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Investment Outlook Q2 2014

by Brian Murphy on April 4, 2014 Comments (0)

On average our model portfolios performed on par with their respective target date benchmarks during the last quarter. Yet around that average performance there was a good deal of variance…so your plan’s models may have under-performed, outperformed, or just kept pace with their Vanguard Target Date comparisons.

We suspect 2014’s 1st was a quarter that will quickly be forgotten – not only for its mediocre returns but for its seeming blandness and the public’s general apathy towards pretty much everything – from Obamacare to the annexation of Crimea; people just don’t seem to care. And when the public becomes indifferent, or even complacent, that’s usually a time for concern.

While voices extolling the virtues of passive approaches to investing seem to grow louder each day, we expect that the next decade will be exceptional not for those focused on paying the lowest fees for an indexed strategy, but for those able to better manage a more hostile environment of increasing volatility, lower liquidity and choppy returns.


Going forward: watch corporate pre-tax operating margins

Corporate pre-tax operating margins are our “canary in the coalmine”. They’re where the first signs of “market stress” are likely to be found going forward and are likely to foreshadow the next big market meltdown.

On whole, U.S-based companies have become very adept at managing earnings growth through share repurchases and the clever use of debt over the past few years. They’ve had a lot of internal flexibility to offset sub-par external demand. The net result is less volatility in reported earnings growth, expected future growth, and stock prices than might otherwise be the case.

Yet, seemingly unrecognized by the mainstream media and analyst community, the elevated corporate pre-tax operating margins that have allowed for corporate internal flexibility are an indirect result of Federal Reserve intervention.

As the Fed slowly steps away from intervention, corporate profit margins will contract and interest rates rise - likely constraining corporate flexibility, leading to more volatile earnings, and likely subjecting stock valuations to downward revision.

Just a little something we’re keeping an eye on.

Our thematic views & their resulting investment implications

We believe stocks remain over-valued and over-extended in the U.S. and relatively under-valued in both international developed and emerging markets (but facing stiffer macro-economic headwinds). Hard to believe, but at little more than 3 to 4% yields, fixed income assets may well prove better investments than stocks over the coming decade.

I. U.S. stocks, fully valued, face a challenging environment.
Federal Reserve intervention has been the key catalyst for asset appreciation for the past few years, and is now in the process of being “un-wound” by about $10 billion per month. This, coupled with nearly stagnant organic earnings growth (that achieved through sales growth, not share buy-backs), puts U.S. stocks in a precarious position.

Valuations when adjusted for historically high operating margins, are not cheap - and haven’t been for quite some time. In fact by historically reliable metrics, U.S. stocks look set to deliver no more than 2.5% annually for the next 10 years.

In the face of an economy that remains sluggish at best, the IPO window is wide open, and recent offerings have taken on a more exuberant, though not yet manic, tone. This is a movie we’ve seen before – it doesn’t end well.

II. Drop down a risk level.
Our work continues to suggest that over the next 10 years our aggressive models will likely out-perform our conservative models by no more than 0.25% annually – if at all. That’s not nearly enough incremental return to justify taking on an increased potential drawdown of 20% or more.

There are times to be fully in the market, and times to watch from the sidelines. Now is the time to be scaling back. Instead of aligning yourself with our aggressive model, switch to the moderate or conservative alternatives instead. There will be better opportunities to get more aggressive, and we’ll let you know as they arrive.

III. A further rotation into value (away from growth) in the U.S.
Our models are more heavily biased towards value over growth this quarter – a tilt that paid off modestly in Q1. While the world seems truly starved for the growth associated with companies like Google, Facebook, and Amazon, valuations are simply too rich at present. Instead we’ll focus on the beaten down natural resource cyclicals, attractively priced healthcare and more speculative financial institutions that comprise the value sectors. BTW, believe it or not, Apple and Cisco now part of some U.S. large cap value indices. How times change.

IV. Adding modestly to international stock positions.
Overseas markets are cheap relative to their U.S. counter-parts. But they face harsher headwinds from a stagnant global economy due to their heavy dependence on natural resource-based exports. That said, valuation differentials with U.S companies are now large enough to take modestly increased positions across our models.

V. Believe it or not, bonds returns are likely to remain competitive.
We’ve recommended against holding U.S. treasuries over the past couple of years as their ridiculously low yields have unwaveringly pushed us towards spread sectors – mortgages, high-yield corporates, etc. Well, that bias has paid off as over the past couple of years – so much so that the relative reward for holding credit sensitive bonds is now fairly limited. We suspect our models will now begin taking increased exposure in treasuries.

Investment Outlook Q1 2014

by Brian Murphy on January 8, 2014 Comments (0)
While Kivalia generally added moderate value for most plans on our platform throughout the year, 2013 was an extremely difficult year for managers following “extreme diversification” strategies. Bonds generally stagnated during the latter three quarters of the year, while U.S. equities far out-performed a vast majority of the global stock markets. To the extent you invested anywhere outside of the U.S. stock market during 2013, your performance was likely penalized.

As an example, valuations in emerging markets looked compelling all year, yet broadly diversified portfolios focused exclusively on the sector ended the year down more than 3% - that’s roughly a 36% under-performance versus U.S. stocks! Attractive valuations simply couldn’t overcome investor concerns over the possible impact of upcoming Federal Reserve tightening – and money flowed out of emerging market. We’ll get more constructive on emerging markets in due time, but now is not the time.

While the past shouldn’t be viewed as prologue, what served those following Kivalia’s recommendations throughout 2013, was not extreme diversification (as preached by a growing chorus of online advisors these days), but professional and timely insights into the unique economic environment facing us all today.

That said the performance for your specific plan’s models may vary greatly from those of our overall averages due to the funds available in your plan. If you have questions on the performance of your plan’s models, contact us and we’ll happily provide insights.

Going forward: explosive returns belie tired reality
2013 was clearly a banner year for stocks, as the broad U.S. stock market indices were all up an astounding 30%+. Yet 2013 was also interesting from a number of other perspectives.

Globally, 2013 was the year that economic expropriation made an unsettling return – and nobody cared! Was the Cypriot banking crisis a one-off event, or did it more broadly serve the European Union as a petri-dish for socio-economic policy making? We honestly don’t know, but given the lethargic response by global citizens and policy-makers alike, we suspect talks of “bail-ins” and other confiscatory practices will make return appearances in 2014 and beyond…and that in itself is more than a bit unsettling!

In the U.S., economic growth, while played up by the mainstream media, remains largely lackluster. New U.S. jobs are concentrated in lower-wage positions, with fewer hours offered so that employer’s can forego the high costs of healthcare. Further, our declining unemployment rate masks the fact that our workforce, as a percentage of the entire population, is still shrinking.

The “strong” rebound in housing has been trumpeted as a sure sign of steady recovery, but in reality “all-cash” purchases accounted for a full 42% of all residential transactions in November – more a sign of investor activity than organic demand.

In short, newspaper headlines and economic statistics suggest an economy far rosier than reality has been delivering for most.

Our thematic views & their resulting investment implications
The economic and investment themes we’re focused on this quarter, and how they affect our model allocations, are as follows:

I. U.S. stocks likely to deliver little more than 2% annually over the coming decade.
We view the U.S. stock market as pretty fully valued here. Corporate earnings growth has been modest of late (say 5% annually) and even then primarily the result of continued record-high profit margins, and company share re-purchase programs. Top-line revenue growth has been notable by it’s absence!

High corporate profit margins are temporary and “mean-reverting”. There’s a limit to their growth, whatever that ultimate maximum may be. To us, it’s clear that wide profit margins are being supported in large part by the Fed’s Quantitative Easing program and will revert to lower levels if/when Fed intervention subsides. So at some point, what has acted as a tailwind to earnings growth in the recent past, will become a headwind.

II. We continue to recommend plan participants drop down a risk level at this time.
In our opinion, Fed money-printing has distorted markets far and wide over the past few years and served to “bring forward” future market returns. We fully expect that the difference between our conservative & moderate, or our moderate & aggressive model returns will be on the order of 0.1-0.2% annually over the coming decade, so we see little reason for investors to take on increased risk at this time.

Scale it back! There will be better opportunities to get more constructively bullish, and we’ll let you when.

III. In the U.S., value stocks remain relatively cheap to growth.
Where possible, our models retain a modest bias towards value (and away from growth) this quarter. Nothing too dramatic, but a preference, all else being equal. For perspective, we suspect value sectors will deliver annual returns of about 1% better than their growth counter-parts over the coming decade.

IV. International & developing markets should be downplayed.
While valuations for both international and emerging stock markets remain more attractive than their U.S. counter-parts, deflationary forces prompting outbreaks of civil unrest are likely to persist internationally. The risks of such events can’t be measured, but the likelihoods keep us biased towards U.S. markets, and away from international, at present. Again, we’ll know when to take on more international exposure – and that’s after an event has occurred, not before.

V. Believe it or not, bonds returns are likely to remain competitive.
Over the past few quarters we’ve consistently expressed a bias for higher-yielding fixed income markets relative to treasuries, and we maintain that view now. That said, the slight uptick in yields coupled with the stock market’s strong performance last quarter suggest that even long-dated treasury bond returns will be competitive with U.S. stocks over the coming decade.


Market Views

Investment Outlook Q4 2013

by Brian Murphy on October 4, 2013 Comments (0)

For the quarter ending on September 30th, 2013, our model portfolios generally under-performed their target-date benchmarks during the latest quarter as our near “zero-weighting” in overseas stocks penalized us; international stocks performed well and were accompanied by a depreciation in the U.S. dollar. Of the nearly 400 plans on our site, about 23% out-performed their target-date benchmarks.

Domestically we fared very well however, with roughly 89% of our models outperforming fixed U.S. benchmarks (100% U.S. stocks for our aggressive models, 80% stock/20% bonds for moderate models and 60% stock/40% bonds for conservative models.) Our bias towards small cap stocks and high yield bonds contributed to this out-performance

With the U.S. budget impasse and debt ceiling debates likely to restrain U.S. markets over the short-term, we still see bigger risks internationally and continue to de-emphasize the continent. All is not well in Europe, though the mainstream media would suggest otherwise. The EU is actually slowing down and Greece, Spain and Portugal remain problematic. Timing when Europe comes to a boil is a fools errand, but it is highly probable that economic uncertainty will flair up again.

Our thematic views & their resulting investment implications
For an overview of how we systematically construct our forecasts for the various market sectors that make up the Kivalia investment framework, you can review it here.

Our biases this quarter remain away from international developed markets relative to the U.S. but moderately biased towards emerging markets. Within the domestic equity universe we favor ultra-small companies (micro-caps) and value, over growth, across all capitalization segments. In the fixed income markets high-yield corporates and emerging markets bonds hold sway.

Main takeaways at this time:

I. We recommend plan participants consider dropping down a risk level at this time.
Currently, we don’t believe investors are being well-compensated for taking on incremental risk over the next decade. Sure, you may pick up an extra 0.20% annually by moving from a moderate to aggressive model allocation, but for some plans we forecast you’ll likely give up 0.20% per year.

While we’re not forecasting a market crash (though we can’t rule it out), we don’t believe that the incremental return for taking on additional risk is justified at this juncture. We suspect that there will be better opportunities to become more aggressive in the next few quarters or years (yes, after a notable selloff), so we’d recommend every subscriber consider moving down one risk profile at present. If you’re typically an “aggressive” investor, move down to “moderate” risk. If you’d normally consider yourself a “moderate” investor, move down to “conservative”.

Just sayin’ – no need to take on a lot more risk when the incremental gains from doing so have dwindled so drastically!

II. U.S. stock are poised to return roughly 2.9% annually over the coming decade.
Corporate profits as a percentage of GDP are at record highs, supported by both Federal Reserve Quantitative Easing and management reluctance to expand business in the face of an uncertain economy. As the government scales back stimulus, profit margins will invariably contract, slowing earnings growth and creating a headwind to stock market advances throughout coming years.

III. In the U.S., value stocks look moderately cheap relative to growth.
In a dis-inflationary/deflationary environment, growth stocks are typically favored over value; and such is the case today. The anxiety of if, and when, a solid recovery will take hold causes investors to shun cyclical businesses at times like these. Yet a larger-than-expected valuation gap leads us to a moderate preference for value, over growth, at this time – across all capitalization categories - small, mid & large.

IV. The sharp sell-off in emerging markets this year presents opportunities.
Emerging markets typically get little respect during the economy’s cyclical lows; and admittedly the economy is not far off the lows, having barely budged over the last four years. While it’s not surprising that they’ve had a rough go of it of late, the divergence between the returns in U.S. stocks and those of the emerging markets has been roughly 25% just this year! From a long-term perspective, now is a good time to be rotating into both broadly diversified emerging market stocks and bonds.

V. Select bond sectors will likely perform better than stocks over the next decade.
Most notably, emerging markets, high-yield & high-grade corporate bonds, as well as long-dated U.S. treasuries all look compelling from a return perspective versus the U.S. stock market over the next decade. When one takes prospective market fluctuations into account, they become even more attractive.

The Icing on the Cake - Kivalia Guidance for Commission-Free ETF Programs

by Vincent Cocula on September 23, 2013 Comments (0)

Exchange-Traded Funds, or ETFs in short, have grown enormously in popularity amongst individual investors over the last few years. And for two good reasons: instant diversification and ease of use.

ETFs are securities that track an index, a commodity or a basket of securities much like a traditional mutual fund would. Because ETFs are constructed to track a specific market index or sector, they very much resemble common passively-managed index funds, such as the Vanguard 500 Index fund, providing investors with instant broad diversification at low investment cost.

And because ETFs trade on an exchange, unlike a mutual fund, they can be bought and sold throughout the day, just as easily as any stock.

In recent years, the rapid increase of investable money in ETFs has pushed the industry to provide greater and cheaper choices for individual investors. For the firms managing these funds, a price war drives down costs (for an ETF, like a mutual fund, the cost is called the ‘expense ratio’). Nowadays many of the leading brokerage firms offer defined groups of commission-free ETFs to their clients. That’s right: ETFs are ever cheaper to own, and can even be free to trade. What’s not to like?

To help you navigate through the different offerings, we apply our evolving investment outlook to the various lists of no-cost ETFs at the country’s leading brokerages including Fidelity, Charles Schwab, TD Ameritrade and E*Trade. This makes Kivalia an ideal resource for advice not only on your retirement plans, but also your non-401(k) investment accounts!

Let’s look at these four different no-commission broker lists in more details.


Approximate # of ETFs available 60 100 100 90
ETFs Average cost 0.3% 0.4% 0.3% 0.6%
Recommendations Kivalia's advice Kivalia's advice Kivalia's advice Kivalia's advice


All four platforms offer an extensive set of ETFs to choose from, and at reasonable cost. Fidelity, Charles Schwab and TD Ameritrade all provide ETFs representing a diversified mix of sectors and asset classes, allowing to one to easily construct well-balanced portfolios. The set of funds offered by E*Trade seems to be biased towards international securities and commodities, with very few options for bonds, unfortunately.

Although the performance of a portfolio is almost entirely a result of its allocation, cost of investments can play a significant role. And with all things equal, cheaper is better. Here again, Fidelity, Charles Schwab and TD Ameritrade offer the lowest cost ETFs.

Ease of use, instant diversification and commission-free, these platforms offer a lot of benefits for the individual investor. Deciding on which of these funds to allocate to and by how much remains a difficult task, and that’s where Kivalia can help you.



The Thrift Savings Plan: Simple & Effective.

by Vincent Cocula on July 15, 2013 Comments (0)

As with most designs, there is beauty in simplicity. Coined in the 60s by the U.S. Navy, the KISS principle (KISS is acronym for "Keep It Simple, Stupid") states that most designs work best when kept as simple as possible.
Unfortunately, investing in our retirement plans (401k, 403b, etc...) is hardly ever a simple task. For most of us facing the dreadful list of investment options available in our plans, the #1 problem remains which options to pick and by how much. And the problem only gets worse as the number of available options increases.
But if there is one retirement plan that follows the KISS principle, it surely is the Thrift Savings Plan. Available to more than 5 Million United States civil service employees, the Thrift Savings Plan only sports 5 investment options. Only 5! But that's not all. As recently pointed out by Matthew Amster-Burton of the MintLife Blog, the Thrift Savings plan uses only a few options each covering a broad financial market and for record low investment fees.
The deal is simple. Each option - or fund - invests in broad market indices as follow:
  • G Fund - Government Securities fund. 
  • F Fund - Fixed Income Index fund. These are investment-grade bonds from either the government, high-rated corporations and mortgages backed by the U.S. Government.
  • C fund - Common Stock Index fund which tracks the S&P 500 index, which represents the 500 largest companies in the U.S.
  • S Fund - Small Capitalization Stock Index fund. These are smaller companies not listed in the S&P 500 index.
  • I Fund - International Stock Index fund which provides exposure to equity markets from around the world.
Of course one can argue that these options do not provide exposure to some important markets (the lack of higher-yeilding bonds is one example), but overall, these 5 options should provide for plenty of opportunities to build a well-rounded, diversified and low-cost portfolio for any level of risk. So how do we go about and doing that?
The Thrift Savings Plan also offers a line of Lyfecycle funds: the so-called L Funds. These follow the common methodology of choosing a fixed allocation given your age and follow with you along the "glide path" as you age. From more exposure to equities, towards a larger exposure to bonds as you approach your retirement date. These have the benefit of being a very low maintenance portfolio choice and it works well for some of us. The drawback with these is that your allocation and exposure to different markets and sectors is maintained constant over time. And there lies the problem: financial markets and economies aren't constant. They have cycles. They have booms. And as we all know too well, they have bursts.
Of course no one can time the markets (and please do shy away from anyone who claims to be able to do so), but following the cyclicity of the economy and simple financial valuations, one should be able to use the broad and low-cost options available in the Thrift Savings Plan and provide value above and beyond the lifecycle funds. At Kivalia, we have been providing allocation guidance for the plan for the past two and a half years, rebalancing our allocations quarterly, and have shown this is indeed possible. This isn't as low maintenance as the use of the L Funds, but the added returns should justify the 10 minutes spent quarterly rebalancing your allocations. Or we sure hope so!


Investment Outlook Q3 2013

by Brian Murphy on July 11, 2013 Comments (0)

Our model portfolios generally under-performed their benchmarks during the latest quarter as our investment biases remained “under-appreciated” by the broader investment community. (That’s our gentle way of saying “We were wrong”).

Specifically our models were more heavily weighted in international and emerging markets stocks than our respective benchmarks based on the view that cheaper valuations coupled with a calm European geo-political landscape leading up to Germany’s fall elections would provide a window of opportunity for foreign market out-performance.

Unfortunately, that window slammed shut as money continues to flow steadily out of foreign markets and into the U.S.; pushing domestic markets higher and foreign ones lower.

Our thematic views & their resulting investment implications
Our views are dynamic and evolve over time. We favor following already established trends, as opposed to predicting when existing trends will change. Our views are partly shaped by both market action and what we perceive to be long-term implications of existing trends.

This quarter’s models were created with the following big-picture themes in mind.

I. U.S. Stocks – the best house in a bad neighborhood.
Sporting double-digit year-to-date returns, U.S. stocks remain near the top of the global financial market performance tables heading into the third quarter. While slow and steady company earnings growth has certainly provided a firm undertone to domestic markets, the major drivers to U.S. returns have been continued Federal Reserve money printing and fund flows from overseas investors. Though there will be hiccups along the way, we expect both these trends to continue.

Model implications: very heavy bias towards domestic, versus foreign, equities.

II. Deflation, not Inflation, is the enemy.
From gold’s 30% price drop to the extraordinary weakness in emerging markets stocks and commodities this year, the financial markets are yelling loudly – deflation, not inflation, remains the world’s primary risk.

Unfortunately most global policy makers still don’t appreciate that INACTION FEEDS DEFLATION. For all the talk of creating jobs, our administration has done nothing of real substance. Similarly, steps needed to save the European Union experiment have been known for years, yet are being delayed further until after German elections this fall.

Until our leaders recognize the urgency of the situation, investments aligned with prevailing deflationary forces should be over-emphasized.

Model implications: a continued biased towards high current income and away from precious metals, commodities and emerging market economies.

III. There is no “exit” from quantitative easing.
The following view is based on our interpretations of the facts, as they lie, without a corresponding political bias – so please read it that way!

The only things holding U.S. GDP growth markedly above zero is a combination of government deficit spending coupled with implicit support via Fed quantitative easing policy. Higher cost money is simply not aligned with the current administration’s agenda for social change, so an exit by the Federal Reserve is extremely unlikely to occur until after the next presidential election, if at all.

Is it really a coincidence that Fed Chairman Bernanke is stepping down, with the administration’s support, right at the time he’s proposing we dial back Fed purchases?

Model implications: while valuations look stretched by historical measures, we remain over-weight U.S. stocks. Market volatility will surely increase, but ultimately fund flows will continue into U.S. equities.

Investment Outlook Q2 2013

by Brian Murphy on April 8, 2013 Comments (0)
During the first quarter of the year, Kivalia’s models outperformed their “similar risk” target date benchmarks but fell short of the rip-roaring performance turned in by the U.S. market indices.

Among the world’s developed markets, U.S. stock market indices including the S&P 500 and the Russell 3000 trailed only the Japanese market during the quarter. Yet what the Japanese stock market gave the currency markets took away, as the yen fell nearly 20% versus the dollar.

Current Positioning Cheat Sheet
Here’s what we’re emphasizing within the Kivalia model portfolios this quarter:

I. Foreign Stocks
International large cap value, small cap, and emerging market segments score most attractive amongst all 30 market sectors in our framework, and by a significant margin over all U.S. stock market segments. While we fully expect a bumpy ride, foreign allocations look justified from a tactical perspective. Surprisingly, large cap growth scores fairly poorly at this time and thus remains downplayed throughout the models.

II. In U.S. stocks, small (over large) and value (over growth)
On the whole, U.S. stocks are by no means as cheap as most market commentators suggest – in fact we suspect that over the next decade select income sectors (for example, high-yield corporate bonds) will again outperform the broad stock market averages. Within stocks, Large cap companies have led the U.S. market rally the past few quarters - to such an extent that we now believe small (over large) and value (over growth) are the more opportunistic biases to highlight going forward.

III. For income; favor credit, over interest rate, risk
We continue to avoid developed market government bonds (U.S., European, and Pacific Rim) within the models, as yield suppression by global central banks guarantee limited returns going forward. Instead we remain biased towards high-yield corporates, mortgages and other credit-sensitive income sectors.

Quantitative Easing & The Stock Market

by Brian Murphy on January 18, 2013 Comments (0)

David Rosenberg recently noted that the correlation between changes in the Fed's balance sheet and the returns for the S&P 500 index now stands at roughly 85% - topping the correlation between the S&P 500 index and its constituent company earnings.

While "correlation does not imply causation", a pretty strong case can be made that the two are at least indirectly connected.  I've a hunch Mr. Market isn't going to sit by lightly if and when the Chairman attempts to remove some of that liquidity.


Investment Outlook Q1 2013 - Opportunities In A Dysfunctional World

by Brian Murphy on January 8, 2013 Comments (0)

There are no major sector rotations this quarter, but we’re tweaking our models primarily reflecting our view of improving foreign stock market opportunities contrasted against decreasing domestic potential.

  • In the U.S. we’ve been partial to small caps over large the last few quarters – a bias that’s generally added value. We’re reversing course this quarter, favoring larger cap stocks (specifically value & growth relative to core).
  • We continue to wade back into the developed foreign stock markets and fully expect the European battle between “growth & austerity” (or perhaps “continued bailout vs. alienation”) to continue to play out through 2013, but cheap valuations more than offset these likely flare-ups in our view.
  • Emerging markets remain a secular theme we continue to favor.
  • There continues to be no investment merit in developed market government bonds (U.S., European, or Pacific Rim). Instead we remain focused on mortgages, high-grade / high-yield corporates, and other credit-sensitive sectors.

While the European political/economic landscape seems to have fallen into a wintertime slumber, U.S. leaders are now taking up the reigns – grappling with our own “growth vs. austerity” conundrum, played out against the backdrop of cliffs, sequesters, debt limits and other sinister bogeymen.

The rough and tumble atmosphere surrounding each is just a sideshow. The “true-true” (as taken from “Cloud Atlas”) is that the United States, like every other developed country, can’t afford its debts…and that will eventually come home to roost.

But not yet. The Federal Reserve, indirectly coordinating with the rest of the world’s central bankers, is determined to keep interest rates low; and by low we mean nearly non-existent! In their world this should incentivize investment – in housing, plant & equipment, and oh, incidentally, all forms of speculation. The “true-true” – we’re simply robbing savers, grandma & grandpa, corporate and government pension plans, as a short-term band-aid to a secular problem. We’re blowing bubbles while masking problems in a global economy that, on its own would likely be far worse off…short-term.

From an investment point of view, the only logical direction (again short-term) is to ramp up stockholdings in high-quality companies; those large cap names that can weather the storm.

Value stocks, the Procter&Gamble’s and Coca-Colas of the world have had a nice run, but seem overvalued at this juncture given stagnant developed-world growth. In a tough global economy we anticipate the next run-up to be centered in the “consistent growth” names – as situations where mid-teens growth coupled with below-market risk take on new appeal. Credit card companies, select technology names, and unique situations like Whole Foods, Starbucks, Lululemon, and Chipotle should be favored. In our opinion, deep cyclicals such as oil drillers, mining companies, steel and other commodity producers (and satellite businesses) are to be rented, not owned long-term.

Internationally our preference is with small cap names, but in an extremely diversified manner. Valuations are generally at depression-era levels, and with “bubble-blowing” in full force, have the potential for moderate lift-off over the intermediate term. Owing to valuation, we also favor a moderate allocation to international large-caps, with the expectation that too will be a bumpy ride.

Emerging markets stocks should be a foundation layer of generally between 15-25% of any equity sleeve. Perversely, over the long-term, that’s where we see more stability and growth.

On the credit, or bond side, stay away from developed market government debt – there’s simply no value there. Instead we continue to favor credit-sensitive sectors; corporate high-yield bonds, MLPs, preferred stocks, and a smattering of non-agency mortgages.

And that’s the “true-true”; at least as we see it. Feel free to shoot questions, criticisms and great thoughts. We really do appreciate it!

Magritte, Miro & the 113th United States Congress

Rene Magritte - Golconda

...and the word for this quarter is “dysfunction”. As Merriam-Webster defines it, dysfunction is:

“abnormal or unhealthy interpersonal behavior or interaction within a group”

Sure, we’ve all been exposed to it – whether at home, school or the workplace; and perhaps merrily added to the festivities ourselves. Yet it’s a dynamic that can’t really be taught. It’s a waltz that has to be learned by practice, through years of back and forth movement. Taking a cue from current affairs and melding newfound indignation with historical stereotyping. Ahh, the sport of kings, we suppose.

And the opportunity for mere mortals to witness such widespread theatrics has never been greater than over the past few years…thanks to our governing bodies. Yet, it’s our belief that the European Crisis, Hurricane Sandy, and the Fiscal Cliff are just prelude to the main course set to present themselves over the coming months.

Sad? Certainly. Amusing? Somewhat. But more importantly an endless stream of “content” for the traditional media, a whipped-up source of great angst for investors, and an opportunity for bad ideas to morph into generally accepted “best practices”.

For example - whose idea was it for investors to “take capital gains” before the end of 2012, since tax rates will be increasing in 2013? That passes for good investment strategy…really?

Well, what about foregoing capital gains altogether by simply continuing to hold the shares of quality companies you own? While paying lower capital gains should always be preferred, it seems to me that paying no capital gains trumps either.

So, as the quarter unfolds and we gleefully run face first into the Debt Ceiling discussions, and careen between Japan and Europes insurmountable travails – keep an eye out for bad ideas posing as insightful wisdom…often times the best course of action is to do little more than sit back and enjoy the surreal.

Joan Miro – Composition 1933


401(k) | General

Investment outlook Q4 2012: still the "cleanest dirty shirt"

by Brian Murphy on October 8, 2012 Comments (0)

Here’s a quick rundown of the biases we’ve built into our model portfolios for the last quarter of 2012.

  • In the U.S. large cap portion of the market, our foray into value over growth last quarter proved short-lived.  We’re back to focusing on large growth this quarter.
  • U.S. small & mid-cap market sectors remain attractive in a global economy where the U.S. remains the world’s “cleanest dirty shirt”.
  • We’re retaining only limited exposure to developed international markets, preferably under-weight relative to typical target date, and passively managed global equity, funds.
  • Emerging markets remain a secular theme we continue to favor.
  • Global government bonds continue to offer no value for longer-term investors.  Instead we remain focused on mortgages, high-grade and high-yield corporates, and other credit-sensitive sectors.

Despite the strong performance of stocks this year, this is an unusually difficult and nuanced environment for professional investors.  Often considered the smart money, hedge funds as a whole have vastly under-performed the broad market indices this year.

By and large, they’ve positioned their portfolios defensively, in-line with a slowing economy, but in direct opposition to central bankers who remain dedicated to fighting global deleveraging.  To date, central bankers are winning.

As investors, we all know central bankers excessive incursions will end badly as surely as we know we won’t be around in 200 years.  We also know the end takes a long time in coming, but when it arrives happens seemingly overnight.  By necessity, investing today, in an era of increased central bank intervention, entails expressing a strategic view on how, and perhaps when, change comes.

Our approach is simple – if we focus on when change will arrive, we’ll fare no better than most of the macro-focused hedge funds; poorly.  Instead we’ll focus our advice on how to best ride through expected turbulent events that can’t be timed – managing the prevailing risks using a disciplined approach.

As we look at the global investment landscape heading into Q4 2012, a few themes stick out to us.  First, as bad as things are here in the U.S., they are worse in Japan, Europe and perhaps China.  As Bill Gross of PIMCO fame says, “We’re the cleanest dirty shirt in the laundry bag”.  As such we’re positioning our models predominantly in U.S.-domiciled securities.

Second, while the U.S. is arguably in better shape than our developed global counterparts, lower growth overseas suggests that U.S companies with strong international presence tied to cyclical recovery should be heavily downplayed.  Valuations within the large-cap value sector are seemingly attractive, but likely to get more so in a sagging global economy as downward earnings revisions take their toll.  Hence our bias is once again for companies that have a very high probability of showing consistent, double-digit growth – most of which make up the major large cap growth indices.

Further, although perhaps unintuitive, we believe valuations coupled with the domestic focus of most mid/small cap companies make them ideally suited to perform in a Fed-juiced environment.

In bonds we remain partial to market sectors that remain devoid of Fed intervention including non-agency mortgages, corporate bonds (both high-grade and high-yield) and smaller, more illiquid sectors like REIT preferreds, mortgage REITs and MLPs.  We’re neutral on emerging markets bonds at this time.

So, hold your head up, and play through – we’ve got your back, and valuable ideas for how to best position your retirement account.


401(k) | General

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