Winter 2015

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Market Overview


Heading into 2014, everyone braced for a significant market pull-back and for interest rates to continue to rise. Instead, last January’s stock market retreat quickly reversed itself and interest rates steadily declined through the year. When we analyze the returns for the year, it turned out to be a solid year for the core asset classes of equities and bonds, despite increased volatility in the stock market and greater dispersion of returns among styles and market caps.

The U.S. dollar at its current high value compared to other currencies had a major impact on international managers and was a significant drag on the performance of managers who were not properly hedged. On the bright side, 2015 may be the perfect year to go travel abroad and take advantage of the strong dollar.

In late summer, the oil supply and demand became the top story and continues to be in the headlines as the price of oil has dropped in half. Such a decline is expected to boost consumer spending and soften inflation in the long run. Unfortunately, the drop has hurt assets and strategies that are dependent upon a stabile energy market.

2015 started out with a surprise when the Swiss National Bank changed its stated course and abandoned a three-year-old cap on its currency. As a direct consequence, the Euro and equities across the world dropped in value while the Swiss Franc’s value surged. According to at least one market analyst, this might have been the first time that a G10 currency went up 16% in a single day.

Low oil prices, the strong U.S. dollar, and the policies of central banks could play major roles in shaping the 2015 investment experience. The move of the Swiss National Bank demonstrated that investors can no longer rely on promises made by central banks or other institutions that have the power to shape the investment world. It also showed that previously low-risk considered investments can quickly turn into high-risk disasters. It also appears that several influential central banks may no longer pursue similar policies, which could create opposing pressures in the markets. If you add international crisis, such as armed conflicts and natural disasters, to the mix, predicting market moves is as difficult as ever.


Investment Strategies

The following are a few thoughts on different asset classes based on the current environment.

Fixed Income - With European Central Bank and Japan jumping “all in” on “Quantitative Easing,” and despite warnings from the Fed that a rate increase is looming during the second half of the year, U.S. Treasuries remain the preferred capital preservation asset as Treasury yield continues to decline. With the U.S. dollar continuing to increase in value, the U.S. bond market may have another good year. However, short-term bonds would be negatively affected with a Fed Funds Rate increase and we could be looking at another 2013 with negative total returns on fixed income portfolios. Foreign investors can benefit from the relative strength of the U.S. currency and possibly higher rates. Despite comparable high rates, the U.S. 30-year Treasury bonds yielded an all-time low of about 2.45% towards the end of January (based on an over 300-year history). To target decent rates, investors are forced to take higher risks.

Enhanced Yield - These past few years, many higher yielding bonds have followed the stock performance rather closely with less risk exposure as a study by J.P. Morgan revealed. Unfortunately the high yield sector is highly correlated with the energy market and took a hit late in the year with the decline in the price of oil because energy companies make up a significant percentage of the high yield bond market. The asset class ended the year in positive territory, but investors remain cautious as to whether to jump back in based on attractive yields, such as 7%, or remain on the sideline and wait for a more solid bottom.

We also continue to invest assets in private debt transactions with strong collateral and other strategies that capitalize on the inefficiencies in the lending market. This market had a very solid year, but it appears banks are starting to loosen the purse strings to compete with the private capital. Such a move could prove detrimental to this area of the market as opportunities for private capital dry up, but it could also be very positive for the economy.

Equities - With U.S. stocks leading the rebound in 2013, many experts thought 2014 would be the time to reallocate domestic investments abroad particularly to emerging markets. Despite popular opinion, U.S. stocks outperformed again—especially large cap companies. Managers who diversified into small cap and foreign companies lagged the strong performance of the S&P 500. Emerging markets struggled and may continue to struggle with many investors looking for safety in the strong U.S. dollar. For the first time in 25 years, the U.S. dollar increased in value in 2014 compared to all of its 31 major counterparts. That means no other country offers the strength that investors can currently find in the U.S. But it also means that profits for exporting companies in the U.S. suffer. Approximately 50% of the profits generated by the companies in the S&P 500 come from outside the U.S. Some companies will benefit from the strong dollar and others will suffer. Picking the right companies will take skills, which means 2015 could be the year for any lagging active managers to make up ground. It may also be the year to diversify internationally.

Real Estate - With the steady decline of interest rates during 2014, publicly traded REIT funds had a banner year (up over 30% on average). With interest rates and cap rates back down to historic lows, REITs appear to be an asset class that may be ready for an underallocation of your portfolio. Private real estate also had another solid year. Multi-family housing benefitted from low mortgage rates, low cap rates, and a housing market that is still below needed supply in most markets. Commercial and Industrial properties benefitted as companies continued to hire and expand into new space for employees and storage. We have always favored investing in private real estate over public due to the inefficiencies in the market. For instance, we’ve recently been investing in the Reno, Nevada, markets where both housing and commercial real estate are booming from the inflow of corporate activities from companies like Tesla, Amazon, Petco, and Switch, just to name a few. Despite values appearing expensive in most asset classes right now, we still feel there are opportunities in private real estate due to inherent inefficiencies of this market.

Commodities - The energy market as a whole has dropped close to 30% since last June. Oil prices have dropped almost 60% during that same period. The main reasons for the drop in oil prices have been excess supply with somewhat weakened demand. Most analysts expect oil prices to stay low at least until June, when OPEC has its next meeting. Interestingly enough, market experts are sending conflicting messages. The Saudi Arabian prince, billionaire, and businessman Al-Waleed bin Talal said at the end of January that we will never again see oil trade above $100 a barrel. A few days later, the OPEC Secretary-General speculated that we should see a rebound in oil prices very soon. He then added that prices could climb to $200 a barrel or higher, but he didn’t offer a timeframe for such a scenario. Although commodities can offer a nice addition to a portfolio, we would not over-allocate to this asset class in the near future. We continue to hold our positions in MLPs as we expect this sector to be less volatile than investments with direct exposure to oil and gas prices.

Managed Futures - This asset class finally kicked back into gear during the second half of 2014. The Princeton fund was up over 14% during the second half of last year and over 7% for the year. This year, it is up over 2.8% in January alone. Some traders speculate the sudden appearance of sustainable trends is due to “Tapering” and the Fed ending the most recent round of Quantitative Easing. With the onset of Quantitative Easing by both Japan and the European Central Bank, one would question whether volatility will increase and those trends will disappear. Historically, managed futures tend to fare better during higher interest rate periods. We still believe a small allocation to this asset class can help reduce volatility in the portfolio.


Disclosures: This commentary is submitted for the general information of Cornerstone Wealth Management, LLC clients and may not be distributed to other individuals. This commentary is not deemed to be investment advice and information contained herein may not be current. An investor should consider the investment objectives, risks, charges, and expenses of each investment carefully before investing. For more complete information, you may contact us at 858-676-1000. Past performance is no guarantee of future results. Individual performance may vary and investment performance numbers may not be audited. The information provided herein from third parties is obtained from sources believed by Cornerstone to be reliable, but no reservation or warranty is made as to its accuracy or completeness.

Cornerstone Team Notes