We look back at all the things that happened in the financial world in 2014 and it’s a mixed bag. On the one hand you had the market finishing nears its all-time highs on both the S&P 500 and Dow Jones Industrial Average. At the same time, you had bond yields fall to very low levels and as a result, the bond market put in another positive year. This was all happening while oil plunged from $100+ a barrel to the low $50 range. Housing was lackluster and in the face of low mortgage rates and falling energy expenditures, the holiday season was okay. Russia annexes Crimea (sanctions follow), ISIS rises in Iraq (Nations let by the United States take measures to reduce their effectiveness) and Ebola was a worldwide concern for several weeks all while the Federal Reserve was reducing QE (quantitative easing) in the US. Editorial note, QE is short for printing more money to try and cause inflation by making the dollar worth less and therefore reduce the buying power of many things that we all purchase.
As we look at the portfolio over 2014 we saw a number of trends change. Back in March, Small Company stocks started to fall out of favor and underperformed the rest of the year. We sold out of our small cap stocks at the end of March and generally saw a move from smaller companies to larger more conservative companies on the domestic front. In the international markets, we saw a move from Developed countries (Europe, Japan, UK) to Emerging countries (East Asia, South America and Eastern Europe), only to see things reverse again at the end of the year. We were underweight fixed income, international all year and overweight the US market. We had very little exposure to commodities, though we did have exposure to some energy related companies mostly in the refining or pipeline segments. While they generally held up better that Exploration and Production companies (E & P) they were still affected by the decline in oil prices. Health care, technology and consumer discretionary companies were positives for the portfolio.
In a year where all the returns are in one market (the U.S.), it seems like a reasonable thing to concentrate your assets in that one area of the market. That is where discipline and having been through many cycles comes as a benefit. One of the things we believe is if things can’t continue the way they are going, they won’t. We recognize that holding “under-performing” assets in a portfolio (like international stocks) reduces overall returns relative to the best performing markets, we also know that trying to guess the next “hot” area is not a repeatable strategy. That is where a rules based approach comes in handy. We rank our broad asset classes from best to worst and overweight the top two asset classes, while underweighting the rest. Last year, our top two asset classes were US Equities and International Equities, until the end of the year, where Fixed Income overtook International Equities as our second highest rated asset class.
Finally, we expect 2015 to be more volatile on a daily basis, with valuations at fair value. Keep in mind that we should expect 3 or 4 5%-10% corrections a year and one of those should be in the magnitude of 10%+. If you pay attention on a daily basis, we think you will see more 1%+ moves both up and down in the year ahead. We might suggest a Dramamine.