Good US Consumer

Stocks haven’t had the greatest start to 2015.  Regardless, economic fundamentals are seemingly still solid.  Here are 3 charts indicating consumption could be tailwind in spite of the latest retail sales report:

1. The most apparent, oil is cratering and along with it gas prices, giving consumers more funds to spend on retail items they likely don’t need:
   
2. Wages are likely heading higher, so consumers can use that extra income to get that totally unnecessary Apple Watch.
   
3. And less of that increasing income is going to service debt, so maybe sometime soon Americans can go back to the good old days of maxing out their credit cards!
   

Of course none of this means stocks can’t go down.  But historical returns suggests a drawdown of greater than 20% is highly unlikely.

*Please see the important disclosures that apply to this commentary HERE.  The above charts are for illustrative purposes only and do not attempt to predict actual results of any particular investment.

Oil Down, Good

There has been a big fuss made over lower oil prices and they are cratering:

So the logic goes: lower oil prices = less global demand for oil = weaker economy.  Makes sense.  Except in the US lower oil prices = more cash available for other consumer purchases = stronger economy.  And in reality it’s spikes in oil prices, not dives, that correspond with recessions:

Maybe the market is signaling something different this time, but in the past lower prices have been good for the economy and stocks.

*Please see the important disclosures that apply to this commentary HERE.  The above charts are for illustrative purposes only and do not attempt to predict actual results of any particular investment.

Stocks Should be Okay as Long as Economy is Expanding

• According to the chart below, since 1954, economic expansions tend to be a good time to be invested in stocks (SPX = S&P 500*):

• Some observations:
• As the numbers show, we are about 62 months through this one
• It’s right around the average and median since 1954
• Further, there were 4 expansions longer than this once
• The market return has been greater than average, though the market did have a lower bottom than any market prior
• Valuation level was also at a relative low:
  
• And regardless, there have been 2 expansions where the returns were higher
• Anyway, all this says to me that we aren’t in unprecedented territory in terms of length or stock growth in this expansion…
• And while we might be long in the tooth, nothing in the data indicates we are at extreme levels
• But what if the expansion is ending…
• Maybe the expansion ended this month and we didn’t realize it for 6 months (recessions are usually decided after the fact).  Highly unlikely with GDP coming in at 4.2%, but even so the first 6 months of a recession haven’t been destructive for stock market returns, assuming you hold throughout:
  
• Ok, we likely aren’t in a recession now, but what if we start a recession in 6 months?  After all, the common mantra is that markets lead the economy.  Again, while the returns are likely negative:
  
• Altogether Now:
• Expansions yield solid returns for stocks
• It’s likely we are still in an expansion (note: ISM has been in recession once with ISM at 59 or higher):
  
• Even if we are going into a recession, the months leading up to a recession haven’t had a HUGE drawdown (> 25%), despite a likelihood they will be negative
• Thus, as it’s highly probable the economy is expanding there are potential equity returns that outweigh the risk of a drawdown…
• And as a result waiting to pair back your equity exposure until you are certain the economic fundamentals have deteriorated is likely prudent

*Please see the important disclosures that apply to this commentary HERE.  The above charts are for illustrative purposes only and do not attempt to predict actual results of any particular investment.

Euro Economy = Bad; Euro Stocks = Good (maybe)

1. Europe’s economy is going back in the trash as GDP is flat with even all mighty Germany turning negative (see red bars indicating economic growth from the prior period):
   
2. This has been a persistent theme, since 2009 other developed economies – US, Japan, Britain – have grown faster while Europe has stagnated:
   
3. European stocks have reflected this economic weakness as US stocks (SPX on chart below) have returned much more than European stocks (FEZ on chart below) since the end of 2008 (note: the S&P 500* bottom early March 2009, though chart is intra-month making bottom appear to be February 2009):
   
4. However, this underperformance of European stocks has possibly presented an opportunity though as European stocks are now cheaper (note: cheap stocks in general should have more room to grow than more expensive stocks):
   
5. Further, the ECB has yet to institute quantitative easing (QE), but the rumors are swirling.  In the US, QE worked out nicely for US equity markets as each listed program in the chart below resulted in a subsequent move higher in the stock market:
   
6. Thus, if/when the ECB version of QE it could have a positive effect on European equity prices as it did on the US.  Plus the stocks are relatively cheap so there could be some more room to grow.

Caveat: the trend in the European stocks is weak so for the time being caution should be used.

Note:  On 09/04/14 the ECB cut interest rates and may or may not enact quantitative easing later in the day or in coming months.  European stock markets were higher.  This post was written before today’s news.

*Please see the important disclosures that apply to this commentary HERE.  The above charts are for illustrative purposes only and do not attempt to predict actual results of any particular investment.

Why the QE Tapper Matters.

Stocks have gone up with the Fed’s balance sheet, so what happens when the latter is no longer the case?

There are a lot of things that don’t really matter to the markets much of the time.  A short list:

• Geopolitical – the world is always fighting somewhere
• Congress – do they ever get along?
• Data Points – trends > one piece of data
• Analyst Targets – no idea how any of these can be accurate

Not that any of those can’t ultimately change the markets, but I can’t think of a logical reason to sell because country X on the other side of the world might invade country Y on the side of the world.  How does that matter to the US again?

Anyway, I digress.  One thing I do think matters is the quantitative easing tapering (QE).  QE is when the Fed buys longer-term Treasuries to force down rates in attempt to increase lending and subsequently boost the economy.  Its actual impact on the economy can be argued, but from my point of view it has had a large impact on the stock market:

Shown another way:

So what is obvious from the charts is that the larger the Fed’s balance sheet, the higher the S&P 500*.  Further, when the balance sheet didn’t move we had almost a 20% move down in the stock market (red circle).

Anyway, the Fed is “tapering” their purchases.  What was once $80b a month is now around $25b.  They haven’t stopped buying and certainly aren’t selling, but they are cutting back.    So while day to day noise tend to be the headlines, the real focus should be on what happens when the Fed’s balance sheet stops getting bigger?

Please see the important disclosures that apply to this commentary HERE.  See important definition on the S&P 500 at the same link.  The above charts are for illustrative purposes only and does not attempt to predict actual results of any particular investment.  In regard to both charts, Source: S&P 500 - FRED and FED Treasury Holdings - FRED; calculations by CAL and idea via Market Anthropology

Cash is Okay, if You Hold it the Right Way

Don’t be in cash for the wrong reason, be cognizant of all the risks you can, but avoid making investment decisions until they start to materialize…

Investors are holding cash.  Not only that…

• They are holding more than they were a few years ago
• This is a global phenomenon with the US being somewhere in the middle at roughly 36% of assets in cash (40% Global average)
• This is true, regardless of age and wealth
• Paradoxically, younger investors who have a longer time horizon are increasing their cash holdings as much as older investors

(Source: NYT)

Why the apprehension?  Fear makes the most sense.  The amount of things to worried about seems to be endless and evolving, off the top of my head: high frequency trading, Iraq, Iran, Afghanistan, let’s just call it the whole Middle East, Europe is on the brink (as always), Russia is being mean, China’s real estate bubble never goes away, the Fed will tighten and the market will drop, the Fed will stay easy and inflation will be a huge issue, stock valuations are high, we just had a negative Q1 GDP print, Game of Thrones is gone for a year, the Cavs will blow another top pick, etc.

But despite all that, the S&P 500 is up almost 40% since the start of 2013 and positive this year.  Just my guess, but those who have been invested in cash have maybe earned 1%?  I would guess cash people at the start would list those risks as why they are in cash.  Now they would mention those reasons and a rising equity market as to why they should stay there.

Admittedly this is easy in hindsight.  Further, there are legit strategic investment reasons to hold cash, many investors psychologically can’t handle the volatility of the markets (and that’s okay), and/or who is to say that some of those fears won’t materialize?  What is of concern is how those decisions are made, if reading headlines, watching the News, looking daily at your portfolio values, or listening to a Gold infomercial has you moving to cash there is a high probability this move(s) was made for the wrong reason(s).

Naturally, this begs the question of what to do.  I will tackle this working backwards, here is a list of don’ts:

1. Don’t take on more volatility than you can handle – too much risk means you will likely move to cash as soon as the market moves against you, but most of the time this will be noise
2. Don’t be overly reactive – going to cash because XYZ just happened, again most of the time this will be noise
3. Don’t be overly proactive – dismissing everything as noise, when sometimes there are signals that indicate a market shift
4. Don’t Not Have a Plan (sorry for the 2x negative) – pretty much encompasses the prior three

My approach is simple – be cognizant of all the risks you can, but avoid making investment decisions until they start to materialize and always stay hedged against the unknown and those risks which occur quickly. 

Side Note:  We are working on a way to shrink the disclosures.  Hopefully in the future they won’t be as overwhelming. 

The views and opinions expressed herein are those of the author(s) noted and may or may not represent the views of Capital Analysts, Inc. or Lincoln Investment.  The material presented is provided for informational purposes only. Nothing contained herein should be construed as a recommendation to buy or sell any securities. As with all investments, past performance is no guarantee of future results. No person or system can predict the market. All investments are subject to risk, including the risk of principal loss.

S&P 500 Index is an index of 500 of the largest exchange-traded stocks in the US from a broad range of industries whose collective performance mirrors the overall stock market. 

International investing involves special risks, including, but not limited to, currency fluctuations, economic instability, and political uncertainties, not typically present with domestic investments.

Gross Domestic Product (GDP) is a measure of output from U.S factories and related consumption in the United States.  It does not include products made by U.S. companies in foreign markets.

Inflation is the rise in the prices of goods and services, as happens when spending increases relative to the supply of goods on the market.  Moderate inflation is a common result of economic growth.  Hyperinflation, with prices rising at 100% a year or more, causes people to lose confidence in the currency and put their assets in hard assets like real estate or gold, which usually retain their value in inflationary times.

Advisory services offered through Capital Advisors, Ltd, Capital Analysts, Inc. or Lincoln Investment, Registered Investment Advisors. Securities offered through Lincoln Investment, Broker Dealer, Member FINRA/SIPC. www.lincolninvestment.com

Capital Advisors, Ltd and the above firms are independent, non-affiliated entities.

A Plan When Good Things (Rising Equity Market) Come to End

Tailoring downside portfolio risk to an investor’s risk tolerance, goals/objectives, and future cash flows can help reduce the probability the investor will experience a catastrophic loss. 

I last wrote (way too long ago) that hope isn’t an investment strategy when the markets start moving against you, but I failed to give a solution.  A client then wisely asked me to elaborate on the plan we have in place for him, so I walked him through it.

Below is an abridged version of my response.  It outlines his, as well as other clients, portfolio risk management strategy.  Nothing is full-proof, but what this strategy does attempt to do is prevent losses from becoming catastrophic.  This is where panic selling often takes place, compounding the losses. 

By focusing on the client, their risk tolerance, goals/objectives, and future cash flow we can put together a plan that helps reduce the probability of a loss that would have drastic implications for the client moving forward: 

1. Diversification.  By utilizing bonds we can help reduce the downside if equity markets fall.  This smooths returns over the long-run and helps balance the account when stock returns get ugly.  Still, even with diversification returns can be much lower than would be expected given historic returns and volatility…
2. Quality.  We keep the bulk of our assets in Large Cap equities and also allocate more to blue chips in that space.  This minimizes exposure to some of the riskier equity asset classes out there.  So while we may have a muted upside, we believe the downside should also be muted.  Still, the baby can get thrown out with the bath water when the market tanks, so we aren’t done…
3. De-Risk.  We are still bullish on equities now, but what if that changes or we are wrong?  We look for market signals to tell us when we should de-risk the portfolio (e.g. sell equities).  These signals tell us if the market is at a greater risk of a large loss and happen as the market moves down, so we aren’t trying to pick the top, but rather avoid much of the bottom(ing).  These signals have been very good in the past, we have custom models that illustrate this, but there is a chance they could not work…
4. Custom Waterline.  We put together a bespoke cash flow model for our clients, which maps their inflows and outflows moving forward.  From this we can develop a “waterline” – the minimum portfolio value a client can have and may still reach their long-term financial goals.  What this means is that if all the above risk metrics fail we can move to cash on the equity side when this value is met.  Using the waterline allows us to manage specifically to THE CLIENT’S needs and helps increase the probability we keep them financially stable over the long-run.

Ultimately these strategies are in place to protect the downside for the client, and subsequently help give them some clarity.  If we can do that by minimizing the downside risks, the returns should take care of themselves.

The views and opinions expressed herein are those of the author(s) noted and may or may not represent the views of Capital Analysts, Inc. or Lincoln Investment.  The material presented is provided for informational purposes only. Nothing contained herein should be construed as a recommendation to buy or sell any securities. As with all investments, past performance is no guarantee of future results. No person or system can predict the market. All investments are subject to risk, including the risk of principal loss.

While there is no assurance that a diversified portfolio will produce better returns than an undiversified portfolio, and it does not assure against market loss, a diversified portfolio can reduce a portfolio’s volatility and potential loss.

Large cap stocks typically have at least $5 billion in outstanding market value. 

Good Things Come to End, Have a Plan

Hoping and wishing your portfolio will hold up when the market turns negative, and turn it will, isn’t a strategy.  Being prepared is the only prudent way to invest.

The last few commentaries have had a bullish bent, and rightfully so, but it’s important for me to scratch my “always concerned about the markets” itch.

Here is a snippet from legendary investor Seth Klarman’s letter.  The whole thing is great, but below are my favorite parts:

• On the current state of the economy/markets: monetary policy is distorting markets, Fed can change how things look, but not what they are, Europe isn’t any better, not many bears left, unsustainable tech business models. 
• “Someday, financial markets will again decline.”
• “Someday, professional investors will come to work and fear will have come to the markets and that fear will spread like wildfire. The news flow will be bad, and the markets will be tumbling.”
• “Can we say when it will end? No. Can we say that it will end? Yes. And when it ends and the trend reverses, here is what we can say for sure. Few will be ready. Few will be prepared.”

Currently, in light of all this, Klarman returned $4b to investors and is 40% in cash.  He can’t find much to buy as everything has been bid up.  Does that mean the market is destined to collapse at any moment?  No, and Klarman noted that in his letter. 

But what he does say is that markets will decline again.  I wouldn’t bet against that assumption.  Further, he noted that most will be unprepared for such a drop and thus will be very vulnerable when this happens.

Don’t wish, don’t hope.  Have a plan to protect your capital.  That is the foundation of how I approach investing.

The views and opinions expressed herein are those of the author(s) noted and may or may not represent the views of Capital Analysts, Inc. or Lincoln Investment.  The material presented is provided for informational purposes only. Nothing contained herein should be construed as a recommendation to buy or sell any securities. As with all investments, past performance is no guarantee of future results. No person or system can predict the market. All investments are subject to risk, including the risk of principal loss.

Recessions Matter

Despite the lack of correlation between equity markets and economic growth, de-risking before a recession can help investors avoid large losses. 

Sorry for the delay, but have been out of the country only to return and have a presentation to put together.  Luckily the presentation yielded much commentary level material.  The first of which I want to cover is why recessions matter.

Most probably view this as common sense, but the reality is often times the market and the economy don’t run in sync.  For example, the market bottomed in Q1 of 2009, but the economy was still very weak.  Recently, GDP growth for much of 2013 was lower than that of 2012, but the market basically doubled its return in 2013 from 2012. 

Anyway, by and large is that economic forecasting shouldn’t be a huge factor in determining how you allocate your portfolio.  Aside from being terribly unreliable, even when they are spot on the market may behave in an unexpected way.  I agree with that for the most part, except when it comes to recession forecasting.  Here I walk through why:

1. A reduction in corporate profits often leads or coincides with recessions.
2. As one would expect, profit growth is highly correlated with the S&P 500.  Also, that larger market declines happen when earnings fall at or around recessions:
3. Thus, it follows that if economic growth is positive, as it is projected to be, earnings should grow and subsequently the market.
4. But more importantly, if you have a beat on when the economy will slow (and that is very hard to do) you can get out in front of a fall in corporate profits and the subsequent fall in the market.

The takeaway is to use economic forecasts as part of your risk control strategy to move out of stocks before they have a large move down.  But don’t have it be your only piece and certainly don’t go risk heavy because the economic growth is expected to rip as there are other factors at work.  This is a drawn out way of saying “win by not losing big” and seeing storm clouds on the horizon can help with that.

The views and opinions expressed herein are those of the author(s) noted and may or may not represent the views of Capital Analysts, Inc. or Lincoln Investment.  The material presented is provided for informational purposes only. Nothing contained herein should be construed as a recommendation to buy or sell any securities. As with all investments, past performance is no guarantee of future results. No person or system can predict the market. All investments are subject to risk, including the risk of principal loss. S&P 500 Index is an index of 500 of the largest exchange-traded stocks in the US from a broad range of industries whose collective performance mirrors the overall stock market The Dow Jones Industrial Average is a widely watched index of 30 American stocks thought to represent the pulse of the American economy and markets. 

Not Seeing 1929 Today

While a chart comparing 1929 to now is unsettling, digging deeper reveals the risk is marginal, more subdued, and noise to disciplined investor.

A friend of mine asked my thoughts the above chart, which has been popular over the last week.  Naturally when you see our current stock market compared to 1929 that raises some alarm bells, but let me dampen some of those concerns (also see here and here):

1. Chart overlays are relatively common.  I see maybe 5 a week?  This one took off I would suspect given the 1929 comparison.  That doesn’t invalidate the chart, just shows that this isn’t the only chart overlay around. 
2. When looking at the chart, the first thing that came to mind was the scale (see below numbered bullets).  As Jeff Saut notes:  “You can ‘scale’ any chart to do just about anything you want it to imply! In this case, the scale makes the comparison to 1929 with the present stock market chart pattern appear eerie. However, if you index that same chart so that you are comparing apples to apples, the correlation to 1929 disappears.”
3. For arguments sake, let’s say this isn’t just a coincidence and that the market does follow the path implied by the chart.  The 1929 fall was about 50% per the chart, when scaling to today that fall would be almost 20%.  So while it would indicate a bear market, a properly diversified portfolio with some risk control parameters would certainly weather this storm.
4. The 1929 crash was after a near 10 year bull market.  We are 5 years into this bull market and I would guess the euphoria in 1929 dwarfs the enthusiasm for stock now.
5. The 1929 crash was also after a massive leveraging up.  We are currently deleveraging or maybe bottoming there, but certainly not in ramp up mode.
6. Totally different monetary systems.  We were pegged to Gold then and have a fiat currency now.  This means the Fed can create liquidity during market stress if they see fit, which could (and has since 2009) put a floor on the drop.

Is there anything to the chart overlay?  Probably not.  It could be coincidence or perhaps the author was looking for confirmation bias (searching for evidence to support his claim).  While I do think investor behavior tends to rhyme (not repeat), I just have a hard time seeing that in this chart.  And at least on the positive side this is a good reminder there is always risk in the markets.

Hopefully investors didn’t react emotionally to the chart as since it came out the S&P had a nice snapback and is close to flat for the year.  Nothing about the latest pullback indicates there will be a sustained fall in the markets, but if that proves to be false and the chart overlay comes to fruition a strategy to minimize drawdowns likely will prove more useful than the chart.

The views and opinions expressed herein are those of the author(s) noted and may or may not represent the views of Capital Analysts, Inc. or Lincoln Investment.  The material presented is provided for informational purposes only. Nothing contained herein should be construed as a recommendation to buy or sell any securities. As with all investments, past performance is no guarantee of future results. No person or system can predict the market. All investments are subject to risk, including the risk of principal loss. S&P 500 Index is an index of 500 of the largest exchange-traded stocks in the US from a broad range of industries whose collective performance mirrors the overall stock market The Dow Jones Industrial Average is a widely watched index of 30 American stocks thought to represent the pulse of the American economy and markets. 

Stocks Look Good in 2014, but Stay Vigilant

The backdrop indicates the equity market appears to have a low probability of a large drop, but that doesn’t mean positive returns are guaranteed or that investors can be apathetic.

Domestic stocks ripped in 2013 and ended the year strong.  That’s great, but where do we go from here?  I am firm believer that investors should focus on risk, not return.  So let’s quickly analyze three risks to the domestic stock market:

• Fed tightening and rising interest rates can have negative ramifications on the equity market:
• If quantitative easing ends the reduction of “money” in the system will be small.
• The Fed will keep short-term rates very low for some time, perhaps until 2016, as labor markets and inflation remain weak.
• When longer-term interest rates rise from low levels it has been positive for stocks.

• During a recession earnings and valuations fall leading to lower stock prices:
• Currently though, the recession risk appears to be low.  While we look at a variety of economic indicators, let’s focus on the yield curve as history indicates that the last five recessions were preceded by an inverted yield curve (long-term rates > short term rates):

• Valuations are too high especially given the record profit margins:
• We view intermediate-term valuations as high (Shiller PE, Market Cap to GDP, Q Ratio); however, none of these say anything about the near-term.
• Shorter-term metrics indicate we are slightly above average, but nothing alarming.
• We concede profit margins are high, but outside of rising interest rates we struggle to find a catalyst to change that.  
• Further, history suggests that valuations can expand even if earnings fall unless they are at bubble levels (they are not) or a recession is on the way (see #2).

Succinctly put, when looking at the market in 2014 a low recession risk + an accommodative Fed + non-bubble valuation levels = a market that doesn’t appear to have a high probability of a large drop.

Having said that, there are still a few reasons for concern: 

1. The higher level of intermediate-term valuations indicate lower real returns over the next 10 or so years
2. The above premise is wrong, in particular the impact of the Fed and interest rates
3. Something unforeseen

As a result, moving forward it’s important to stay up the quality chain, allocate to absolute return-ish strategies, look outside our own market (international equities appear to have more attractive valuations) and pair back exposure when the market has historically been more susceptible for a large loss.  

The views and opinions expressed herein are those of the author(s) noted and may or may not represent the views of Capital Analysts, Inc. or Lincoln Investment.  The material presented is provided for informational purposes only. Nothing contained herein should be construed as a recommendation to buy or sell any securities. As with all investments, past performance is no guarantee of future results. No person or system can predict the market. All investments are subject to risk, including the risk of principal loss.

2013 and Beyond – The Bad, and The Ugly

Negative ETF Ranking - 2013
9	-1.37% - shares International Treasury Bond ETF (IGOV)
10	-1.83% - iShares S&P GSCI Commodity-Indexed Trust (GSG)
11	-1.98% - iShares Core Total Aggregate U.S. Bond ETF (AGG)
12	-2.00% - iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD)
13	-3.44% - iShares National AMT-Free Muni Bond ETF (MUB)
14	-3.64% - iShares MSCI Emerging Markets ETF (EEM)
15	-6.09% - iShares 7-10 Year Treasury Bond ETF (IEF)
16	-6.73% - iShares Emerging Markets Local Currency Bond ETF (LEMB)
17	-28.33% - SPDR Gold Shares Trust (GLD)

Shockingly, not every asset class went up last year.  I say shocking because usually when stocks are hot nobody really cares what anything else is doing.

Last post I covered the ETFs that finished in the black last year and what we should expect moving forward.  This time I will cover the ETFs that finished in the red in 2013 (with the help of this file).  Again, when looking forward I am using this thesis:

Growth should accelerate and, despite the “taper”, given the benign inflation outlook the Fed should stay accommodative, which would provide a good tailwind to stocks along with a reduction in systemic risk.  Still relative valuations in the US, particularly small caps, are now higher and at or slightly above their near-term average and the prospect of rising interest rates could pose a threat.  On a relative value basis, international markets look attractive where developed market growth should also pick up and while emerging markets face secular headwinds they do appear cheap.  The aforementioned backdrop should cause long quality US interest rates to rise and strengthen the dollar; however, other countries could embark on programs to bring long rates down.

I will again mention the caveat that what I attempt to do is make assumptions (i.e. NOT a price target) based on a more global thesis like the aforementioned and when things change portfolio and thesis adjustments will be made accordingly…

And now, the ETFs that had negative returns in 2013…

• IGOV – 2013:  International treasuries almost finished positive, but alas they finished with every other fixed income asset class.  They did finish the second half of the year very strong with the help of a weaker dollar.  Moving Forward:  While the US is pulling in the reins on QE – pushing our yields higher and bond prices lower – other countries are expected to remain easy or possibly become more accommodative (see Japan’s “success” with their own QE).  This would push their yields lower (or stable) and prices higher, but also cause their currencies to fall and thus washing out any positive.  Thus, an investment that is USD hedged could provide some boost.
• GSG – 2013:  The commodity chart looked a lot like USO last year, but worse as it includes agriculture and precious metals.  Commodities look to be in a range, and while that’s subjective the alternating black (Q1, Q3) then red quarters (Q2, Q4) would appear to validate that.    Moving Forward:  see USO (note: energy and industrial metals make up the bulk of index).
• AGG – 2013:   The pulse of the US bond market had its first negative calendar year return since inception and didn’t break its intermediate-term trend for the last eight months of the year.  Interestingly though it only had one negative quarter (Q2).  Moving Forward:  Assuming interest rates to continue to rise in 2014 it should yield another negative year for bonds.  While it appears interest rates may have hit a secular bottom in 2012, it’s important to remember that bonds hedge against a decline in risky assets (note: this has held as of late with equity markets off their highs and AGG moving up) and that they present much less risk (unless they are high yield or high duration) in terms of large capital loss.  Finding a balance between rising rates and the portfolio hedging benefits fixed income brings should be the goal.
• LQD – 2013:  See AGG, though the Investment Grade Corporate Bond LQD did break its intermediate-term downtrend at the end of the year.  Moving Forward:  See AGG.  There doesn’t appear to be much room for investment grade spreads to compress any further, so outside a 2008 credit event I would think they will have a high correlation with Treasuries.
• MUB – 2013:  Munis were hit harder than their taxable counter parts in 2013 with Detroit’s bankruptcy taking center stage.  While they did recover in the later part of the year, MUB like AGG finished the year below its intermediate-term trend for the last eight months.  Moving Forward:  Quick math, 3% yield on MUB equates to a tax effective yield at the 40% bracket of 5.00%.  AGG has a yield of 2.32%.  So if you are in a higher tax bracket, pick out some attractive munis, ladder them by maturity, hold to maturity, and you get a decent yield with not much interest risk. Note: as interest rates rise prices do fall, so prepare to watch your values drop, but if you hold to maturity you get the face value back.
• EEM – 2013: While EEM finished with two positive quarters and the last three months above the intermediate-term trend (barely), it still couldn’t overcome a poor start to the year as money moved out of Emerging Markets when our interest rates moved up.  EEM is also over 60% below its 2008 peak.  Moving Forward:  Even more so than developed markets, emerging markets appear to have an attractive relative valuation to our market.  Much of this is likely due to some longer-term demographic and geo-political issues and is especially true of the ones that got beat up last year (Russia, China).  Further, a sharp rise in US interest rates could continue the capital flow out of emerging markets.  Thus, while there are opportunities for upside until the trend reverses it’s hard to have much conviction.
• IEF – 2013: See AGG.  Moving Forward:  See AGG, though I think it makes sense to take a more tactical (over and under weighting when the market dictates) approach to the 7 – 10 year Treasury space.
• LEMB – 2013:  See EEM; rising domestics rates equates to capital moving from emerging markets local currency bonds back into US markets.  Moving Forward:  See EEM and IGOV.  While rising domestic rates would continue to be negative for emerging market bonds, a USD hedged exposure could be a nice boost.
• GLD – 2013: The gold chart for the year went pretty much straight down.  You can take your pick why: higher interest rates, decrease in systemic risk probability, lower inflation.  But at the end of the day you see three out four negative quarters, the whole year below the intermediate term trend, and down nearly 30%.  Moving Forward:  All three items I listed for gold’s 2013 decline are still in place.  Maybe one of those reverses and this turns into a great contrarian trade, but until the trend changes it’s difficult to allocate dollars to gold.

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