View from the Top

1Q 2013

We concluded our last quarterly summary by noting “there will be plenty of good that can be done in 2013”. Although this statement related primarily to the perceived benefits of comprehensive wealth management, the market’s continued strength surely provided some incremental support. By the end of March, most U.S. headline stock indices (S&P 500, Dow Jones Industrials, and the Russell 2000) had eclipsed the previous highs of October 2007. Yet again, the financial markets confounded the expectations of the crowd that thought gains could only follow some “grand bargain” designed to resolve the long-term structural issues present in today’s world.

Given that we now find ourselves at new heights, the titling of this commentary seemed appropriate. For anyone that’s ever spent time in the mountains, you’ll understand that there are many observations that can be made from the summit. The most obvious is the unfettered view of the valley from which you ascended. In the case of global stock valuations, this took place roughly four years ago and it’s admittedly been a challenging period of wealth recovery for many investors. That said, we find it both encouraging and satisfying to have come through an environment of unrelenting concern and doubt.

Of course, there may be some “forward thinkers” out there that believe we are now poised for a symmetrical descent. Judging from the bulk of content that we’ve witnessed, an appreciating or elevated market has certainly given the industry’s pessimists something to talk and/or write about. We believe, however, that it’s critically important to understand the many positive differences that exist between today’s market and that of late 2007. We would specifically point to: higher corporate earnings (lower valuations), stronger corporate balance sheets (ability to reward shareholders or internally fund growth), and the Federal Reserve’s aggressive and ongoing policy accommodation (creating a better relative return opportunity versus cash & bonds). While we cannot rule out, and would actually expect, an eventual pull-back in global stocks, it’s not current fundamentals that are worrisome.

What remains somewhat eerie is the market’s measured volatility (or really the lack of it), as global stocks have marched consistently higher for 9 of the last 10 months. On a relative basis, the “fear gauge” is currently checking in at 1/7th its all-time peak during the financial crisis in October 2008, and less than 1/3rd the levels obtained during Greece’s initial flare up (May 2010) and also following the U.S. debt ceiling debate and credit rating downgrade (August 2011). Perhaps it’s important to remember that the market often reacts to deviations from investor expectations. With the consensus opinion already somewhat guarded, it’s less likely that we’re shocked by Cyprus or North Korea.

Focusing now on international markets specifically, it’s worth noting how performance overseas lagged during the first quarter. As can be observed from the asset allocation structures we recommend, non-U.S. companies generally make up around 40% of all equity exposures. Our ongoing belief in the multiple sources of diversification justifies this position. Currency is one such factor, although it has detracted year-to-date as the U.S. Dollar strengthened against the Euro and especially the Japanese Yen. Timing of events is another factor, and it’s important to remember how international securities outperformed in the final part of 2012 as we digested the national elections and considered the “Fiscal Cliff”. Notable variations in growth patterns, is also a key element of diversification through time.

Fixed Income, with the exception of certain more risky categories, generally struggled during the quarter given persistently low yields and modest interest rate volatility. Despite this reality, we believe a managed, multi-strategy bond approach will continue to deliver acceptable risk-adjusted returns going forward. Where applicable, we have remained vigilant in our stock-tobond rebalancing discipline.

The successful stewardship of wealth requires preparation, care, and an understanding of context. It’s a fact that very few people in this world can afford the certainty we all want. However, when you factor in the overwhelmingly favorable outcome of being consistently engaged in the financial markets over time, the risks of being out of the game are huge compared to the risks of being in it.