world economy
is operating at a sub-trend rate. In Europe, the possibility of a double-dip recession has
given way to the prospect of protracted stagnation, with the European Central Bank needing
to be identified as the buyer of last resort. In Japan, the spurt of nominal growth has
stalled, and another dose of stimulus is needed to sustain reflationary momentum. In
China, the cyclical progress in the economy can be best described as “two steps forward,
one step back”, with the authorities trying to juggle both reforms and growth at the same
time.
We believe the lack of re-leveraging in the developed world economy will undercut strength
in demand, and de-leveraging will continue to create over-savings around the world. As a
result, continued monetary reflation will be necessary to sustain growth momentum.
Reflective of the uneven global growth environment, monetary policy cycles between the
U.S. and the rest of the world will remain out of sync. Our bet over the coming years is a
more volatile market that eventually steps sideways for longer than most think.
We remain overweight U.S. equities and as the markets move higher we will begin to sell
our more volatile small-cap allocations. Our strategy as global markets trend lower is to
own more international developed, in particular Europe as the ECB gains favor to establish a
true quantitative easing the U.S. experienced over the past 4+ years. Over the coming
months we expect to tactically overweight towards Europe due to cheap valuations and a
healthier household balance sheet relative to GDP than in years past.
Our underweight fixed-income allocation changed significantly in the quarter by reducing
interest rate and credit risk with the sale of our high-yield bond allocation and swapping into
a more conservatively run strategic income fund with lower interest rate sensitivity and a
management team who’ve worked together for almost 25 years through numerous interest
rate cycles.
Market Index Performance – 3rd quarter 2014:
Our tactical underweight to fixed income in the more conservative model portfolios hurt our
returns in the quarter for the Income with Growth and Capital Preservation model portfolios.
We regard the cautious stance in our conservative allocations as prudent given the concern
we have with historically low interest rates.
What are our concerns going forward?
The U.S. Federal Reserve will continue to issue $60 to $65 billion of U.S. treasuries on a
monthly basis. This effort is tied to the Federal Reserve’s long-term plan to pay down our
massive $17+ trillion of debt and “hope” the stimulus put into our financial system will
begin to generate real growth through broader bank lending that parlays into higher tax
revenue to pay our national debts. To put this into context, the amount of “printed” money
over the past 5 years is valued at almost 2x times annualized U.S. GDP. In our opinion, this
grim fact will only become more evident once interest rates begin to rise, thereby increasing
the cost to pay down our obligations.
In the interim, monthly U.S. treasury auctions take place to finance our U.S. debt, which
are principally bought by two buyers today. Over two-thirds are bought back by the U.S.
Federal Reserve who initially “printed” the refinanced debt and one-third by foreign entities
and essentially none of it by U.S. financial institutions or consumers. The two-thirds buyer
is going away, if you believe what U.S. Federal Reserve Chair Yellen says. A portion of that
other one-third is China who is now shifting reserves to stimulate growth. Another is
Europe, which has little need to balance currency reserves and a set of emerging market
economies that would rather see interest rates in the U.S. go higher, hence strengthening
the U.S. dollar and buying power to accelerate emerging market exports to the U.S.
In the fixed income arena interest rates will move higher; the question of concern is how
fast and how long. Once the Federal Reserve stops QE, volatility could ensue. Historically,
absolute low levels of interest rates, such as the current term structure we are experiencing
today, have meant that there is room for the stock market to climb higher due to
exceedingly low risk premiums. We consider this to be the case today and believe the
market will do so if earnings in the second half of the year justify maintaining the historical
highs in corporate operating margins and the ability to continue to find absolute low, but
modestly higher levels of financing.
Our tactical plan today, after selling portions of riskier fund weightings in our portfolios over
the past year and investing back into “less correlated” allocations, places us in a position to
weather the potential volatility in the market. Higher equity markets would warrant us to
sell portions of our overweight U.S. equity position. Lower averages and more volatile
markets would have us allocate to our underweight international developed positions, in
particular, Europe.
The next five years will NOT be like the last five. We have discussed with our clients our
focus on finding “less correlated” investment objectives from time-tested fund managers
that can generate modest returns into a bullish equity market and protect the downside with
either absolute positive returns or generate less loss than the broader market averages.
We continue to work closely with your Client Account Manager to communicate our efforts
and welcome queries and perspectives on the markets and our work.
– Jon Horick, CFA, CPA, Vice President, Investments, October 10, 2014
“The Stevens Advisor” is a market update from sources deemed reliable, but Stevens, Foster Financial Services, Inc. does not make
any warranties of its accuracy. The opinions and forecasts are those of the author and are subject to change without notice; no
representation is made concerning actual future performance of the markets or economy. The opinions voiced herein are for
general information only and are not intended to provide specific advice or recommendations for any individual. Past performance is
no guarantee of future results.