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4th Quarter December 2014

What a Surprising Year 2014 Turned Out to Be!

If we had predicted an Ebola crisis and oil prices falling from $100 a barrel to less than $50, during a time of great turmoil in the Middle East and around the world, you would have asked for a reality check, yet here we are. The things many economists predicted, such as higher interest rates and flat markets, did not occur. Actually, the ten-year Treasury bond rate has a lower yield today, 1.85%, than it did at the end of 2013, 3.03%. Also, the U.S. markets, as measured by the S&P 500 and the DJIA, hit all-time highs during the year. However, many investors are unaware that many investment were negative or had low-single digit returns. Generally, bond returns were low single digits. Small and mid-size companies were low-single-digits, especially if they contained energy related companies. Because commodities are heavily weighted in energy, they were sharply lower for the year. International markets were also negative with problems in Europe, as well as the emerging markets. Some dividend focused companies did not perform as well as growth companies.

The S&P is a cap-weighted index. This means that larger companies like Apple, Goldman Sachs, and 3M, which had banner years in 2014, "weigh more" or have more effect on the direction of that index than do many smaller companies in the S&P 500. There were 122 of the 500 S&P companies that were negative for 2014. To me, this feels a bit like the late 1990s. The U.S. markets then were growing by double digits led by technology companies, whose earnings were exploding. By comparison, other boring stocks that paid dividends were shunned, as were bonds, real estate, international, etc. Alan Greenspan famously declared in 1996 that the markets displayed "irrational exuberance." Yet it took four more years for the markets to collapse and we all know how the tech bubble ended in 2000. I remember conversations in the late 90's about not overweighting technology, then again in the early part of this decade regarding "flipping" real estate – before the bust. It is not different this time!

For the last five years the S&P 500 and the Russell 2000 (which is an index of smaller companies) were actually equal in terms of average returns. Properly diversified portfolios should have components of many different asset types. It is impossible to predict what group will lead the next leg and which group will lag. You also need some ability to protect from large losses and the ability to recover sooner. While U.S. markets may continue to dominate, we do not recommend reducing diversification or chasing returns. If the EU decides to get aggressive around quantitative easing, it may be that those markets will do well in the future. When you least expect it, some part of the market can change and it is impossible to anticipate. Did anyone predict a collapse in oil? After the global financial crisis, most asset types recovered at a similar rate. We are just now starting to see negative returns, which is more normal and should be expected. We will typically see negative returns in some types of assets and positive returns in others. That is why diversification is so important.

Interesting Facts

For the last 50 years there have been 53% of the days that were up days and 47% of the days that were down days. The S&P has now gone 1,189 calendar days without a 10% or greater drop, which is the fourth largest stretch in this 50-year period. In the last 42 years, international stocks were up 22 years and U.S. stocks were up 20 years. Currently, U.S. markets are near all-time highs and interest rates are near zero. Historically, future returns from these points for the next five years are typically low single-digits. I am not suggesting that I know the direction of the markets. We are still in the recovery phase from a historic recession. It may be a few years before this cycle ends. Volatility has increased and the world is more dangerous. A properly diversified portfolio and rebalancing strategy reduces risk and can help avoid the wealth destruction of having all your eggs in one basket. The investing process is about science, art, emotion, and execution. As so many Americans are in or near retirement, managing portfolio risk, taxes, and cash flow is as important as ever and is where we focus much of our time.

Health Care

We have discussed here before our concerns and focus on the aging of America and the future of health care. Beyond the cost factor are decisions about where to live, who can help, access to resources, etc. Whether you are the parents, grandparents, or the child, you will likely grapple with many of these decisions as 10,000 people a day are turning 65 every day for the next 15 years. As the baby boomer's age, it will have a huge impact in many of these areas. Expect that this will be an ongoing planning process for us to address.

Anniversary

This year, 2015, will be the 40th year that I have been working in this career – hard to imagine since I cannot possibly be old enough! When I started, I never imagined I would be able to stay in a career that is so rewarding and be able to work with so many wonderful people. As I look forward to 2015, I am truly blessed and I hope your year is a happy and healthy one.

Best Regards,

Sherri

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