Portfolio Newsletter 2Q 2014

This year has been a tale of two extremes. The U.S. stock market continues to shrug off any bad news as it marches toward new highs. At the same time, interest rates continue to fall despite renewed Fed tapering and the fact they will eventually increase interest rates.

The Fed’s purpose in continuing to maintain a zero interest rate policy is to entice and reward investors for taking risks. It’s paying off – at least for the time being – as people begin to believe this Fed induced stock market rally has only just begun.

After nearly three years of growth, the market hasn’t even experienced so much as a 10% correction. This rare occurrence has only happened four other times throughout history. It’s easy to see why investors have become complacent. And as more boomers retire in the years to come, this seemingly never-ending market rally couldn’t come at a better time.

If the Fed can manage to slowly raise interest rates, they will have successfully turned the economy around. This won’t be an easy task.

Over the past 3 years, consumers have taken on more debt, which is actually a sign of a healthy economy. However, consumers now accustomed to low interest rates could very easily balk when higher rates eventually hit. This could lead to a potential slowdown in consumer credit markets. In general, when consumers finance less, the economy will perform poorly. In turn, this can negatively affect stock prices.

All portfolios are hitting their averages this year. In terms of performance, they remain on par with their retail peers.

In terms of risk, the portfolios are 25% less risky, on average (when comparing the Beta), than their retail counterparts. All portfolios are well diversified and well positioned to deal with systemic shocks, such as a 10%+ correction or rising interest rates.

On another note, I’ve recently been conducting research to improve the mutual fund selection criteria by pouring through sector data on all the 3,000+ mutual funds I have access to through Charles Schwab & Co. Each mutual fund invests in 10 sectors. The mutual funds are required to report the percentages of the 10 sectors in which each of the underlying stocks are invested.

The process of researching this data involves taking into account where we are in the economic cycle, as well as determining which sectors usually perform well at this point in the cycle. I then monitor how the funds with higher than average concentrations in those sectors perform.

So far the research has led to positive results. The overall goal is to incorporate this new information into the mutual fund selection criteria model by the end of the year. The expectation is to generate a few extra percentage points in annual return without sacrificing risk. I’ll keep you posted on my findings.