Just a note on what worked and what didn’t in July, because August looks like more of the same.

Quality, large cap companies performed well; leveraged firms did not.

  1. Why? As economic fears resurfaced, investors preferred firms with more solid balance sheets.Higher quality bonds outperformed lower quality bonds of similar duration (handily).

  2. Why? Greece, China contributed to a risk-off mindset.Capitalization weighted funds beat equal-weighted fund with the same objective as large company stocks beat small and mid-cap stocks.

  3. Why? As many active funds continue to struggling versus the major indices, investors are switching to passive. Those switches reinforce index performance relative to funds whose average cap is lower – especially value funds.Europe outperformed Asia by a considerable margin.

  4. Why? Greece is insignificant; China is not!Frontier markets outperformed emerging markets.

  5. Why? China and Chinese exposure are currently a negative.Currency –hedged foreign fund beat non-hedged foreign funds.

  6. Why? The dollar continues to be strong anticipating a rate hike this fall.“New economy” stocks crushed “old economy” stocks.

  7. Why? Those who are able to create or deploy productivity enhancing products are doing well; those leveraged to the commodity cycle are hurting. The strong dollar is a big factor.“Risk off” industries like utilities and consumer staples beat risk on industries like industrials and materials.

  8. Why? See first two notes on quality above.Growth beat value by a wide margin.

  9. Why? Fewer firms and fewer industries are experiencing organic growth – as opposed to growth supported by balance sheet manipulation. Those firms are commanding a higher multiple. Past performance is no assurance of future results. Trademark Financial Management, LLC (“Trademark”) is a registered investment adviser with its principal place of business in the State of Minnesota. Trademark and its representatives are in compliance with registration requirements imposed upon investment advisers by those states in which Trademark operates. Trademark may only transact business in those states in which it is registered or qualifies for an exemption or exclusion from registration. This newsletter is limited to the dissemination of general information pertaining to its investment advisory/management services. Any subsequent, direct communication by Trademark with a prospective client shall be conducted by a representative that is either registered or qualifies for an exemption or exclusion from registration in the state where the prospective client resides. A complete list of all recommendations will be provided if requested for the preceding period of not less than one year.   It should not be assumed that recommendations made in the future will be profitable or will equal the performance of the securities in this list.  Opinions expressed are those of Trademark Financial Management and are subject to change, not guaranteed and should not be considered recommendations to buy or sell any security. For information pertaining to the registration status of Trademark please contact Trademark at (952) 358-3395 or refer to the Investment Adviser Public Disclosure web site (www.adviserinfo.sec.gov). For additional information about Trademark, including fees and services, send for our disclosure statement as set forth on Form ADV from us using the contact information herein or by calling 952-358-3395. Please read the disclosure statement carefully before you invest or send money.

  1. Commodity prices were weak when July began and they’ve plunged sharply over the past two weeks (before catching a small bounce over the past two days). The high commodity prices of 2010-2012 influenced massive capacity additions from oil to potash to iron ore to gold.  Capacity takes years to add in these areas, so we’ve been seeing the new supply continue to come on line and prices continue to weaken.  Michael Filloon wrote in Seeking Alpha<1> about the improvements in fracking technology.  Fewer wells are being fracked but we are still producing more oil and gas.   The situation is going to get worse for most commodities before it gets better.  The question is, at what point do you buy on the anticipation of future lower production and ultimately higher prices?  The bottom will come in the stocks before the commodity cycle turns, but this month the sector has been filled with “falling knives”.  Chart 1 below is an ETF that tracks the DB Commodity Index.

  1. High quality bonds nearly always have value as a stock portfolio stabilizer. In and of themselves they may not be attractive, but as an asset class they are uncorrelated to stocks.  For that reason alone, they merit inclusion in nearly every portfolio.  The fact that lower grade corporate and international bonds outperform high quality bonds over time is beside the point for most investors.  Lower total portfolio volatility means happier clients even if some long term return is sacrificed.  All of that said, I would not be a buyer here as rates have fallen from 2.48% to 2.27% (on the 10 year Treasury).  If you don’t own some high quality bonds, buy after the stock market stabilizes and the 10 year is pushing 2.40% again.  Two ETF’s to consider are the iShares Barclay’s 3-7 Year Treasury Bond (IEI) and the Vanguard Intermediate Term Government Bond (VGIT).

  2. The underlying technical picture for the U.S. stock market continues to deteriorate and the indices do not accurately reflect the weakness in the average stock.<2> The 50 day moving average is moving closer to the 200 day moving average, and the advance-decline ratio is really weak.  The strategy if this trend continues would be to make sure that the mutual funds and ETFs you own are the ones you would be able to stick with in a bear market.  If you are ultimately going to sell something, you may as well do it now (into a rebound) rather than later (into weakness).

  3. I’m not a fan of using capitalization-weighted index for emerging markets. Internationally (and especially in emerging markets), the largest companies tend to have more governmental involvement.  This tends to make them more bureaucratic and less entrepreneurial.  Thanks to its large positions in such firms as Brazil’s troubled oil giant Petrobras, active emerging market managers have been able to best the passive index investment much of the time.<1> July 27, 2015

    <2> As of the close of July 29, 2015 the S&P 500 was up 3.58% and the equal-weighted S&P 500 was up 1.63%.  Among smaller stocks the difference is much more pronounced:  The Russell 2000 is up 2.77% but on an equal weight basis it is down 3.10%.  A few big winners are skewing the indices.

Past performance is no assurance of future results. Trademark Financial Management, LLC (“Trademark”) is a registered investment adviser with its principal place of business in the State of Minnesota. Trademark and its representatives are in compliance with registration requirements imposed upon investment advisers by those states in which Trademark operates. Trademark may only transact business in those states in which it is registered or qualifies for an exemption or exclusion from registration. This newsletter is limited to the dissemination of general information pertaining to its investment advisory/management services. Any subsequent, direct communication by Trademark with a prospective client shall be conducted by a representative that is either registered or qualifies for an exemption or exclusion from registration in the state where the prospective client resides. A complete list of all recommendations will be provided if requested for the preceding period of not less than one year.   It should not be assumed that recommendations made in the future will be profitable or will equal the performance of the securities in this list.  Opinions expressed are those of Trademark Financial Management and are subject to change, not guaranteed and should not be considered recommendations to buy or sell any security. For information pertaining to the registration status of Trademark please contact Trademark at (952) 358-3395 or refer to the Investment Adviser Public Disclosure web site (www.adviserinfo.sec.gov). For additional information about Trademark, including fees and services, send for our disclosure statement as set forth on Form ADV from us using the contact information herein or by calling 952-358-3395. Please read the disclosure statement carefully before you invest or send money.

Summary

Financial assets had a tough second quarter.  Interest rates rose while corporate profits dipped.  Greece was once again in the headlines, this time joined by Puerto Rico and China.  Those negatives were offset by continued growth and rising employment in the U.S. economy combined with economic improvement in Japan and Europe.  It seems like we have been on the verge of a Greek default since 2012 and an interest rate hike since the summer of 2013.  At some point, investors got tired of the “crying wolf” aspect of these two crises, lifting stocks up over 60% since the summer of 2012.  Now, however, those situations are too pressing to ignore, and that is proving to be an increasingly strong headwind for both bonds and stocks.

The major U.S. stock index, the S&P 500, did eke out a slight gain (0.28%)<1>. (See Figure 1)  Increasingly, however, the market is being driven by a handful of larger consumer names like Disney, Nike, Facebook, and Apple.  On an equal-weighted basis, the market would have declined -1.09%<2>.  Health care was the top sector once again with a gain of 2.8%, while the biggest loser was real estate (-10.69%)<3>.  With the Dow Transportation Index off -7.12% and the Dow Jones Utilities Index down -6.26%, it felt like the losers lost more than the winners gained. (See Figure 2)

Figure 1

Source: YCharts.com

Figure 2

Source: YCharts.com

Foreign stocks were a very mixed bag.  Overall they gained 0.62% in U.S. dollar terms.  Japan and Latin America each rose more than 3%.<4>  For Japan it was the continuation of gains made over the past three years as the yen has declined, whereas for Latin America it was a bounce off deeply oversold levels.  Latin America has struggled mightily since commodity prices peaked in 2011.  China is probably the most interesting market.  It shot up more than 42% from March 11th to June 12, only to give almost all of it back by the second week of July. China’s economy is slowing, and the volatility associated with this is playing havoc with countries whose economies have become somewhat dependent on supplying it raw materials, such as Australia, Chile, South Korea, and Canada.

As for fixed income, this was the quarter that the bond bears had warned us about for the last six years.  The Barclays Capital Aggregate Bond Index sank -2.11%. (See Figure 3)  Bonds had their worst three months since the second quarter of 2013.  Interest rates rose across the board and credit concerns increased as well.  This meant that neither Treasuries, nor municipal bonds, nor corporate bonds (whether investment grade or high yield), nor international bonds posted a gain.  Obviously, shorter duration bonds had less interest rate sensitivity so they performed better.

Figure 3

Source: YCharts.com Activity

The most important thing to do this past quarter was to monitor exposure to interest rates.  Interest rate exposure will hurt you when rates rise, of course, but long duration bonds are usually the best possible asset during periods of economic or political instability.  For most investors, we trimmed existing bond positions because their upside is limited in most scenarios.  For more aggressive investors, however, we actually bought long bonds in order to offset some of the risk of our foreign stock positions. We also reduced our weighting in interest rate sensitive equities like REITs and utilities and in global bonds.  Some of the proceeds went into mid cap stock funds that emphasized health care, but in most cases we held on to the cash to await better entry points.  We are increasing cash levels because our concerns are growing and we want to have money on the “sideline” to invest if and when prices fall.

Outlook

We have written about the U.S. stock market being overvalued for several years now. With the Federal Reserve maintaining very low interest rates and the economy continuing to expand modestly however, there has been little to indicate that stock prices were about to fall toward fair value anytime soon.  Bear markets tend to need a catalyst.  Greece has danced in and out of the headlines since 2011, but it does not seem likely that its troubles (in and of themselves) could cause more than a modest correction unless the rest of the European Union really screws things up.  A crash in the Chinese stock market, on the other hand, could be the catalyst to a broader global decline because it is not priced in.  China is experiencing at least a partial unwind of a speculative mania which started last summer and then went parabolic in March.  The plunge since June 12th has been frightful, and the authorities have had only modest success in halting it.  Because we are concerned about China we are raising a little more cash.  That said, it is not our policy to sell everything when market conditions deteriorate.  We’d like to explain our reasons below.

Commentary – Nobody Has a Crystal Ball

We do not go “all in” or “all out”.  There are several reasons for this:

  1. Conditions may change very rapidly.

  2. Almost nothing happens in the market that doesn’t benefit at least somebody.

  3. Frequent trading isn’t tax efficient.

  4. Frequent trading increases costs.

  5. Frequent trading has never been shown to be effective over the long term.
    Let’s discuss each of these points in detail.

    Conditions may change very rapidly.

    We are in an age of extremely interventionist central banks.  Whether here, in Europe, in Japan, or in China, market troubles seem to be met with aggressive measures to halt the slide.  Each of our “quantitative easings” has come as a result of stock market weakness and been quite effective (at least in the short run).  The same can be said of European interventions in 2012 and earlier this year.  Recently the Chinese government brought a stop to its stock plunge by banning short selling and buying stocks.  Even if you believe that all of these measures are ultimately doomed to fail, they can and have been very successful at delaying any potential day of reckoning.  Selling into a market correction has been a very unprofitable strategy over the past six years. Almost nothing happens in the market that doesn’t benefit at least somebody.

    It is extremely rare that everything in the stock or bond market goes up or down at the same time.  Typically, markets go back and forth between a “risk on” mode and a “risk off” mode.  The risk in question may be economic, interest rate, liquidity, or something else.  For example, when the Greek crisis hit, there were elements of economic and liquidity risk involved, so investors sold European stocks aggressively and to a lesser extent U.S. stocks and Asian stocks.  They were hardest on stocks that benefitted from global growth and Euro-denominated securities.  On the other hand, they bought Yen and Dollar denominated government bonds, and they bought higher yielding domestically focused stocks in both the U.S. and Japan, such as utilities and real estate.

    Money is constantly flowing, seeking the best payoff for a given level of risk.  These calculations are made and remade with every new piece of information that comes out.  When we calculate capture ratios, we are basically looking at how each security does when the tide is rolling in versus how it performs when the tide is rolling out. <5>  Volatility gives active strategies more of a chance to shine.  If we can find a mutual fund or ETF that tends to consistently make a little more or give back a little less, we get interested in looking more closely at the strategy.

    Frequent trading isn’t tax efficient.

    If you trade frequently, all of your profits will be taxed at the higher short term tax rates.  For taxable investors in higher tax brackets, the savings could be as much as 19.6%.

    Frequent trading increases costs.

    Frequent trading can be expensive.  Most brokerages will not let you trade for free and those that do will not let you do it frequently.  At TD Ameritrade, for example, the vast majority of trades we make do not carry a transaction fee.  The fund or ETF we purchase, however, may have a restriction that allows them to retroactively charge a fee if we don’t hold it for a certain period of time.  In addition, TD itself will charge us a separate fee if we do not hold a fund at least 90 days.  Mutual fund and variable annuity companies typically allow free trading within their family, but they generally limit the number of trades you can make in a twelve month period.

    Frequent trading has never been shown to be effective over the long term.

    The most important reason we don’t make large “in or out” market calls is that they usually don’t work.  I’ve been in the securities industry since the mid-1980s and I remember exactly two professionals getting the 1987 crash right and neither ever had a timely call like that again.  Several people were right about the tech crash in 2000 but they were not the same people who were right about the sub-prime crash in 2007 and in each case the people that were right were early enough to have to endure some real pain first.  But oh, there were so many more people over my nearly thirty years that were disastrously wrong!  I remember the gold bugs who were wrong for 16 years and missed a stock market run from Dow 1500 to over 10000 before their ship finally came in in 2001.  I remember for years hearing that bond yields had nowhere to go but up while bond yields were busy falling to 5%, 4%, 3%, and lower (greatly enriching bond investors).  Inflation didn’t come back when the Federal Reserve started quantitative easing back in 2010 and the stock market didn’t crash either, though both were widely predicted by the folks who run scary advertisements on CNBC.

    Jumping in and out of the market requires being right not only about the “what” but the “when”.  The best investors in the world do not try to do this.  They focus on getting the “what” and the “how much” right, because the “when” is notoriously unpredictable. Financial writer John Mauldin has often used an avalanche metaphor to indicate that imbalances in markets are relatively easy to spot, but knowing what will finally set them off and what kind of collateral damage they will do is the hard part.  It is impossible to react to breaking news faster than the market; the only possible advantage we can create is to react more thoughtfully.

    So what do we do instead?  It is Trademark’s practice to carefully decide what to buy, and then modestly add to or subtract from those positions as conditions warrant.  From time to time we have to replace securities either because something happened at the fund (manager change, deviation from the stated investment process, etc.) that causes us to believe the fund’s track record cannot be maintained, or because the fund’s particular approach is less suited to the current environment as one of its competitors.  We may under or overweight sectors or regions because of economic fundamentals, but we don’t put all of our eggs in one basket.  For us, it is not about making the biggest profits when we are right; it is about being in the right asset class and the right funds as often as we can while trying to limit the consequences when we are wrong.  Nobody has a crystal ball.  The biggest investing mistakes are made by those that think they know what is going to happen and therefore don’t have a strategy when things inevitably move against them.

    <1> S&P 500 Index per Morningstar

    <2> S&P 500 Equal Weight Index per Morningstar

    <3> Sector returns courtesy of FactSet and Russell per JP Morgan’s quarterly report

    <4> Foreign stock returns from MSCI per Morningstar

    <5> Upside/downside capture ratio show you whether a given fund has outperformed–gained more or lost less than–a broad market benchmark during periods of market strength and weakness, and if so, by how much

Past performance is no assurance of future results. Trademark Financial Management, LLC (“Trademark”) is a registered investment adviser with its principal place of business in the State of Minnesota. Trademark and its representatives are in compliance with registration requirements imposed upon investment advisers by those states in which Trademark operates. Trademark may only transact business in those states in which it is registered or qualifies for an exemption or exclusion from registration. This newsletter is limited to the dissemination of general information pertaining to its investment advisory/management services. Any subsequent, direct communication by Trademark with a prospective client shall be conducted by a representative that is either registered or qualifies for an exemption or exclusion from registration in the state where the prospective client resides. A complete list of all recommendations will be provided if requested for the preceding period of not less than one year.   It should not be assumed that recommendations made in the future will be profitable or will equal the performance of the securities in this list.  Opinions expressed are those of Trademark Financial Management and are subject to change, not guaranteed and should not be considered recommendations to buy or sell any security. For information pertaining to the registration status of Trademark please contact Trademark at (952) 358-3395 or refer to the Investment Adviser Public Disclosure web site (www.adviserinfo.sec.gov). For additional information about Trademark, including fees and services, send for our disclosure statement as set forth on Form ADV from us using the contact information herein or by calling 952-358-3395. Please read the disclosure statement carefully before you invest or send money.

  1. How seriously should we take the notion of a strengthening economy when commodities prices fell 3.8% in the first half of 2015? Last Thursday’s unemployment report with its downward revision to previous months and no increase in average hourly earnings furthers the notion that while the economy is growing, it just isn’t that strong.

  2. Despite this, bonds are a tough place to be right now. For the past three months bonds have been losing more on reports of economic strength than they gain when the economy appears soft.  High yield corporate bonds are also declining because participants know the next rollover cycle promises to be a lot more difficult.  Developed foreign bonds are rebounding from absurdly low yields.  Emerging market debt is being hurt by fears of capital flight when the Fed hikes.  In absolute terms, emerging market debt is the only bond category that is inexpensive.  It is hard not to feel that bond investors should be underweight across the board.  It would be a mistake, however, to underweight only duration and assume you are safe in lower quality short durations.

  3. Technically the U.S. stock market has taken strike one by falling below its 50 day moving average (orange line) and appears ready to take strike two by flirting with the 200 day moving average (red line). See Figure 1.  Even if that happens, investors would do well to remember how good of a two-strike hitter this market has been.  The chart of October, 2014 should be a good reminder.  Stocks rose more than 15% from their October 15th lows by the end of February.  That said, there are several factors that suggest the market is not as internally healthy as it was last autumn.  We continue to monitor Dow Utilities and Transports, as well overall breadth for signs of continuing deterioration.Figure 1

  1. The most difficult thing about investing near bull market peaks is that the final stage is usually driven by more questionable stocks like Facebook (84 times earnings), Tesla (not currently profitable), Amazon (also not profitable), and Netflix (171 times earnings). I’m not arguing that these aren’t good companies, but they are trading based on assumptions about the ultimate profitability of business models that have no precedent.  Companies like Honeywell, Cisco Systems or PepsiCo, which have well-established business models have hit their P/E ceilings in the upper teens and their prices have more or less stalled out.  In many ways, investing is a “bird in the hand” (safety) versus “two in the bush” (opportunity) proposition; you just have to assess your likelihood of getting the two.  If the “bush” is metaphorically on a peak in the Andes, I’ll take the one in the hand.

  2. Rob Arnott published an interesting analysis of factor investing recently. Among his insights:

  3. New “factors” are being discovered these days through vast numbers of tests (data mining). If you discovered, for example, that midcap stocks had a strong tendency to outperform on the fourth Thursday of the month, would you actually try to build a strategy around it?  Increasingly, ETF companies are.

  4. The value premium does exist, but largely because value investors try to time the market. By selling as value goes out of favor and buying when it appears to be returning to favor, value investors are actually supplying the alpha to those that do not trade.

  5. Greece has voted “No” and the world is still trying to figure out what that actually means. Everyone is in a tough spot.  The Greeks don’t know if they are going to have a banking system at the end of the week.  The Germans fear that Greece will pull out and six months from now their economy will have stabilized and start to benefit from a very cheap drachma.  That would put a lot of pressure on Italy, Spain, and Portugal which would likely bring about the end of the monetary union. In the short run I would avoid trading on this news.  Knee jerk is for stocks to fall and the dollar and U.S. Treasuries to rise.  Then stocks might recover just as they have anytime over the last three years when bad news has come out of Greece.  As noted above, however, there could be wide reaching repercussions of what happens over the next few days.  Considering how expensive stocks and bond are anyways, my vote for the best way to play the Greek situation is extra cash. Past performance is no assurance of future results. Trademark Financial Management, LLC (“Trademark”) is a registered investment adviser with its principal place of business in the State of Minnesota. Trademark and its representatives are in compliance with registration requirements imposed upon investment advisers by those states in which Trademark operates. Trademark may only transact business in those states in which it is registered or qualifies for an exemption or exclusion from registration. This newsletter is limited to the dissemination of general information pertaining to its investment advisory/management services. Any subsequent, direct communication by Trademark with a prospective client shall be conducted by a representative that is either registered or qualifies for an exemption or exclusion from registration in the state where the prospective client resides. A complete list of all recommendations will be provided if requested for the preceding period of not less than one year.   It should not be assumed that recommendations made in the future will be profitable or will equal the performance of the securities in this list.  Opinions expressed are those of Trademark Financial Management and are subject to change, not guaranteed and should not be considered recommendations to buy or sell any security. For information pertaining to the registration status of Trademark please contact Trademark at (952) 358-3395 or refer to the Investment Adviser Public Disclosure web site (www.adviserinfo.sec.gov). For additional information about Trademark, including fees and services, send for our disclosure statement as set forth on Form ADV from us using the contact information herein or by calling 952-358-3395. Please read the disclosure statement carefully before you invest or send money. As measured by the S&P 500

  1. The May Employment report was surprisingly strong. Labor force participation rose by 400,000 and average hourly earnings climbed to 2.3% year-over-year, so there is no way to put an asterisk on the report.  Bonds were weak leading up to the report and continued to sell-off thereafter.    It increases the pressure on the Federal Reserve to raise rates sooner rather than later.

  2. Bonds continue to struggle. Over the last three weeks it has been the middle of the yield curve that has borne the brunt of the selling.  This indicates the market fears rate tightening more than it fears actual inflation, but at this moment it fears both.  While I believe to some extent that we are seeing leveraged long positions getting forcibly liquidated, support has not held and at this point buyers may be catching the proverbial falling knife.  Floating rate bonds have done well relatively to all but the shortest duration bonds.  While I don’t find their risk/reward especially compelling, they will probably be the bond sector of choice in the short run.  Consider holding more cash.

  3. The dollar jumped sharply last Friday, but has not been able to build on that spike. September is the consensus month for the first rate hike, but the “no hike” minority gained steam until Friday.  Last Wednesday, Doubleline’s Jeffrey Gundlach said he didn’t think the Fed would move at all in 2015.  Today I would suggest that October is the very latest the Fed would move.

  4. Dollar strength is bad for those investing overseas in the short run, but good in the intermediate term. Since May 21 we have seen a nearly -3.3% correction in the EAFE in dollar terms (the S&P 500 has given back just -1.6%). This will ultimately benefit foreign companies that export and hurt domestic companies that do, so I wouldn’t be worried about one’s foreign stock positions.  It remains a good idea to have part of this exposure currency hedged.  See Chart 1 below.

  1. Roughly, two weeks ago I wrote about the three phases of the market cycle. If this quarter’s action marks the end of the cyclical bond bull market, we have entered into the excess phase where high quality bonds are sold for stocks and high yield/floating rate bonds.  REITs broke through their 200 day moving average in May, bounced back above it for two weeks, then plunged decisively below it last week.  The Dow Jones Utility and Transportation Averages have also broken below their 200 moving averages recently.  Though the broad market remains solidly in “bull” territory, the “early warning” indicators are flashing.

  2. Good economic news is bad market news now. The bull market was built and extended on very low interest rates and the belief that the Fed was investor friendly.  Gradually, this is no longer becoming the case.  Save for perhaps the Materials, Mining, and Energy sectors, history suggests this is a headwind for stocks.  Bull markets top out when investors begin to take profits on rallies (versus buying on dips, which has strongly characterized the environment since the Autumn of 2001).  Failure to build on Wednesday’s 238 point rally (which did not take us to a new high) is not an encouraging sign either.  However, it is summer and liquidity is traditionally lighter, so I have to try not to read too much in to these numbers.Past performance is no assurance of future results. Trademark Financial Management, LLC (“Trademark”) is a registered investment adviser with its principal place of business in the State of Minnesota. Trademark and its representatives are in compliance with registration requirements imposed upon investment advisers by those states in which Trademark operates. Trademark may only transact business in those states in which it is registered or qualifies for an exemption or exclusion from registration. This newsletter is limited to the dissemination of general information pertaining to its investment advisory/management services. Any subsequent, direct communication by Trademark with a prospective client shall be conducted by a representative that is either registered or qualifies for an exemption or exclusion from registration in the state where the prospective client resides. A complete list of all recommendations will be provided if requested for the preceding period of not less than one year.   It should not be assumed that recommendations made in the future will be profitable or will equal the performance of the securities in this list.  Opinions expressed are those of Trademark Financial Management and are subject to change, not guaranteed and should not be considered recommendations to buy or sell any security. For information pertaining to the registration status of Trademark please contact Trademark at (952) 358-3395 or refer to the Investment Adviser Public Disclosure web site (www.adviserinfo.sec.gov). For additional information about Trademark, including fees and services, send for our disclosure statement as set forth on Form ADV from us using the contact information herein or by calling 952-358-3395. Please read the disclosure statement carefully before you invest or send money.

  1. Recently, both the S&P 500 and Dow Industrial Averages again closed at all-time highs and are up 4.3% and 3.3% respectively<1>. The Nasdaq made its high late last month and is sitting just below it now.  It is up 7.3% on the year.  Certain economically sensitive industries have improved recently, notably materials, packaging, and industrial products.  The market is conveying the message that the economy is picking up.  This is underscored by the steepening of the yield curve so far this quarter.  See Figure 1.<2>Figure 1

  1. Just a rough quarter for bonds so far. Bonds didn’t provide a lot of return potential at the beginning of the year, and even less so after growth related concerns saw investors shift even more money from stocks to bonds in the first quarter.  I don’t know if it was the comments by bond managers Bill Gross and Jeffrey Gundlach in late April to the extent that German bonds were the “short of the century” or not, but bond yields have sharply backed up in recent weeks.  With oil prices in sharp decline from last September into this past March, inflation numbers were very weak.  Oil has rebounded to just north of $60, suggesting future inflation readings will not be so benign.  In any event, sentiment in the bond market has turned around 180 degrees, with bond outflows now returning to the global stock market.

  2. If I am right about points 1 and 2 above, I believe the Federal Reserve will raise rates in September. Their decision is easier now that the dollar has come off its highs and has clearly lost momentum.  They were concerned about a rate hike putting additional pressure on currency markets.  Certain countries were struggling with dollar denominated debt and currency flight earlier, but those concerns have abated recently.

  3. High yield bonds provided a modest window for accumulation earlier this year, but that window is rapidly closing. BB yield spread over Treasuries bottomed at 2.56% in June of 2014 before the energy related second half sell-off.  By March 18th the spread had widened to 3.32%.  It has come in considerably since.  Today it stands at 2.97%.

  4. Asia has taken over from Europe as investors’ favorite region. Better economic performance in Japan is part of the story, but a bigger part is the belief that China is going to open up its currency market sometime in the next year, which would mean a much higher weighting in international stock indices.  Some are front-running the idea that indices are 9% underweight the amount of Chinese stocks they would have if they were included in the capitalization weighting.
    Trying to step back and look at the big picture, I think you can break bull markets into three phases:

  5. In this phase stocks recover in aggregate what they lost in the bear market.  This phase is paced by those stocks that lost the most in the bear market EXCEPT those in the leadership group during the previous cycle.  Technology stocks were routed in the 2000-02 bear market and financials were crushed in the 2007-09 bear market, and they lagged the next bull market.  That said, stocks with weaker balance sheets that fell further in the bear market had a greater response to sharply lower interest rates and greater liquidity.

  6. In this phase investors step back and appreciate the fact that the market has recovered to new highs and that stocks are no longer cheap.  There is often a mid-cycle lull that convinces many that the bull is ending.  This phase is led by higher yielding defensive stocks like utilities, real estate, and consumer staples AND whatever industry has emerged this cycle as the secular leader.  This time it is health care and biotechnology.

  7. In this phase investors grow tired of cries of “wolf” and they pursue return with a vengeance.  Investors often feel they have underperformed the market because they were too fixated on risk.  By this point, money market rates typically do not provide any inflation adjusted return and safer, higher quality bonds are feeling interest rate pressures.  Conservative stocks aren’t doing anything either.  Whether they realize it or not, performance chasing investors are being herded into an ever narrowing group of stocks that drive an increasing degree of the performance.  Some do realize it, but cannot resist the pressure.  In the immortal words of then-Citigroup Chairman Chuck Prince in 2007 “As long as the music is playing, you’ve got to get up and dance”<3>.
    If this is true, we probably have several months (if not a year or two) left to party.  We may have entered the excess phase (and valuations are certainly rich), but there isn’t much real exuberance out there yet.

    Past performance is no assurance of future results. Trademark Financial Management, LLC (“Trademark”) is a registered investment adviser with its principal place of business in the State of Minnesota. Trademark and its representatives are in compliance with registration requirements imposed upon investment advisers by those states in which Trademark operates. Trademark may only transact business in those states in which it is registered or qualifies for an exemption or exclusion from registration. This newsletter is limited to the dissemination of general information pertaining to its investment advisory/management services. Any subsequent, direct communication by Trademark with a prospective client shall be conducted by a representative that is either registered or qualifies for an exemption or exclusion from registration in the state where the prospective client resides. A complete list of all recommendations will be provided if requested for the preceding period of not less than one year.   It should not be assumed that recommendations made in the future will be profitable or will equal the performance of the securities in this list.  Opinions expressed are those of Trademark Financial Management and are subject to change, not guaranteed and should not be considered recommendations to buy or sell any security. For information pertaining to the registration status of Trademark please contact Trademark at (952) 358-3395 or refer to the Investment Adviser Public Disclosure web site (www.adviserinfo.sec.gov). For additional information about Trademark, including fees and services, send for our disclosure statement as set forth on Form ADV from us using the contact information herein or by calling 952-358-3395. Please read the disclosure statement carefully before you invest or send money. <1> Source: YCharts.com as of 10:10CT 5/21/15

    <2> IVV tracks the S&P 500, DIA tracks the Dow Jones Industrial Average and QQQ tracks the Nasdaq composite.

    <3> New York Times, 07/10/2007 (according to Wikipedia)

Summary

The U.S. economy improved modestly in the first quarter of 2015.  The bigger story, however, was how well the rest of the world’s developed markets responded to financial stimulus.  In the U.S. quantitative easing has been a fact of life since 2009 and the stock market is up over 200% from the March 2009 lows.  In fact, “QE” has been so successful in stimulating financial activity that the Federal Reserve has signaled it is prepared to raise rates later this year.  By contrast, Japan and the European Union started their stimulus programs much later and have not seen anywhere near the market recovery the U.S. has.  That said, U.S. economic growth has been so gradual over the past several years that bond yields have continued to decline, providing another surprisingly good quarter for bond investors.

After two years in which large company U.S. stocks handily outperformed every other asset class, the benefits of diversification were quite evident in the first quarter.  The S&P 500 index gained less than half a percent (0.47%) on the quarter, as the strong dollar hurt many multinational companies.  Small and mid-size firms, which tend to do more of their business domestically, were up 4.35% and 5.01%, respectively. See Figure 1. Health care was the best performing industry group as investors continued to be attracted to their strong earnings growth.  The worst sectors were utilities and transportation stocks – each gave back more than -4%.  Both sectors gained more than 25% in 2014.

Japanese stocks posted a 10.2% quarterly gain.  The sharp decline in the yen in 2014 paved the way for the export sector to do exceptionally well.  The rest of Asia was up 4.9% led by India which was up 9.9%.  Europe has also been trying to push its currency lower, and that effort is finally starting to bear fruit.  Europe rose 3.5% in dollar terms, but more than 10% in local currencies.  The worst region was once again Latin America (off -9.5%) as Brazil is reeling from rising inflation and a corruption scandal.

Bond yields continue to confound the experts by staying low.  Every time we think the interest rate cycle has decisively bottomed we get a surprisingly weak economic report and the next interest rate increase gets pushed a few more months into the future.  The Barclays Aggregate Bond Index rose 1.6% last quarter.  Inflation protected bonds rose 1.4%, and municipal bonds tacked on 1.0%.  As one might expect in a strong dollar environment, foreign bonds posted a loss on the quarter.  The best bond sector was high yield corporate debt, which shook off a fairly awful second half of 2014 to end the quarter 2.5% higher.

Activity

Seeing that the depreciation of the euro and the yen were stealing growth from the dollar, the move to make this past quarter was to increase one’s foreign stock weighting, especially on a currency-hedged basis.  There are ETFs and mutual funds that enable us to do this, and where available and risk-appropriate we took advantage.  The second performance enhancing step this quarter was favoring growth-oriented funds at the expense of value-oriented funds.  See Figure 2  In the later stages of a cyclical market rally, investors tend to get more aggressive and are willing to pay up for companies they feel would not be hurt if the Federal Reserve raised rates.  Slower growing large companies with strong balance sheets tend to do well during most phases of the market cycle, but not this one.

Outlook

We wrote last quarter that we really need to see economic growth pick up elsewhere in the world, because the U.S. couldn’t remain the one and only economic engine indefinitely.  Happily, we have seen growth pick up overseas (admittedly from pretty low levels) and that gives us hope that the cycle can continue even longer.   There are some headwinds, however, that suggest the going will get tougher:

  1. The Federal Reserve is almost certainly going to raise rates in the next few months. Given the massive amount of borrowing over the past several years, this is a concern that nobody seems to be able to accurately quantify.  Higher rates don’t guarantee a decline in the stock market, but equities do perform much better historically when interest rates are falling.

  2. The U.S. manufacturing sector had an advantage when the dollar traded at $1.45 to the Euro and at 85 yen two years ago, but now we are at $1.08 and 121 yen. This is going to cost U.S. exporters.  Iron ore mines in northern Minnesota have recently been idled because they are no longer competitive.

  3. According to Goldman Sachs’ David Kostin the S&P 500 Index trades at a forward P/E of 17.2x, the highest level in the past 40 years outside of the Tech Bubble. The median stock trades above 18x, ranking in the 99th historical percentile since 1976. Sure, we could go higher on a 1999 style blow-off top, but do you really want to bet on that?
    Headwinds notwithstanding, as long as we remain in economic “Goldilocks” territory – weak enough to keep interest rates well behaved but strong enough to permit gently rising employment – stocks are probably going to remain the asset of choice.

    Commentary – Extra Innings

    Every quarter I attempt to come up with an analogy to describe the type of market environment we are in.  This quarter I’m going to present two analogies. The big takeaway should be that we are in a favorable but fragile environment where any type of change will be viewed skeptically by market participants.

    The Wheel of Fortune Analogy: Imagine you are watching the well-known television game show Wheel of Fortune.  One of the contestants has been successful this round and has piled up $6,000 and a trip.  There are only three consonants left and you are sure she must know the answer to the puzzle.  You yell at the TV “Solve the puzzle now!” but she has noticed that each spin lands her in the same section of the wheel with only money spaces.  So, despite the fact that each new spin offers only incrementally more money while risking all her winnings, she spins again.

    The Baseball Analogy: It has always been fashionable for market pundits to describe the market cycle in baseball terms.  For example, “Stocks have done very well over the past several years, but the Federal Reserve hasn’t even begun raising rates, so we think we are only in the seventh inning of the rally”.  Maybe so.  On the other hand, a better baseball analogy may be that the rally that began in the Spring of 2009 wasn’t the first inning of a new game but instead the top of the tenth in the old game.  Let me explain.

    The Federal Reserve, through its bailouts and liquidity programs, succeeded in making sure the fallout from the previous game, the real estate and financial crisis, did not result in a general deflation (which had historically always been the result of a debt crisis).  The effects of this are mixed – the economy is unable to hit a home run, but it doesn’t strike out either.  Though it is theoretically possible that one good hit could end the game, the Federal Reserve (umpire) is acting like the referee in those Buffalo Wild Wings commercials by pulling out all the stops to make sure that doesn’t happen.

    The Federal Reserve and other world central bankers are working to create an environment that rewards risk taking on the belief that taking risks leads to economic growth and more jobs.  But for some of the key players in the global financial system, the central banks won’t let them fail – even when they make bad decisions.  China for example is struggling under the weight of overinvestment in infrastructure to the extent that many of their projects will never earn a return that justifies the cost of the capital provided.  Similar if smaller inefficiencies are promoted by central banks all over the world (including our own).  The concern here is that if you keep bailing out small missteps then  bad behavior continues until it reaches a critical mass that becomes uncontainable (ala 2008).  In market terms, we are in an investment environment where we no longer have frequent modest declines of 10-15%, which serve to remind us that market risk is always with us but can be overcome with patience and prudence.  Instead, we have long rallies without significant pullbacks such that risk is forgotten.  Ultimately these end in devastating routs that wipe out a significant chunk of the market’s value and leave individuals with a profound sense of distrust.

    The upshot is that investors are playing a game where the odds of success in the short term are very favorable but the negative consequences of a sudden end to this “not too hot, not too cold” environment are so much greater than the upside should it continue.  Put another way, the risk reward tradeoff is skewed.  All things being equal, we would prefer not to be market timers since it is extremely difficult to call a market top.  That said, the market is approaching a point where raising some cash might be prudent, despite the odds.   We are not afraid to be early.  After all, if you don’t have an eye on the exit, you risk getting trampled when the game ends.

    Past performance is no assurance of future results. Trademark Financial Management, LLC (“Trademark”) is a registered investment adviser with its principal place of business in the State of Minnesota. Trademark and its representatives are in compliance with registration requirements imposed upon investment advisers by those states in which Trademark operates. Trademark may only transact business in those states in which it is registered or qualifies for an exemption or exclusion from registration. This newsletter is limited to the dissemination of general information pertaining to its investment advisory/management services. Any subsequent, direct communication by Trademark with a prospective client shall be conducted by a representative that is either registered or qualifies for an exemption or exclusion from registration in the state where the prospective client resides. A complete list of all recommendations will be provided if requested for the preceding period of not less than one year.   It should not be assumed that recommendations made in the future will be profitable or will equal the performance of the securities in this list.  Opinions expressed are those of Trademark Financial Management and are subject to change, not guaranteed and should not be considered recommendations to buy or sell any security. For information pertaining to the registration status of Trademark please contact Trademark at (952) 358-3395 or refer to the Investment Adviser Public Disclosure web site (www.adviserinfo.sec.gov). For additional information about Trademark, including fees and services, send for our disclosure statement as set forth on Form ADV from us using the contact information herein or by calling 952-358-3395. Please read the disclosure statement carefully before you invest or send money. Per JP Morgan Guide to the Markets, 4Q14

    All of the international market  indices cited in this paragraph are from MSCI via Morningstar

    All of the bond market indices cited are from Barclays via Morningstar

    Source: GSAM Short Stories in 3 Chapters, April 13th, 2005

Market Summary

The first quarter of 2015 is just over and it has been fairly disappointing for most investors.  The S&P 500 was up 0.45% and the Dow Industrial Average was down -0.24%.

In 2014 the pundits couldn’t seem to resist the temptation to use the phrase “cleanest dirty shirt” to describe the idea that despite The U.S. economy being far from perfect, the U.S. was still the most attractive place to invest.  We haven’t heard that much in 2015.   What has changed is the realization that money is made at the margin and at the margin, other countries and regions have become more compelling:

  1. Europe – European countries do not have the rate of economic growth that the US is experiencing (2.2% GDP growth at last check), but Europe is clearly improving from previous quarters, where our growth appears stalled out. Europe is experiencing the benefits of sharply lower oil prices as all but Norway and the U.K. are oil importers.  Their experience with quantitative easing is starting to bear fruit as the positives of increased export competitiveness outweigh the negatives of higher import prices.  Earnings estimates are starting to rise.  This contrasts with the U.S. where the earnings decline in the energy sector has not yet been offset by earnings increases in the consumer sector as had been expected.  Dollar-based investors in Europe are up 4.3% this year through March 28th; in local currencies the gain is 11.3%.<1>

  2. Asia (ex-Japan) – Asian countries tend to have their own currencies, unlike Europe, so it is harder to generalize about monetary policy. Suffice it to say they have been affected by the suddenly much more competitive Euro.  China has responded by increasing reserves in its banking system, whereas raw material-exporting countries like Australia have seen their currency fall precipitously without having to resort to extraordinary financial measures.  India has been helped by hopes for reform and the fact that it may have the world’s most favorable demographics.  All in all, Asia (ex-Japan) is up 5.1%.<2>

  3. Japan – Japan has been actively taking measures to weaken its currency for almost three years, and the pay-off has really been there this year for equity investors. The yen has fallen sharply this year (though it has risen in March) to a level that enables its extremely efficient exporters to post strong profits.  It’s year to date gain is 11.3%.<3>
    It’s important to understand that when a country or region seeks to weaken its currency to try to improve its trade position, the gains are not instantaneous.  Usually the currency needs to fall through a certain level before the markets really start to believe.  For the Euro, that level was $1.18 give or take two cents.  Once the Euro fell below that level, investors began to revise profit estimates in earnest.  If, like China, the country more directly stimulates the economy by injecting liquidity into the banking sector, then the payoff to investors is usually immediate.

    In any event, the relative out-performance of the U.S. relative to the rest of the world since 2009 has been enormous.  This year has provided the first sign that the trend is reversing.  I expect that the trend reversal will continue, barring a major adverse surprise.  What I don’t know is whether this will mean U.S. market performance goes negative or is just less positive.  The fact that the U.S. is the only major economy to be contemplating raising interest rates increases the likelihood that investors heavily weighted toward U.S. stocks will be disappointed.

    Growth versus Value

    Growth stocks continue to outpace Value stocks this year.  The margin of victory is 624 basis points year-to-date.

The superior performance of the growth-heavy health care sector and the dismal showing of the lower P/E energy, utilities, and financial services sectors explain a lot of it.  If you look back, value hasn’t meaningfully<4> outperformed growth in any year since 2006 (the last year in an amazing run of value outperformance that began in 2000).  A recent study suggests that the so-called “value premium” exists because value as a discipline is so hard to stick with over the long term because of long fallow periods like we’re currently experiencing.  The takeaway:  it may not be wise to try to take advantage of the value premium if you, or your clients, do not have the patience to see it through.

Bonds

Bonds have provided surprisingly good returns yet again this quarter so far.  The Barclays Aggregate Bond Index has advanced 1.2%, while some more adventurous funds have added a percent or more by taking more credit risk.

I am ambivalent about the merits of moving down the credit spectrum at this point.  I suspect it will pay off for several more months, but the volatility may not be worth the added total return.  My best idea is to be long duration in high quality bonds and short duration in “junk” or lower credit quality bonds.  The latter might find the going a bit tougher if rising short term rates make refinancing trickier.

<1> MSCI AC Europe net return

<2> As measured by the iShares MSCI All Country Asia ex-Japan Index ETF.

<3> As measured by the iShares MSCI Japan Index ETF

<4> By more than 200 basis points

Past performance is no assurance of future results. Trademark Financial Management, LLC (“Trademark”) is a registered investment adviser with its principal place of business in the State of Minnesota. Trademark and its representatives are in compliance with registration requirements imposed upon investment advisers by those states in which Trademark operates. Trademark may only transact business in those states in which it is registered or qualifies for an exemption or exclusion from registration. This newsletter is limited to the dissemination of general information pertaining to its investment advisory/management services. Any subsequent, direct communication by Trademark with a prospective client shall be conducted by a representative that is either registered or qualifies for an exemption or exclusion from registration in the state where the prospective client resides. A complete list of all recommendations will be provided if requested for the preceding period of not less than one year.   It should not be assumed that recommendations made in the future will be profitable or will equal the performance of the securities in this list.  Opinions expressed are those of Trademark Financial Management and are subject to change, not guaranteed and should not be considered recommendations to buy or sell any security. For information pertaining to the registration status of Trademark please contact Trademark at (952) 358-3395 or refer to the Investment Adviser Public Disclosure web site (www.adviserinfo.sec.gov). For additional information about Trademark, including fees and services, send for our disclosure statement as set forth on Form ADV from us using the contact information herein or by calling 952-358-3395. Please read the disclosure statement carefully before you invest or send money.

Summary

It is hard to overstate the impact that weakness in the global economy had last year.  Because the United States was the only major economy to have clearly strengthened in 2014, capital poured into dollar-denominated securities.  This boosted the highest quality U.S. stocks and bonds disproportionally, partially because these are the easiest for foreigners to buy.  Economic weakness overseas also contributed to the collapse in oil prices, as demand fell below supply and suppliers were either unable or unwilling to cut back on production.

U.S. stocks finished the year with a gain of 13.7% according to the S&P 500 stock index, but the year was not as good if you look at it from any other perspective.  The gain drops to 12.1%<1> if you include the rest of the U.S. market (the 5000+ companies too small to make it into the S&P 500) because by themselves, U.S. small companies only rose 4.89%<2>.  The biggest sector winners were those that appeared to be immune from the business cycle – utilities, health care, and real estate.  Losing industries were those most affected by slowing world demand – energy, mining, and materials.

With the message of the markets worldwide being a lack of confidence in global growth, high quality bonds had a very good year.  The Barclay’s Aggregate Bond Index rose almost 6% in 2014.  Again, the major benchmark doesn’t tell the whole story.  If you weren’t willing to take interest rate risk, your return wouldn’t have been nearly as good.  Intermediate term bonds gained just 2.8% and short term bonds only 0.8%<3>.  Municipal bonds had an even better year (9.0%)<4> as investors were attracted to their long maturities and low default rates.

While 2014 was a very good year for “plain vanilla” securities like blue chip stocks and Treasury bonds, it was a fairly dismal year for risk takers.  On the equity side, foreign stocks delivered negative returns whether large cap or small cap, developed market or emerging market.  Asian stocks managed a modest gain ex-Japan, but that was more than offset by double-digit negative returns in Latin America as currencies in that part of the world performed especially poorly versus the dollar.  On the bond side, high yield corporate and emerging market debt lost much of their first half of 2014 gains in the last three months as the combination of credit concerns and a soaring dollar were too much to overcome.

Activity

Most portfolio changes last quarter had one of two primary objectives: improving the credit quality and lengthening duration in the bond portfolio, or reducing the foreign currency exposure in both the bond and equity portfolios.  To achieve the former, we sold out of the shorter, more opportunistic Thompson Bond fund and put the proceeds in a more interest rate sensitive government or municipal bond fund (depending on the tax status of the portfolio).  To reduce dollar sensitivity, we exchanged many foreign bond positions into PIMCO Foreign (Hedged) which as its name implies hedges currency exposure.  In some portfolios we bought a dollar bullish ETF.  For other risk tolerances we exchanged a foreign stock fund for a competitor (say FMI International) that hedges currency exposure.  As always there were some trades we made because a former “flower” had become a “weed”.  This was especially true last quarter since many fund managers got caught overweighting the U.S. energy renaissance theme.

Outlook

Volatility has picked up lately.  We had a correction of close to 10% in October and two five percent pullbacks in the last six weeks.  This doesn’t necessarily mean the bull market is over, but it reminds us that we are closer to the end.  Just as stocks almost always start their cyclical ascent before there is evidence that the economy is recovering, the bear market usually begins before the economy has peaked.  Increased volatility is often the leading indicator.  We often see volatility pick up when the Federal Reserve contemplates raising interest rates, as they are now.  We need to see economically sensitive stocks perform better in order to believe we can have another leg up, because market gains have largely been confined to high dividend and blue chip stocks so far, and valuations in those areas are stretched.  Furthermore, dividend-oriented stocks typically don’t respond well to rising rates.

Probably more important than anything else, we need economic growth to accelerate somewhere else in the world.  If the current trend continues, the dollar will rise to a level where U.S. products are not competitive, causing our balance of trade to deteriorate and eventually our economy to suffer as well.  A strong dollar also draws money out of emerging markets causing those economies to contract.  More economic balance in the world is in every investor’s best interest.  This is what we will watch most closely in 2015.

Commentary – This Too Shall Pass

I have been working in the investment field since 1986, so for me it is a given that investment returns are cyclical.  By now I have seen every asset class, every sector, and every geographical region go in and out of favor at least twice.  Because of this, I have a hard time placing a strong overweight on any particular asset class.  I know every asset class’ good fortune is temporary and furthermore, I know they won’t ring a bell at the top. 

Let me give you an example.  Figure 1 below is a table showing year by year returns for twelve asset classes from 2000 through 2009.  The cells are shaded green to red (left to right) to help highlight relative performance for a given year.  Best performers are shaded green and worst performers are shaded red.  Only one asset class failed to achieve a positive 10-year average annualized return – large cap U.S. stocks.  Everything else made at least a small amount of money.  The best – commodities – posted a sizzling 14.49% average annual return for the decade.  Of course we know what happened thereafter – U.S. stocks have been a star performer over the subsequent five years to 2014 (trailing only Real Estate Investment Trusts).  Commodities, on the other hand, have been the very worst performing asset class by far over the last five years.

The lesson here is that every asset class goes through periods of stronger and weaker performance, and often extreme highs are followed by extreme lows (and vice versa).  We don’t know in advance when a particular asset class is going to bottom out or top out, so we can’t risk putting all our assets in one “basket”.  Figure 2 shows nine assets and one “asset allocation” portfolio, which is a diversified mix of the representative asset classes.  Notice that while the diversified portfolio doesn’t ever make it into the top three in a given year, it never falls into the bottom four either.  Asset diversification does not guarantee you a positive return, but it does tend to keep the losses manageable.

Figure 1

Source: Trademark Financial Management.  Selected Asset Class Indexes: (1) S&P 500 Index (2) S&P Midcap 400 Index (3) Russell 2000 Index (4) MSCI EAFE Index (5) MSCI Emerging Markets Index (6) Dow Jones U.S. Select  REIT Index (7) Goldman Sachs Natural Resources Index (8) Deutsche Bank Liquid Commodity Index (9) Barclay’s Capital Aggregate Bond Index (10) Barclay’s Capital Aggregate Bond Index(11) Citibank WGBI Non-US Dollar Index (12) 3-Month Treasury Bill Figure 2

Source: JP Morgan 1Q15 Guide to the Markets

As you can see, 2014 was dominated by REITs and large cap stocks, but most asset classes were either mediocre or downright crummy.  While this may appear to suggest that investors should flock to REITs and U.S. stocks right now, the performance history of buying the leading asset class on a ten year basis is not good (see the returns of commodities and emerging markets post 2009).  If we ran a chart showing 1990 through 1999, it would show sizzling performance for U.S. large cap stocks, and it would have been similarly prophetic in terms of calling the top.

We diversify because we believe this is the best way to help investors realize their financial goals.  We believe it is more significant to our clients’ long term financial success to avoid significant losses than it is to make significant gains.  Why?  Because the 5.2% return generated by the diversified portfolio in Figure 2 last year and the 6.7% return over the last ten years would have kept almost anybody’s investment plan on track.  On the other hand, if one had gotten too bullish (or bearish) at the wrong time, they could have put a meaningful dent in that plan.  In the end success becomes less about beating the market and more about not letting the market (through its periodic appeals to either your fear or your greed) beat you.

Past performance is no assurance of future results. Trademark Financial Management, LLC (“Trademark”) is a registered investment adviser with its principal place of business in the State of Minnesota. Trademark and its representatives are in compliance with registration requirements imposed upon investment advisers by those states in which Trademark operates. Trademark may only transact business in those states in which it is registered or qualifies for an exemption or exclusion from registration. This newsletter is limited to the dissemination of general information pertaining to its investment advisory/management services. Any subsequent, direct communication by Trademark with a prospective client shall be conducted by a representative that is either registered or qualifies for an exemption or exclusion from registration in the state where the prospective client resides. A complete list of all recommendations will be provided if requested for the preceding period of not less than one year.   It should not be assumed that recommendations made in the future will be profitable or will equal the performance of the securities in this list.  Opinions expressed are those of Trademark Financial Management and are subject to change, not guaranteed and should not be considered recommendations to buy or sell any security. For information pertaining to the registration status of Trademark please contact Trademark at (952) 358-3395 or refer to the Investment Adviser Public Disclosure web site (www.adviserinfo.sec.gov). For additional information about Trademark, including fees and services, send for our disclosure statement as set forth on Form ADV from us using the contact information herein or by calling 952-358-3395. Please read the disclosure statement carefully before you invest or send money.

<1> Wilshire Total Market Index

<2> Russell 2000 Index

<3> Barclays 3-5 year Gov’t/Corporate Bond Index and 1-3 year Gov’t/Corporate Index, respectively.

<4> Barclays Municipal Bond Index

  1. I am not concerned about the stock market’s rough start to the year because January 2014 also got off to a bad start and yet finished the year 13% higher.  I am more concerned that this recent selloff occurred just three week after the previous one, and fewer stocks rallied between December 15th and December 26th.  Increasing frequency of declines and fewer stocks participating in each rally are signs of the market topping.  By contrast, between October 2011 and September 2014 corrections occurred about every 3-5 months and every bounce had more stocks making new highs.  The sharper correction we saw in October 2014 probably marked the end of the acceleration phase of this cyclical bull market.  That said, the topping process can take several months.

  2. Again this year just about every market strategist has come out for higher interest rates, and as usual interest rates have fallen.  At this point, I’d ignore everybody who says anything about bonds whose last name isn’t Gundlach or Hunt, because they’ve probably been wrong.  If either of them tells me bond yields are going to rise, then I would start taking that position seriously.

  3. Also, when the credit spread stops narrowing I believe you need to sell high yield bonds.  The credit spread is always in motion – it does not spend several months at cyclical lows.  Too many strategists recommended lower credits in 2014 because their yields were greater and the economy was still growing.  Markets anticipate.  Just as stock prices head lower before earnings peak, typically, credit spreads start widening before the economy crests.  Therefore, you need some high quality duration to protect your portfolio from a potential decline in the equity market, because no other types of bonds will do that.  Do not forget municipal bonds in your quest for high quality duration.

  4. I have been concerned (and still am) about what might happen as a result of the rapid fall in oil prices.  Other than the junk bond sell-off (the energy sector was the largest junk bond issuer by far in the last five years), we haven’t seen much fallout beyond energy company shares.  If there are banks or hedge funds in trouble, we may not know until it becomes a crisis (the Long Term Capital crisis in 1998 and the Bear Stearns mess in 2008 came up all of a sudden), which could take weeks or even months.  On the other hand, sometimes these “dislocations” can have a positive effect.   Geo-politically we saw a historic thaw in the relationship between the U.S. and Cuba, no doubt helped by the fact that the latter can no longer rely on economic support from Russia and Venezuela.

  5. If any meaningful stock valuation anomalies exist today (by this I mean things that we will look back on in the future and wonder how we allowed prices to get that “out of whack”), I believe there are two leading candidates.  One, the prices of lower volatility stocks/industries like utilities, consumer staples, and REITs versus more cyclical stocks/industries; and two, the valuation of U.S. companies versus those domiciled outside of the U.S.  I understand why investors want low volatility stocks (studies have shown they provide more upside over time, and investors are still fearful of the huge drawdowns they saw in 2008) and I understand why investors prefer U.S. stocks today (our economy is growing at an apparently sustainable rate and our currency is strong).  That said, these are two areas where reversion to the mean has always eventually occurred.    Higher valuations lead to greater volatility because much more is expected from a stock trading at 22 times earnings than one trading at 12 times.  A rising currency eventually discourages exports (your products become less globally competitive) therefore reducing economic growth.  I expect each trend to continue well into 2015, and probably even strengthen.  I’m just saying that the reversion (when it comes) is going to be highly investable because there is statistically a lot of room for cyclical stocks and foreign stocks to out-perform to get back to their historical average valuation relationships.

  6. Given the strength of the dollar lately, gold has not performed as poorly as I would have expected.  This suggests it might be time to add a small amount to each portfolio. Past performance is no assurance of future results. Trademark Financial Management, LLC (“Trademark”) is a registered investment adviser with its principal place of business in the State of Minnesota. Trademark and its representatives are in compliance with registration requirements imposed upon investment advisers by those states in which Trademark operates. Trademark may only transact business in those states in which it is registered or qualifies for an exemption or exclusion from registration. This newsletter is limited to the dissemination of general information pertaining to its investment advisory/management services. Any subsequent, direct communication by Trademark with a prospective client shall be conducted by a representative that is either registered or qualifies for an exemption or exclusion from registration in the state where the prospective client resides. A complete list of all recommendations will be provided if requested for the preceding period of not less than one year.   It should not be assumed that recommendations made in the future will be profitable or will equal the performance of the securities in this list.  Opinions expressed are those of Trademark Financial Management and are subject to change, not guaranteed and should not be considered recommendations to buy or sell any security. For information pertaining to the registration status of Trademark please contact Trademark at (952) 358-3395 or refer to the Investment Adviser Public Disclosure web site (www.adviserinfo.sec.gov). For additional information about Trademark, including fees and services, send for our disclosure statement as set forth on Form ADV from us using the contact information herein or by calling 952-358-3395. Please read the disclosure statement carefully before you invest or send money.