If MCS clients were one large portfolio, the year-to-date return through June 30th was 5.5%. Individual client returns ranged between 1.7% and 9.8%. Auxier portfolios, on average, gained 3.2%. For comparison purposes, the S&P 500 Total Return index gained 7.13%, and the Barclays Aggregate Index gained 3.92% in the first half of this year.
The difference in client returns is to be expected. While risk tolerance is very similar, the lowest client return is attributable to a new client coming in with cash, who is not yet fully invested. The highest client return is attributable to a client that had inherited many low cost basis stocks which we were comfortable holding for both investment and tax reasons. No two client households have the same portfolio. Client relationships begin in different market environments. For example: a client who started with us in early 2010, or who made substantial deposits at that time, got tremendous returns when I took advantage of the panic in municipal bonds that unfolded in the 3rd and 4th quarter 2010. New clients coming in over the past year or so have faced a more limited set of market opportunities and greater risks; today’s investment environment offers no bargains.
While many investors feared a decline, the second quarter saw stock prices slowly climb a wall of worry with few setbacks. The gain in stock prices which didn’t take hold until mid-May has been driven primarily by the continued decline in interest rates through the second quarter. See Figure 1, below.
2014 Ten Year US Treasury Bond Yields
Factors underpinning low US interest rates are: 1.) tepid US economic growth, 2.) ultra-low interest rates on comparable 10 year European (France 1.6% / Germany 1.2% / Spain 2.6% ) and Japanese ( 0.54%) bonds making US Treasury bonds at 2.50% look ‘attractive’ 3.) Investors buying US bonds due to geopolitical turmoil.
Both the stock and bond market appear expensive and are reliant on low rates to justify current prices. Here is a comparison with peak stock prices in 2007. See Figure 2, below.
Since the beginning of 2014, 80% of stock gains have been due to an expansion of the PE and in the second quarter 95% of gains were due to expanding PEs not earnings growth (source: UBS report July 17). This PE expansion is consistent with a decline in interest rates. The above should be considered a flashing yellow caution light; low interest rates are playing a very significant role in underpinning stock prices. Unfortunately, warnings about stock value do not offer any precision about timing when to get out. The above caution tempers my enthusiasm to add more stock exposure now however, given the likelihood of a prolonged period of low growth and low interest rates, the caution is not enough to convince me to sell stocks. The point is that any change in interest rates should not be assumed to affect only bond prices. Stocks and real estate prices reflect continued low interest rate assumptions too.
Lastly the Middle East appears to be burning out-of-control; risking further increases in oil prices which would have a negative impact on most economies and stock prices. Conflict resulting in higher oil prices helps the oil export driven Russian economy. This has implications for Russian policy in the Middle East and Crimea.
Strategy: continue to be highly selective with any investment buys; keep cash on hand for opportunities when events go wrong and investment prices are lower. Be patient.
1MCS Family Wealth Advisors (MCS) client returns are dollar-weighted, net of investment management fees unless stated otherwise, include reinvestment of dividends and capital gains and represent all clients with fully discretionary accounts under management since 12/31/2013. These accounts represented 99% of MCS’s assets under management as of 06/30/2014 and were invested primarily in US stocks and bonds (19% of the Income/Growth assets on 06/30/2014 were invested in tax-exempt municipal bonds). The Stock Index values are based on the S&P 500 Total Return Index, which measures the large-capitalization US equity market. The Bond Index values are based on the Barclays Capital US Aggregate Bond Index, which measures the US investment-grade bond market. Index values are for comparison purposes only. The report is for information purposes only and does not consider the specific investment objective, financial situation, or particular needs of any recipient, nor is it to be construed as an offer to sell or solicit investment management or any other services. Past performance is not indicative of future results.