January 15, 2015
Investment Review and Outlook
2014 was a year of broadening economic recovery but narrowing financial market progress. The U.S.
economy showed encouraging signs of improvement including accelerating job gains and better GDP
growth. However, as reported by the Financial Times, “very few sectors and an unusually small number
of individual [very large cap] stocks accounted for the bulk of the S&P 500’s return”.
The S&P 500 was up 13.7% in 2014, but as indicated by the FT, that number belies the investment
challenges of the past year, the most notable of which were as follows: (1) the small and mid cap sectors
which usually deliver better results than large caps trailed the S&P 500 by the largest margin in 15 years,
(2) defensive sectors uncharacteristically outperformed growth sectors, (3) the falling price of oil and
agricultural commodities weighed on energy and agriculture related stocks, and (4) the stronger U.S.
dollar pinched the earnings and stocks of various companies. Notwithstanding the various challenges of
the year, our diversified investment approach enabled us to achieve a satisfactory result.
The following is a summary of our 2015 outlook:
1. The U.S. continues to have the strongest economy and financial markets in the world. In the
U.S., GDP will probably grow between 2% and 3-1/2%, while inflation will likely stay below 2%.
Corporate earnings should continue their upward trend and the employment picture should
further improve. Equity valuations may fluctuate more this year, but the current valuation
range should be sustainable.
2. The U.S. economy and markets will benefit from four key factors: (a) the Fed’s ongoing
accommodative monetary policy, (b) the decline in the price of oil, (c) the stronger U.S. dollar,
and (d) improving business and consumer confidence. The stronger dollar and lower oil prices
are both net positives, but both have underlying cross-currents. The stronger dollar is a boon
for consumer buying power; however, it is likely to create some headwinds for export
businesses. Lower oil prices are like a tax cut for consumers and many businesses, but these
price declines will reduce profitability in much of the energy industry and related areas.
3. Although there have been real improvements, there is still too much slack (i.e., excess capacity
relative to demand) in the economy; and the recovery remains sub-par. This is evidenced in part
by the ongoing low supply and demand for new credit, the continuing absence of wage
pressure, and the still subdued housing market. Consequently, in light of these factors – and the
economic slowdown in the rest of the world – U.S. interest rates may stay lower for longer with
a shallower eventual upward path as the Fed does not want to impede growth or contribute to
disinflation or deflation.
4. The Euro Area will have very low growth with mild deflation in 2015. EU GDP growth is likely to
be 1% or less. Europe remains a political-economic “house divided” that is still unable to
implement effective counter-measures to its economic problems.
5. Japan will also have soft economic growth this year. The economy is not likely to respond
significantly to government stimulus policies due to longstanding and deeply entrenched
structural problems.
6. China will have solid but slowing mid-single digit growth. The Chinese are attempting to reduce
credit excesses and are working through various imbalances as they continue to transition from
an infrastructure/export economy to a more consumer/domestic model.
7. Emerging markets are still dealing with deteriorating economic growth and corporate earnings.
Weak commodities prices are a significant challenge for many of these countries due to lower
global marginal demand, especially from China.
8. The forces that kept bond yields down in 2014 will persist in 2015. Deleveraging continues to be
a significant factor throughout the world. Consequently, high quality dividend-paying stocks
should remain an attractive alternative for investors seeking income.
9. Geopolitical risks will be concentrated in oil related economies. Russia is a particular focus of
concern given its unique combination of oil dependence and foreign policy assertiveness. Other
petro-states to watch more closely include Saudi Arabia, Iran, and Brazil. More broadly, Chinese
regional muscle-flexing, North Korean provocations, and Middle Eastern strife will remain
potentially destabilizing forces. Finally, it will be important to monitor both U.S. and Eurozone
politics in connection with their respective political-economic governance issues.
10. The Fed may begin to raise short-term rates by mid-year, but any hikes will likely be very
gradual, and the economy and markets should take them in stride. It is also distinctly possible
that the Fed will wait longer than is generally expected before taking any action. Additionally,
long-term rates may stay lower for longer (whether or not the Fed takes action), reflecting a
persistent low growth, low inflation, and low return global environment for the foreseeable
future. In sum, this would suggest a 2015 stock market that continues to grind upward for
moderate overall gains, but with greater volatility over the course of the year. This is an
environment in which equities will remain the best asset class and investment strategies that
balance risk and reward will deliver reasonable long-term returns.
Since 1977, our business has grown primarily by referral. Broadly speaking, our two basic goals are to be
astute investors and to focus on individual needs. Please keep us in mind if you know anybody who
would benefit from joining us. We would like to take this opportunity to wish you and your family a
happy, healthy, peaceful, and prosperous 2015.