2013–the Year of the Punch Bowl

Last year, the S&P 500 rose 29.6%, the equity index’s highest return since 1997. The Federal Reserve’s Quantitative Easing “QE” program of $85 billion a month in U.S. Treasury and mortgage purchases appears to be the catalyst that drove this market’s exceptional performance. S&P 500 earnings rose an anemic 6% in 2013. The Bank of Japan drove the Nikkei 225 up 57% by adding, on a relative basis, even more monetary accommodation. Last year’s stock and bond market weakness occurred during discussions of the Federal Reserve’s plans to begin its “taper” of QE.

The Federal Reserve will slowly reduce its purchases from $85 billion per month to $0 over the next two years. This reduction in monetary accommodation takes the proverbial “punch bowl” away. Stock and bond markets won’t like this. Discussions of the “taper” have already led to yields rising on the Ten Year US Treasury from 1.5% to 3.03% and weakness in the equity markets. We expect yields to rise on Ten Year US Treasury to 3.9% by year end and 4.5% in 2015. This less accommodative interest rate environment will lead to modest returns for stocks.

With a mindset focused on conservatively growing wealth and preserving capital, we continue to recommend Master Limited Partnerships which have been strong performers relative to the S&P 500 for over a decade. Their high tax advantaged yields, stable business models, and growing distributions have provided excellent total returns. We look for more of the same.

Our returns in the MLP sector, over the last 13 years, have been 20.7% on an asset class performance basis and before management fee. This has beaten the Alerian MLP Total Return benchmark by over 3% annually and the S&P 500 by over 16%, annually. We are working to have our MLP returns audited as these returns are very strong and have been generating institutional interest.

For retirement plans we are using quantitative strategies to augment our investment idea generation. Recent experience has made us more interested inexpensive and profitable companies found through quantitative strategies than through “insight” from discussions with management. Additionally, we are more inclined to focus on larger growing franchises at fair valuations like The Home Depot, Inc., Microsoft Corp. and Dell Inc. in the 1990s and Apple Inc. this century. In this vein, we have been buying some Google for customers as they appear to have an excellent growing franchise, yet still be fairly valued relative to its growth rate.

The U.S. economy appears to be slowly strengthening, but it struggles with large deficits and high unemployment. Consequently, the stock market, which trades at a fair multiple, could decline. This bull move is five years old and market is no longer inexpensive. While we want to grow your assets, we are advocating a conservative approach to building wealth at this time.

Best Wishes in the New Year,