AEPG's 2015 Global Economic & Market Outlook Tuesday, January 27th at 7pm

As we begin our journey through what is likely to be a very interesting 2015, there are a number of positives and potential tailwinds for the global equity markets. Economic growth continues to improve in the U.S. despite the end of Federal Reserve inspired quantitative easing, driven by the repairing employment and housing markets and healthy corporate balance sheets. Tailwinds include significantly lower oil prices which provide a “tax cut” of sorts for the U.S. and developed market consumer and the likely implementation of a much larger quantitative easing program in Europe. This could put the Europeans on the same path to recovery that we have experienced in the U.S. over the past few years.

However, given the unpredictability of the markets and unforeseeable circumstances, we still believe strongly in creating and maintaining a well-diversified global portfolio for our clients and helping clients stay invested for the long-run. Why is diversification so important? Well, one glance at The Wall Street Journal’s Moneybeat Year-End Roundup by Paul Vigna clearly depicts the events that transpired in 2014 and the impact on market volatility.

In 2013, markets had their best performance in the past five years. However, 2014 was somewhat of an unpredictable year. At the end of 2013, Barron’s surveyed their top 47 economists/strategists for their predictions of interest rates in 2014. All but one predicted that interest rates would rise in 2014. The 46th predicted that interest rates would remain flat. Believe it or not, all 47 got it wrong!

46 predicted that interest rates would rise in 2014 and the 47th predicted interest rates would remain flat, but interest rates did in fact fall.

By the second week of January 2014, after the confirmation of the new Federal Reserve Chief, Janet Yellen, the market started to sell off with the prospect of reduced stimulus and rising rates considered a given for 2014. At the end of January 2014, the global markets were down just under 4% and the conversations we were having with clients at the time were more about protecting the 2013 gains. Many clients noted the prospect of mid to upper single digit return would be great.

Then the markets had four more scares:

• In March, the Russia/Ukraine conflict escalated, and U.S. stocks declined 4%
• In August, U.S. and foreign banks were fined, and U.S. stocks declined 4%
• In October, we had the Ebola scare, and U.S. stocks declined over 7%
• In December, global growth concerns surfaced, and U.S. stocks declined 5%.

Each of these events resulted in more conversations with clients regarding the safety of their portfolios.

However, despite several geopolitical scares, the Wilshire 5000, the broadest measure of U.S. stocks, finished the year up over 12%, almost half of which came from a strong 5% return in the final three months of the year. This highlights the importance of staying invested. If investors sold on one of the event induced declines, they would have missed out on the continued upward trend.

2014 was also a year of strongly diverging returns. Even within the U.S., the difference between the heavily followed large cap indices and lessor known small cap indices was almost 10% with the S&P 500 up 14% and the Russell 2000 (small company stocks) up 5%.

The differences were even more striking when looking at international versus U.S. stocks as international as a whole finished down 4% with almost all the decline coming in the last quarter of 2014. The total world stock market, including the U.S., was up 4% percent last year, including a rise of 0.6% in the fourth quarter. European stocks declined over 8% and emerging market stocks declined 2%. However, some of the standouts posting gains were Argentina (19%) and India (24%). Driven by plummeting oil prices, by far the worst asset class for 2014 was commodities and commodity-related investments, down 33% as measured by the Goldman Sachs Commodity Index.

This is one of the negatives of having a globally diversified portfolio. For an investor who owned a diversified portfolio, his or her performance suffered because being diversified means having some exposure in these investments. When foreign stocks are down compared with the U.S. markets, U.S. investors tend to look at their statements and wonder why they’re lagging the S&P index that they see on the nightly news.

But that’s the point of diversification: when 2014 began, the U.S., international and emerging markets all had varying degrees of promise and most (if not all) investors were certain bonds would perform poorly. Diversification is a prudent strategy for long-term investors because forecasting trends is difficult. Getting the timing right on a continuous basis is nearly impossible. When you are truly diversified, all assets will not move in the same direction or rise together at the same rate. If the weather forecast gives you 50/50 odds of rain, shouldn’t you bring both your umbrella and your sunglasses? Yet behaviorally, humans are wired to focus on the negative.

Research shows that global diversification is an important tool for risk reduction. We do offer a U.S. only growth portfolio, but recommend using it to very few of our clients and instead recommend our global portfolios, (70%/30% U.S./global). Global portfolios have underperformed U.S. centric portfolios for five of the last six years. However, forty plus years of global market returns show that over the long term, global portfolios perform as well as or better than U.S. centric portfolios, but with lower average volatility and, hence, better risk-adjusted returns and a smoother ride. The problem is that there are periods of significant differences in the U.S. and international performance which often leads to investors changing their strategies at the wrong time.

2014 was a year where, in general, passive investing outperformed active investing. In other words, the indices beat the managers. An abnormally low percentage of active mangers (less than 20%) beat their benchmarks in 2014.

Besides interest rates falling when every expert and amateur alike thought they would rise, other strange anomalies occurred last year. Most expected good earnings and growth with an improving economy which is actually how things played out. Despite this, conservative and defensive stocks rose the most while the more growth-oriented stocks struggled. The opposite of what one would logically expect. Utilities, consumer staples and health care stocks (considered more defensive-oriented stocks) were three of the best performing sectors in 2014, while consumer discretionary, materials stocks and energy stocks (considered more cyclical/growth-oriented stocks) were three of the worst performing sectors. This can happen over short time frames and we do expect that our view on the economy will continue to play out and that eventually this will flow through into the equity markets.

As we look forward to 2015, we are optimistic. There are a number of positive factors that should allow for continued economic improvement which should filter through to good stock market performance. However, we still believe in bringing an umbrella to protect against potential storms because we wouldn’t be surprised to see market pullbacks or a correction in 2015.

Please read our 2015 Global Economic & Markets Outlook containing a summary of our thoughts for 2015.

Attend our Global Economic & Markets conference on Tuesday January 27th to learn more.

As always, we also encourage review meetings with your wealth advisor to discuss your personal portfolio.

About AEPG ® Wealth Strategies:

www.aepg.com

For over 30 years, the clients of AEPG Wealth Strategies have benefitted from personalized, comprehensive wealth management and financial advisory services. Our services to individuals, business owners, physicians and corporations include: Financial Planning, Investment Management, Individual Insurance, Group Insurance, 401(k) and Retirement Plan Solutions.