It has been an interesting year, to say the least. On the geopolitical front, things have been heating up all year and have recently – and very sadly – reached a boiling point in Paris last Friday. At the same time, after seven years of subpar global economic expansion, parts of the world have experienced a deceleration of growth – namely China, Japan and the US. Lastly, the Federal Reserve stands committed to raising rates in the near future, which effectively will reduce economic growth even more. Given all of these negative data points, it is surprising to us that global stock indexes are almost exactly where they began one year ago today. That’s right! No progress – but lots of volatility! What does this mean for markets going forward?
As our team examines global economies and corresponding stock indexes, one thing is obvious: though stock indexes have held up, the underlying sectors of the market have, one by one, begun to falter. One can simply look at the catastrophic decline of material and energy stocks (none of which we have owned) over the last year as a great example of the underlying weakness that exists in some of the economic sectors. Industrial stocks and consumer discretionary stocks (which we reduced during the summer) are two of the most recent sectors to underperform. As a result, fewer and fewer sectors and stocks are holding the indexes up – which is historically a sign of an aging bull market. However, this condition can last for quite some time offering opportunities in those sectors that continue to perform well. Often, this condition ends with a decline of all stocks and indexes and the normal cyclical bear market.
As you may have noticed, we have been actively making your portfolio more defensive this year. Depending upon your investment policy statement and our conversations, you have less stock exposure, and a collection of more defensive stocks – companies whose fortunes are not tied to economic growth. Think consumer staple companies: baby powder, Band-Aid and toothpaste. You also own some unique companies that, given their business strategy, have been able to succeed in this environment, specifically in technology. We believe that this mix of companies should provide respectable upside should global markets continue higher.
Given the reduction of your stock exposure, we have increased your allocation of utility stocks and preferred stocks which are much less correlated to the stock market and serve as an attractive alternative to the bond market, which is still not providing enough yield to be worthwhile.
This more defensive posture is not a long term strategy, but one that has served us well prior to previous bear markets or periods of very slow economic growth. The Federal Reserve will eventually raise rates – probably a number of times – which may make the next few quarters challenging for investors. Of course, at the first sign that current risks abate, we will actively get more growth oriented for you…and we look forward to doing so! In the meantime, we will continue to manage your portfolio’s risk through your overall allocation to stocks, sector exposure and the use of carefully placed stop loss orders.
We hope this update finds you well. If you have experienced any change in your financial circumstances or have questions, please let us know.
As always thank you for your vote of confidence in our work – Happy Thanksgiving from all of us to you and your family!
Sincerely,
Your Team at Main Street Research