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September 2014 Outlook

“A groundhog is like most other prophets;

it delivers its prediction and then disappears”

–Bill Vaughn


In our office we frequently make sport of the countless headlines we encounter on a daily basis from various media outlets across the web.  These headlines are often splashed across the “home” pages of market or financial sites—though often across mainstream “news” outlets, or the business sections of Sunday newspapers as well.  Usually in 48-point font, they include such intellectually enticing teasers as; “5 Reasons to Flee the US for Canada”, “11 Things You Need to do to Protect Yourself from the Coming Crash”, or “Time to Ditch Rising Stocks, or Stick With Them?”.  Of course rarely does a click-through to the article reward the reader (or surfer) with cogent, reasoned and researched financial advice (which by definition cannot be disseminated to a mass-market audience).  More often they are simply an amalgam of quotes and predictions from like-minded money managers, economists, or academics; perhaps with a particular trading position to justify, axe to grind, or perhaps simply the desire to raise their profile as a sought-after commentators.  Not to worry of course, the following days or weeks will present us with “Why this Bull Market has Just Begun”, or “7 Stocks You Need to Own Before Christmas” (and as an aside…why always a prime number?).

The real trouble, it seems to us, is that in today’s information-saturated society, many—perhaps even most people have come to conflate headlines with actual news, rarely “clicking through” to understand that no notable conclusions have been offered; or they may absorb the splashy headline prediction of a crash one day, but miss the splashy Bull-Market prediction the next.  We arrive at this theory in-part because we, like most advisors, are the recipients of  sometimes concerned, sometimes panicked phone calls from clients who may feel they’ve alighted on an opportunity to save themselves considerable financial heart-burn.  Frequently, these headlines are highly correlated with the short-term direction being pursued by the stock market; a three-day down draft in the S&P 500 is often accompanied with negative “news” headlines—and the phones become more active.

David Edwards of Heron Financial, an unaffiliated investment advisor, wrote in a newsletter last month;

“US stocks as defined by the S&P 500 made 31 record highs in 2014, most recently

               through July 24th.  Through Friday afternoon stocks declined by 3.3%….Fox and CNBC

               declared an apocalypse because of an increase in e-mails and phone calls….


The CNN Money Fear and Greed Index swung to “Extreme Fear” from last month’s “Extreme Greed”.


He went on to describe how a long-time client had called to complain about a “$44K paper loss” during this market volatility—never minding that the client’s $2 million portfolio was up $117K year-to-date.  Thankfully, we can say our clients have been comparatively more circumspect—but Mr. Edward’s anecdote dovetails with our own experience, and doubtless that of most advisors.  We attribute much of this general behavior to the “CNN Money Fear and Greed” indexes of the world.  The internet, after all, competes for eyeballs alone.  Like Punxsatawney Phil—the prophets who write the headlines never concern themselves with accuracy, and rarely revisit their prediction failures.

Capital Markets


Of course we do pay attention to very well-informed opinion, particularly from those with “skin in the game”—and what strikes us today is the divergence of opinions among market strategists on the topic we’ve been commenting on in our Outlooks and client reviews for most of the last twelve months; that of current stock valuations.

By now the refrain should be familiar; stocks are “not cheap”.  But neither is the most frequented alternative to stocks—bonds.  In fact, from a historical perspective, one could argue that stocks are much “cheaper” than bonds.  Adding fuel to this debate, renowned Yale economist and Nobel Prize winner Robert Shiller recently opined that stock prices are dangerously overvalued.  Shiller cites his own so-called CAPE index, a cyclically adjusted P/E index whereby the denominator is measured using mid-business cycle earnings averages over the last 10 years (rather than most recent year’s earnings, or earnings forecasts).  This measure, he tells us in an Aug. 16 New York Times article, has reached a “worrisome level”, a level which preceded 1929, 1999 and 2007.  However, Burton Malkeil, author of the best-selling A Random Walk Down Wall Street points out in an Aug. 27 Wall Street Journal piece; “The CAPE does a reasonably good job at predicting 10 year equity returns.  High CAPEs predict low future returns…The CAPE is not useful in predicting returns one or two years into the future.”

Malkeil goes on to point out what we mentioned above, and have alluded to frequently over the last year, and that is that “the main competitors for stocks in individual and institutional portfolios are bonds”, and it is almost universally agreed that bonds, in general, have little upside beyond the low coupon rates they currently pay.

We have surveyed market perspectives from most fund families we do business with—and many we do not.    Key themes range from “the US expansion remains intact”, to “the current market rally is getting old” to “large caps tend to lead later in recoveries”.  Frankly, we agree with all of the above.  There is no doubt that measures of equity valuations are all trending to the upper end of their normalized range—but there (finally) is little doubt, based on Q2 revised GDP of 4.2% that the economy is growing, and that jobs are being created.  Richard Skeppstrom of Eagle Asset Management answers the proclamation put forth by Robert Shiller’s CAPE calculations saying it “reflects the fact that margins are at all-time highs.  If one adjusts the denominator lower under the assumption that earnings are overstated, then naturally one gets a higher price-to-earnings (P/E) ratio as a result”.  To paraphrase, US corporate profit margins are at record highs, which explains much of the stock market rise over the last 18 months.   Adjusting earnings for cyclicality given current profit margins is, in fact, adjusting earnings downward from their current level, and results in Shiller’s very high CAPE ratio.

Finally, and speaking of prophecies, we recall the 2010 thesis put forth by PIMCO’s Bill Gross and Mohamed El-Erian which was titled “The New Normal”.  Back then there were widespread expectations of an imminent interest rate hike as financial asset prices rocketed off their 2009 lows.  The US was technically coming out of recession—and concerns were high that inflation was inevitable due to the Fed’s historically unprecedented accommodation.  The “New Normal” thesis held that for a variety of economic reasons, interest rates would remain extraordinarily low for a protracted period of time.  As far as predictions go—this one was spot-on.  As of August, we have had 68 months of a 0% Fed Funds rate, and four years of “quantitative easing” on top of that.

This Spring, PIMCO’s updated Secular Outlook is titled “The New Neutral”.  The premise can be boiled down to their expectation that while interest rates will indeed rise, global central banks will likely be targeting real policy rates of 0%-2% (translating into nominal policy rates of 2%-4%), much lower than the return to “normal” expected by much of the market and many market commentators (2%-4% real, 4%-6% nominal).  PIMCO’s William Benz, CFA explains the investment implications over the long term:

Bond and equity market returns will likely average a more modest 3%-5% in this

               environment, though risks will be lower as well.  This doesn’t signal an end to volatility;

               it just means bond yields are unlikely to increase much above current forward rates,

               while equities and other risk assets remain relatively range-bound….in a world of

               lower expected market returns, or beta, every basis point matters….our concern is that

               future returns will not only be lower than in the most recent past but will also fall

               short of what most investors need and expect.

Let us summarize our take on this myriad of investment opinion; Recency Bias is a behavioral finance term defined by the CFA Institute as “the tendency to recall recent events more vividly and give them undue weight…Research points to a tendency for individual private investors to extrapolate trends and to suffer more from recency bias…”  Given the traumatic market events of 2008-2009, we believe the media outlets which produce so many absurd daily headlines are actually counting on recency bias to draw eyeballs to their websites.  However it is important that investors not lose sight of actual economic facts when examining equity valuations; facts like the 4.2% GDP growth in the last quarter, record corporate profit margins, the sustained improvement shown in the Purchasing Manager’s Index (an amalgamation of market sector indicators), and of course the slowly improving labor picture this year in the US.

We’ve written recently that a near-term market correction is certainly possible—but given the underlying and improving fundamentals both in the US and globally, we do not anticipate the source of such a correction to be simply equity valuations.  We’re reminded of a quote from famed money manager Peter Lynch a few years back;

Far more money has been lost by investors preparing for corrections, or trying

               to anticipate corrections, than has been lost in corrections themselves.


Over the longer term, however, we recommend investors absorb the research done by Robert Shiller, the PIMCO Investment Committee, and several others not cited in this Outlook.  Return expectations for the next 5 years or so—in both stocks and bonds should be adjusted downward from recent experiences.  Our biggest concern remains the bond market’s ability to deliver anything beyond current paltry bond yields—and plenty of downside exists.  And while equity markets should continue to plod ahead with global growth—that growth is not booming.  The US remains the “cleanest shirt” in a pile of dirty laundry economically, but globally (including the US) economic growth is converging to a much lower level than has been experienced over the last forty years.  True value in equities will be more often than not found outside the US.


Despite this nuanced tour of near-term market opinions and our own conclusion that equity valuations shouldn’t necessarily keep us up at night, CCR Wealth Management has made some recent, modest adjustments to our model portfolios;

  • We have reduced small cap exposure in our models from 10%-12% of equities to 7%-8%, and are in the process of reviewing client portfolio small cap allocation levels.  This is an acknowledgement that while we feel fairly comfortable with our position in the economic cycle, the market cycle is aging—and large-cap stocks tend to outperform later in the cycle.  Small caps are also among the most richly valued equity categories.
  • We have limited our high-yield bond component (specifically, dedicated high yield funds) within the fixed-income models to 10% of the total bond allocation.  Realistically, several other bond portfolio components including our “core” bond funds have high yield exposure as well—so this adjustment will not actually limit high yield to 10% in most cases.  High yield, like small caps stocks, are the most highly valued category within its asset class, and bonds in general are arguably overvalued relative to stocks.


In the “New Neutral” environment as foretold by PIMCO, investors will be stuck with total portfolio returns averaging in the mid-single digits, perhaps for a protracted period of time.  In our January 2014 Outlook we introduced the concept of non-traded REITs as a viable alternative to stock and bond market exposure as a source of investment return.  “Every basis point matters”.

The benefit of non-traded REITs as a component of a diversified portfolio are essentially two-fold; First, there is no correlation to equity markets or bond markets.  While REITs are readily available as traded securities (and we in fact employ a REIT fund in many of our allocations), REITs which trade on the stock exchange have a correlation to the stock market which actually approaches 1 during downside market turbulence (i.e., they capture all the market downside).  In contrast, the value of the commercial property down the street from you—be it an office building, drug store or hotel, does not drop in value just because the stock market had a tough week, month or even year.  Non-traded REIT companies operate under the exact same business principals as their traded counterparts—with the exception that they are valued purely on the periodically updated valuation of their properties, rather than by the laws of supply and demand for their stock which may be in effect on any given day, week or year.

Secondly, as a source of return non-traded REITs generally pay 6%-7% dividends.  This monthly income is rental income (or mortgage payments—depending on the type of REIT), made under long-term contracts.  As such it diversifies a portfolio’s source of return.

As with most truly alternative investments, an investor must give up some liquidity to reap these benefits.  These liquidity restrictions do limit the scope of investors for whom they are appropriate.  CCR Wealth Management will be discussing non-traded REITs with clients for whom this diversification tool is appropriate in the months ahead.

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May 2014 Outlook

US equity markets have seen what we would describe as mild volatility over the last few weeks, mostly attributed to geopolitical tensions emanating from the Ukraine-Russia belligerence.  For the first quarter, the S&P 500 rose 1.30%, while the Dow Jones Industrial Average and the NASDAQ composite were both down slightly.

This lack of any meaningful gain from the major indices is just fine with us, frankly.  As we pointed out in our previous Outlooks, US stocks have been approaching a “fair value” given the run-up we saw in 2013.  Fair value in this context refers not to an intrinsic measure, but to current versus historical P/E valuations.  As the chart to the left indicates through March 31, 2014, while the S&P 500 itself is just shy of its 29 year average P/E level, many other equity sub-divisions within US markets are trading at or slightly above their historical averages.  “Growth” stocks may look cheap on a relative basis here, but we attribute this historical discount more to the “outlier” years of soaring technology valuations in the late ‘90s which has inflated their long-term average P/Es.

The US first quarter GDP growth rate of 0.1% was just released—a fairly dismal figure that came in even below reduced consensus expectations of 0.11%.  This slow-down has been attributed almost entirely to our bout with the “polar vortex” weather challenge which consumers, businesses and home-builders faced this past winter.  Yet, as corporate earnings pour in for Q1, we expect no downward revisions to the consensus 3% full year GDP estimate.  Rising earnings with a pause in stock price appreciation will eventually work to lower P/E levels, providing more attractive entry-points for US stock investing.  We ultimately believe the fiscal drag caused by the “sequester” last year, estimated to have shaved ~1.3% from GDP in 2013 will become a much lighter headwind this year and next, offsetting the effects the “polar vortex” may have on the full year GDP.

The new Fed Chair, Janet Yellen, could be said to have had a rocky debut in March with her somewhat confusing comments regarding the timing, or economic mile markers for a projected increase in the Fed Funds rate.  While Fed guidance has always been more rhetorical acrobatics than substantive insight, stirring confusion (along with disavowing previous “rules”—like the 6.50% unemployment target) risks devaluing their credibility in the financial markets, in our view.

We’ve given further thought to this muddled message after listening to PIMCO’s Saumil Parikh’s self-described out-of-consensus views on an increase in inflation, possibly this year.

The Great Recession of 2008 left millions of Americans unemployed, and today, nearly six years later, the unemployment rate stands at 6.3%, having dropped sharply from 6.7% last month.  In our discussions with clients over these years, we find that by now nearly everyone is aware that the more shocking statistic lies in the actual employment rate—or the ratio of employed civilians to the working-age population. This rate stands at just 58.9% according to the US Bureau of Labor Statistics through March of this year.  This is a level on par with the dismal economic conditions that existed in the recessionary 1970’s and early 1980’s.  Add to this the ranks of under-employed, and the US employment picture would seem to paint a picture of economic contraction, rather than the steady (if tepid) growth we’ve experienced.  We would summarize Saumil Parikh’s thesis on inflation as having its origins in possible wage inflation.

To flesh this out further consider the staggering number of US citizens who were forced out of the work-force in 2007-2009, and who, six years later, remain unemployed (and increasingly unemployable).  This number contrasts with the more transitory rate of “normal” unemployment, which, as depicted in the chart above, is actually back to pre-recessionary levels.  The long-term unemployed may simply remain unemployed, and/or officially “retire”.  This would actually represent a structural shift in US employment rather than simply a prolonged cyclical issue (indeed, it could make the US look much more like Europe from a labor perspective).  The thesis is that under these conditions, we may not have the deep pool of “available” labor many attribute to our population, increasing the competition among employers for employable workers and thereby ratcheting up wage inflation, which would eventually find its way into consumer prices.  Its notable then, that even as the most recent unemployment rate dropped sharply, the employment rate hasn’t budged.

We haven’t spent much time musing on the topic of inflation since our 2009 Outlook discussed it as an inevitability once the economy returned to growth with a 0% Fed Funds rate.  We were of course wrong—but we at least have plenty of company.  While we expect the Fed to continue to reduce bond-buying to zero by the end of this year, and we continue to expect an “orderly” reaction in the bond markets (in contrast to last year), we see the inflation issue as an interesting thought to ponder as GDP and labor statistics conflict.  Surprises are what really move markets, and we think a notable pick-up in inflation this year or next could be that catalyst, precisely because consensus disagrees.


CCR Wealth Management’s US equity models remain unchanged in our balanced weighting between growth and value investment styles.  Quarters like Q1 make us appreciate dividends all the more.  We continue to have a small cap equity weighting in our portfolios of approximately 10%.

While we discussed inflation as a possible surprise, and we discussed equity valuations as a function of P/E, we do not know what short-term shocks may come into play for US equity markets. We think it’s a good idea to remind our clients that true corrections, defined as a significant draw-down of equity values within an otherwise upward trending market, are both commonplace, and perhaps healthy to a longer-term bull market.

Over the past 34 years, the average intra-year (calendar year) down-draft in US Equity markets has been approximately 10%.  As the S&P 500 rose over 13% in 2012, and over 30% last year, it’s notable that we haven’t seen a stock market correction of 10% since 2012.


CCR Wealth Management continues to view non-US developed markets and particularly European markets as attractively valued relative to the US.  Additional dovish comments by ECB President Mario Draghi in early April opened the door to possible “extraordinary” stimulus measures akin to those adopted by the Fed several years ago, and those currently being pursued by the Bank of Japan and in the UK.  Given the lower P/Es of global European companies (which are drawing from the same revenue sources as global US companies), we continue believe a European equity market surge is possible within the next 12 to 18 months.  In some ways it’s hard to believe how far Europe has come considering less than three years ago many in the financial community thought we were witnessing the unraveling of the European Monetary Union itself as Greece, and then Cyprus became virtually “failed” states, along with strong and continual support needed for financial institutions within Spain and Italy.

The fact is, there has been a remarkable turn-around in confidence both within Europe and across the broader global financial universe.  Consensus views for Euro-zone GDP growth this year are 1.0%-1.5%.  While this seems an unremarkable number, it’s coming off a level of -0.5% a year ago, and represents a significant jump relative to US GDP expectations vs. a year ago.

The European investment “theme” is not without challenges and potential pitfalls ahead.  Mario Draghi’s comments were made in-part to address the issue of the rising value of the Euro relative to their major trading partners.  The Euro has risen as a result of the aforementioned increase in investor confidence.  As money floods in to buy stocks and bonds, it needs to be converted to Euros, increasing demand, and therefore increasing the price of Euros.

Exports are the only real way to continue to grow out of recession, but with the Chinese devaluing the Yuan, the Japanese in their second year of aggressive quantitative easing, and the US continuing an asset-purchase policy—though at a tapering pace—growing exports with a rising currency is a daunting task.

An asset-purchasing strategy like that being pursued in the US, UK and Japan is not a simple prospect in Europe, which has 18 different geopolitical components to contend with.  We expect to hear much more “jawboning” of extraordinary measures from monetary officials.  Beyond that, they may need to pursue more direct intervention, selling Euro’s for Dollars to keep the exports rolling.

If the developed world’s economic engine can be represented by a three legged stool, then the third leg is represented by Japan.  The Japanese Nikkei index was by far the best performing market among developed countries in 2013, soaring nearly 57%.  Japanese Prime Minister Shinzo Abe’s ambitious plan to end years of stagnation and deflation through aggressive monetary and fiscal stimulus fueled this major rally.  We have heard a range of opinions from strategists and portfolio managers with whom we work regarding the staying power of this optimism.  While “Abenomics” is no-doubt popular among investors (most of whom are foreign), Japan has a multi-decade history of political turn-over which has posed a challenge for any long-term economic plan to take hold and finally produce real long-term economic results.  Further, the recent implementation of a VAT tax will be an economic drag, and it remains to be seen whether the stimulus will continue to the extent of offsetting this hurdle.  Longer term, Japanese demographics are actually quite unfavorable to sustained GDP growth given a very low birth-rate, a population in decline, and an aversion to immigration reform.  The Nikkei is down 11% year-to-date, and we would be content to watch from the sidelines to see how long and short term economic pressures are reconciled.


Taken as a whole (i.e. from a broad index viewpoint), emerging markets remain problematic.  CCR Wealth Management’s model portfolios continue to keep a footprint in emerging markets equities, although the footprint is modest, and we continue to advocate a managed approach rather than a broad-based index, or regional approach.  Valuable, yet undervalued companies reside in Brazil, Eastern Europe and throughout Asia, though they are diamonds in the rough—and are best uncovered with a bottom-up fundamental “stock picking” approach.

In years past this Outlook communication went to great lengths to highlight China’s importance as an engine of world economic recovery post-financial recession.  As a major consumer of raw materials from around the world, Chinese economic growth had much to do with dragging many different developing economies up the growth curve as a major destination for their exports.  China is of course important today, though as growth continues to decline, the inverse effect of this association hampers emerging markets virtually everywhere.


In January we expressed a little more comfort with the near-term outlook for bonds—certainly in relation to our outlook of the prior two years.  Year-to-date, the Ten Year Treasury yield has actually fallen roughly 12% and our core bond fund holdings are up 3%-4%.

We continue to think that as long as the Fed tapering continues on a steady pace, messaging from the Fed remains consistent, and that consensus for a higher Fed Funds rate remains pushed out to the second half of 2015, that bonds should achieve our low to mid single-digit return expectations this year.

There are two caveats we feel compelled to inject into this outlook; the first has to do with credit spreads of high-yield securities.  As stock’s relative valuations are best expressed as a ratio of price to some fundamental multiple (often earnings), bond valuations are expressed as a yield spread accounting for credit risk (for the most part) over comparable maturity risk-free Treasury notes and bond yields.  Spreads generally tighten (expand) as credit risk is perceived to be lower (greater) as a function of economic activity.  As spreads tightened substantially since the financial meltdown of 2008, higher-yielding (riskier credit) bonds have appreciated nicely.  CCR Wealth Management has had a significant center of gravity in the BBB rated bond category for most of the last six years.

Today we see credit spreads approaching levels last seen in 2006 and 2007 as leverage has returned from the abyss of the financial recession.  We don’t wish to make structural comparisons between the natures of leverage today vs. that which did-in the housing and financial markets 6 years ago—but we would point out that today’s credit spreads are indicative of investors getting much less return per unit of credit risk today than they were 4-6 years ago, much the way a stock buyer would pay much more for a dollar of earnings by buying a high P/E stock.

The second caveat to our generally benign near-term outlook for bonds concerns the “out-of-consensus” risk of inflation we previously discussed.  Inflation does great damage to bond returns which are fixed over specified periods of time.  While being in higher yielding securities provides some buffer over inflation, market sentiment could sour on bonds broadly if inflation data shifts significantly.

We continue to suggest to investors that near-term return expectations from their bond portfolios should likely be confined to the yield of the portfolio.

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January 2014 Outlook

It cost $0.32 to mail a letter, unemployment was 4.9%, O.J. Simpson was found liable in a civil suit, Hong Kong was returned to Chinese rule, Timothy McVeigh was sentenced to Death, Green Bay defeated the Patriots in the Super Bowl, Titanic came crashing into movie theatres, and Dolly, the first genetically engineered lamb was unveiled to the public; the year was 1997.

1997 also held the distinction of being the year that produced the highest return of the S&P 500 (+31.01%) within the last 16 years—until it was narrowly eclipsed by 2013’s index return of 32.39%.  For ourselves, we recall the rather heady days of 1997, a year which was squarely sandwiched within a five-year span that saw consistently out-sized market returns.  “Goldie-locks”, “Dot-com”, and “Irrational Exuberance” were a few of the terms that became part of the investment lexicon during this period to describe either the stock market, the US economy, or both (we do not believe “Bubble” came into vogue until a few years later, of course).  Ahh, the nostalgia!

To be sure, there have been years within the last decade that were quite good—both 2003 and 2009 produced returns of over 20%, but we would note that these years were more characteristically reversions to the mean rather than organically generated equity performances reflective of underlying economic or fundamental conditions; 2003 was a reversion up from the preceding three years of tech-bubble deflation, and 2009 of course was the reversion following the financial debacle of 2008.  So the natural questions we are pondering today are;

  • What are the similarities between 2013 and the late 1990’s?
  • What are the differences that matter?  Are we in another equity bubble?
  • And of course, will the Patriots pull it off this year?

As for the first two questions—we think the answer is obvious.  While the S&P 500 performances are nearly identical, there are very few similarities between the current underlying economic structure and that which underpinned the stock market 16 years ago, and we actually think this bodes well for equity markets.  Economic growth—as measured by GDP—is perhaps one of the most obvious departures in comparing the two eras, as the US economy has struggled though a tepid recovery since the great recession of five years ago.  However we would note the most recent Q3 GDP revisions show a growth rate over 4% (4.1%) for the first time in two years.  Compare this to 1997’s 4.87% growth rate and its clear the US economy seems to have finally found some traction—despite last year’s “fiscal cliff” and “sequestration” dramas.  As the stock market is a generally leading indicator, we are optimistic that current market levels (on average) should be sustainable with an underlying economy which is growing at a faster pace.  One additional and important distinction between last year’s returns and that of the late 1990’s includes the fact that last year’s stock market rally was very broad-based, with nearly every sector within the S&P generating positive returns, while the late ‘90’s remarkable stock index advances were marked by a relative few sectors (and often a small handful of very large companies) propelling this market-cap weighted index absent any support from the rest of the market.  In our opinion, this is the distinction between broad-based economic profitability (2013) and narrowly focused, even speculative stock “chasing” (1997).

Equating GDP growth to stock market performance can be tricky—and here we point to other measures which highlight a significant difference between the market of today and that of the late 1990’s.  We’ve commented in recent Outlooks and reviews on the importance of measuring equity valuations in a manner other than a simply numerical factor which may make splashy headlines whenever it makes a new high.  The simplest method is to view market valuations is as a ratio between price (tied directly to market levels) and earnings (tied directly to GDP) to make a more sensible comparison between current stock price levels and those of prior years.  Taking an even more specific variation of this ratio, using forward earnings estimates (i.e. looking forward rather than backward), the Wall Street Journal lists the current forward P/E of the S&P 500 as 16x.  Looking back to the era of the late 1990’s, we note that the forward P/E for the S&P was over 17x in 1997, and in subsequent years it climbed well into the 20’s, according to Yardeni Research, Inc.  These valuation differences are material in our view, and while the markets are certainly richer in valuation than they were a year ago given their rise in price, we do not believe they are “over valued” on a historical basis, or based on evidence of accelerating economic activity.

We think it is important to note that while the Federal Reserve finally announced a modest tapering of their bond purchases, interest rates (i.e. the “Fed Funds rate”) will certainly remain at 0% this year, and quite possibly for the next 24 months.  There was little movement in the Fed Funds rate in 1997, but it’s a notable difference that this benchmark rate was consistently above 5% back then—which further contrasts the relative economic strength of that period with the current period.  While we think the actual catalyst for further P/E multiple expansion needs to come from further gains in corporate profits, expectations of continued ultra-accommodative monetary policy continues to foster an environment conducive to higher P/Es.

The market obviously accelerated right through a year that was, like the several before it, rife with political rancor and outright governmental dysfunction, beginning with the Fiscal Cliff, and peaking in October with a partial government shutdown.  Things ended on a higher note though with a two-year budget deal struck in December.  This late-in-the-year deal has created hope that 2014 could be a year of détente.  2014 being a mid-term election year, our bet is that both Democrats and Republicans will be playing a more conservative game when it actually comes to issues of governance this year.

And Lastly, GO PATS!


We have already taken considerable space commenting about US equity valuations and, as mentioned, we remain comfortable with our allocations.  There is little evidence for an S&P 500 earnings decline in 2014, and continued accommodation by the Fed should allow US companies, particularly large-caps, to operate at relatively high profitability levels.  We see meaningful expansion in sectors which will likely benefit the broader economy, including technology (which has had a hand in corporate profitability enhancement across all sectors), energy (which will continue to innovatively exploit domestic reserves, driving down the actual cost of energy, and thereby continue to benefit the broader economy), and the industrial sector (which has arguably gained the most from lower energy prices, and stands to gain further from a potential global economic up-tick).

A tried and true equity  strategy is to identify a sector or market that has become relatively cheap for a particular reason, understand the reason, and buy-into the investment as confidence increases that the reason will dissipate.  CCR Wealth Management increased our allocation to non-US developed markets, and European markets specifically for just this reason last summer.  Europe has been in a two-year self-induced recession caused by stern fiscal austerity which has weighed on the economic climate across the continent, in-turn causing valuations to compress—certainly in comparison to the US.  Despite the monetary and economic “union”, as we have highlighted before, the European economy is still largely divided among its geopolitical constituents, and we can value these constituents individually.  Forward P/E ratios for France, Germany, Italy and Spain respectively are 12.9x, 12.2x, 12.1x, and 13.9x—all well below the aforementioned 16x the S&P 500 trades at.  As in the US, the economic recovery in Europe has been slow—but it is happening.  We think more and more this process of stabilization will be recognized, and investors will follow suit with greater allocations to EU stocks and markets, possibly producing 2014 returns greater than those in the US.

Emerging markets are less clear, and economically speaking, potential is even more disparately distributed over even more individual economic zones than in the EU.  Never the less, we view the potential as compelling.  Certainly the MSCI Emerging Markets Index greatly underperformed the US and developed markets in 2013 (-2.60%), but we continue to shun the broad-index play with emerging markets, focusing on a managed approach which can uncover fundamental values within regions and countries.  Our preferred manager returned 8.68% in 2013.  Importantly, as economic recovery continues to accelerate in Europe and the US in 2014 and beyond (according to our thesis), developing economies stand to benefit enormously, and we anticipate their equity markets will reflect these expectations.  Investors in this space should continue to have patience.


Clearly 2013 was one of the most challenging environments for bond investors within recent memory.  Our fixed income model acquitted itself well—finishing with positive returns while the Barclay’s Aggregate Bond Index lost 2.02% for the year.

We’ve been warning for some time about an imminent end to the fixed income “party”—and at points last summer, it seemed the end would arrive dramatically following Ben Bernanke’s tapering comments.  The municipal bond market was particularly spooked by the concurrent Detroit bankruptcy.  So here we are, officially within the “tapering” window, and with a seemingly accelerating GDP; as a recent research piece from Wells Fargo asked, “Are We in the Eye of the Storm?

We surprise ourselves a bit by being somewhat less negative on bonds (in general) than we were a year—even two years ago.  Let there be no misunderstanding; bonds, and the aggregate bond index specifically, will continue to underperform relative to the last 5, and even 10 year averages, in our view, and investors should adjust their expectations accordingly.  We fully expect the bond market to underperform the stock market again, which will again provide heavily bond-allocated portfolios with subdued returns.

On a more positive note, we reiterate that actual raises in the Fed Funds benchmark are likely 24 months away, and while the Ten Year Treasury yield rose nearly 70% in 2013, the current yield of ~3% is at a more “normalized level” given the underlying economic performance.  In short, “duration risk” (down-side volatility due specifically to higher interest rates) is lower than it was a year ago in our opinion—though it still exists.  So while we still view bonds as having very limited upside, our return expectations are driven almost solely by portfolio yield, rather than total return metrics, and this is how we are positioned.  We remain “allergic” to aggregate index-hugging bond portfolios.


CCR Wealth Management has always included an allocation slot to investments which are generally uncorrelated with stocks or bonds (it should be noted that an “uncorrelated” investment may at times move with or against either stocks or bonds, but for reasons not specifically tied to the equity or fixed income market drivers).  Over the years this category has included precious metals, oil, particular commodity exposures, and publicly traded REITs.

Two years ago we began reducing—and most recently eliminating our precious metals positions.  While a direct Brent Oil position remains in the portfolio—all other commodities have also been phased out.  In fact the current combination of oil and listed REITs represent the lowest publicly-traded allocation to this investment category we’ve expressed in our models in the last six to eight years.

While our listed “Alternative” allocation has dwindled over the past two years, diversification principals fully support a portfolio allocation to investment elements not correlated to equity or fixed income drivers.  This position may or may not include hedging characteristics, and it may or may not include income or total return characteristics or stocks and bonds.  What it should exhibit over time though is a long-term “smoothing” effect on portfolio volatility.  These characteristics are found in our non-traded REIT model portfolio allocation, an alternative investment which over time may provide both income and total return characteristics, but which is generally insulated from traded equity and fixed income market gyrations.  Due to the liquidity characteristics of non-traded REITs, we recognize that this alternative is not broadly applicable to all clients, and allocation discussions are based on individual circumstances.