2014 was an extremely challenging year in managing a diversified portfolio. In the end, US equities delivered superior returns compared to most other investment opportunities. Extreme volatility returned to the capital markets during the entire 2nd half of the year, and in particular, during the fourth quarter which included minor corrections in early October and early December followed by strong relief rallies during the months of November and late December. A huge draw down in the global price of oil was the main culprit, responsible for the ensuing market volatility which was further exasperated by weak foreign currencies. An accommodative Federal Reserve also played a role in the appreciation of non-commodity assets.
Equity Markets 4th Quarter
International Developed and Emerging markets have continued to struggle with negative quarterly returns of (- 3.04 %) and (-5.25%) respectively. Both indexes ended the year with full year over year declines of (-7.35%) and (-4.62%).
The Bond and Credit Markets
At the conclusion of its December 17th meeting, the Fed once again kept the Federal funds rate unchanged at just 25 bpts and delivered a message that juiced the equity markets going into the final sessions of the year. “The committee sees this guidance as consistent with its previous statement that it likely will be appropriate to maintain the 0 to ¼ percent target range for federal funds rate for a considerable time following the end of its asset purchase program in October, especially if projected inflation continues to run below the Committee’s 2 percent longer run goal, and provided that longer term inflation expectations remain well-anchored”.
The 10 year Treasury note and 30 year Treasury bond yields declined back to 2012 levels and consequently ended the year with yields well below 3%. (2.17% and 2.75% respectively). This was the reverse of the 2013 direction which most economists and market strategists missed.
The Barclay’s Aggregate Bond index rose 5.97% during 2014 including an advance of 1.77% in the fourth quarter. The municipal bond market recovered from a poor 2013 with a 9.05% advance, 1.36% coming in the fourth quarter. High Yield bond’s (plus 2.45% ytd) relatively poor performance was somewhat attributable to its exposure to mining, gaming and energy issuers.
Alternative & Commodity Update
Gold and precious metals stabilized during 2014; however, they continued on a downward trend going back to calendar year 2012. Gold, which began the year at $1,218 ended the year at $1,183, a modest decline of 2.8%.
Real Estate Rise
The unexpected decline in interest rates during 2014 helped real estate investment trusts outperform the broad stock market by a wide margin.
Oil, which began the year at $98.50, peaked in late June near $110 before falling off a cliff the Friday after Thanksgiving. (More than $10 in one trading session). Oil finished the year below $54 per barrel, a shocking peak to trough decline of over 50%.
U.S. oil and gas companies have been an engine of growth through much of an otherwise lackluster economic expansion, providing steady employment, solid wages, and fierce competition for workers across wide swaths of the country.
In addition to the slowing demand from Europe and China, the US energy renaissance is partly responsible (as well as OPEC) for the current world over supply of oil. The US transformed itself in a relatively short period of the last five years, into one of the world’s largest oil producers. While this expansion has been a main driver of the US economic recovery, it may now act as an impediment in the near term. Now, after a roughly 50% plunge in oil prices, exploration and production companies are cutting capital budgets, service companies are weighing layoffs, and energy firms that popped up to support the industry are bracing for a protracted slowdown. This may have some dampening effect on the US Economic recovery in 2015, although for most of the economy the steep drop in gas prices is akin to a huge tax cut.
Many of our clients have exposure to energy related equities and in particular MLP Infrastructure investments, and may be wondering why we have not only decided to keep MLP allocations, but in certain cases have actually been increasing our weighting. Here is why: energy infrastructure holdings (midstream) such as oil and gas MLPs, receive cash flows that are more driven by commodity volume than by commodity pricing. In short, retail investors in many cases just sold anything that had the word energy associated with it. The recent weakness in performance of MLPs, in our view, is a short term set back. Conversely, our firm is willing to have these cash flow investments weigh on overall returns now, for bigger gains down the road, once oil stabilizes.
In a recently released report by Goldman Sachs, oil was forecast to stabilize in the range of $80-$85, far above where it presently trades (below $50). In addition, they estimate nearly $1 trillion of energy infrastructure spending through 2025, which means more pipelines, more cash flow, and more growth.
We did it!
We are really happy with our new office configuration. Please stop by and we will be happy to give you a personal tour.
In a regular rebalanced portfolio, an investor is constantly adding out of favor assets while trimming expensive ones. Over time it will deliver superior risk adjusted returns. It just takes some courage and some patience. For the 2nd year in a row US Equities continued to outperform most major world equity markets by a wide margin. According to Bloomberg TV, such a large disparity in returns such as in 2013 and 2014 has only happened three other times in the modern era. In all cases, the International markets outperformed in the third year. Please keep that in mind when reviewing and evaluating your own foreign investment allocation.
We wish you and your family good health and fortune in 2015.