In recent weeks there have been two significant discussions in regard to the investment landscape: the first is in regard to US interest rates, the second is related to signs of economic recovery in the euro-zone. Each of these, in addition to the aging bull market, may have significant implications for investors over the next 18 months.

Interest Rates
In regard to US interest rates, there is a growing consensus that they are headed higher. This is mostly fueled by Federal Reserve commentary stating that “if” the US economy gets “meaningfully stronger” they will cease taking action to keep rates low. There has been no commentary from the Federal Reserve about actually raising rates. We have a few thoughts about this. First of all, the consensus in the short run is usually wrong. In addition, a “meaningfully stronger” economy may be further away than today’s investor appears to anticipate. Regardless of our opinion, in fear of a potential rise in interest rates, many investors have liquidated bonds and other yield-like securities, in an effort to do so before the Federal Reserve actually raises rates (which would have the effect of temporarily reducing the price of these securities). Our research indicates that the recent selling (which by itself has caused the value of these securities to decline) is most likely premature. Once investors recognize that the economy is in fact further away from “meaningfully stronger growth” there will be most likely be a reversal of this short term trend. Just one weak employment number would probably do the trick! In the longer run, (which used to be measured in years but now months) rates will eventually move significantly higher and yes, as we approach this period it is wise to reduce holdings in interest rate sensitive yield securities — just not quite yet.

Euro-zone Recovery
The good news for those of us who are global investors is that the largest euro-zone economies, including France, Germany and Britain, have reported economic data indicating that the worst of the economic decline may have past and that a real economic recovery may be in progress. In addition, high quality euro-zone stocks (many of which you own) have begun to outperform their US counterparts in a fashion that is reminiscent of the beginning of the recovery in 2009. Our research indicates that this is not a short term phenomenon. High quality European companies are selling at much cheaper valuations (price/earnings ratios) than US shares and economic and earnings growth rates are positive for the first time since the crisis in 2011. Though US stock indexes were ahead of global markets recently, that margin has narrowed significantly as euro-zone stocks are gaining the attention they deserve. We believe that this theme will give the global investor attractive returns as opposed to those that invest solely in the US.

The Aging Bull Market
Many have questioned the longevity of this global bull market since its inception in 2009 (even we did briefly in 2011!) and more than an average number of investors continue to do so. This lack of participation has caused the amount of money market and bond funds to be higher than average. Given the still reasonable valuation of stocks — this includes US stocks, but particularly European shares — there is room for stocks to move higher and certainly enough investor cash on the sidelines to get them there.

There is always the risk that our cautiously optimistic case could be de-railed by an unexpected recession, geopolitical disturbance or alien invasion. Therefore, we make an effort to manage these risks through your portfolio’s asset allocation, sector exposure and the use of carefully placed stop loss orders, all of which are intended to mitigate the risk of catastrophic loss.

We hope this update finds you well. If you have any questions for our team or have experienced any significant changes in your financial situation please let us know. As we celebrate our 20th year in business, all of us thank you for putting your confidence in our team.

Sincerely,

Your Team at Main Street Research