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How We See It

Kimberly Spinks

Kimberly Spinks

March 27, 2015

Investment Themes for 2015

1. An unloved bull

Happy 6th birthday to the current economic recovery!

Six years ago on March 9, U.S. equity markets hit their lowest point, marking the end of the 50% loss during the 2008 Financial Crisis. During the ensuing six years, equities have delivered an average 15.8% annual return.

We do not expect 2015 to bring an end to the expansion; however, we do expect increased volatility as the Federal Reserve approaches its anticipated tightening, as well an increase in geopolitical risks.

U.S. equities are not cheap by any definition, we readily admit. But the S&P 500 reaching new highs is not a reason – in and of itself – to sell your stocks. As February 2015 came to a close, the Price-to-Earnings (“P/E”) ratio on the S&P 500 stood at 19.0: far below the 2000 bubble peak of 28.5. Furthermore, new highs do not equal asset bubbles. The definition of an asset bubble (like the prices of dot-com stocks during from 1997 to 2000) is a category of assets at very high risk of severe loss of capital, compounded by excessive use of leverage (or margin) and investor overconfidence. Sentiment surveys show that the current bull market is definitely not driven by overconfidence.

The next step is to incorporate inflation into our discussion. The current low inflation environment further supports equity prices. Low inflation enhances the quality of corporate earnings growth because rising profits aren’t simply a function of rising prices.

2. Interest rates: low for a long time

We – along with the rest of the world – expect the Federal Reserve to begin raising interest rates; the most recent Fed statement regarding the timing of the first rate hike hints at late 2015.

The Fed’s action is not a sign that interest rates in general are about to climb. Keep in mind that when the Federal Reserve raises rates, it will only impact very short term rates. The rest of the yield curve is driven by supply and demand: “free range interest rates” if you will.

The forces driving those free range interest rates create the environment for a low-for-a-long-time forecast. The main reason can be summed up in three words: supply and demand.

Supply-side forces: The Fed will be raising short term rates, however, it is unlikely that the Fed will be selling any of the bonds purchased during its Quantitative Easing policy, contributing to lack of supply.

One supply-side bright spot, however, is municipal bonds. New issuance in tax free bonds has increased to its highest level since 2007.

Demand-side forces: The European Central Bank implemented a negative interest rate policy last year in its efforts own monetary easing policy. Let’s face it: no global investor is going to sell a 2% U.S. Treasury bond to turn around and buy a 1% French sovereign bond. Demand for U.S. fixed income will remain elevated, keeping interest rates low.

What does it all mean for investors?

For equity investors: don’t allow this year’s increased volatility to frighten you into abandoning your investment plan. Accept the fact that we will have pullbacks, and many times they will be based on pure headline risk. Stay the course.
Also for equity investors: favor domestic large cap companies over foreign companies, but now is the time to begin a slow tip-toe into developed international markets.

For fixed income investors: municipal bonds – especially in the 7 to 12 year maturity range – offer potential value. High yield also appears attractive from a risk/return perspective.
As always, we are honored that you give us the opportunity to serve you, and to help you be good stewards of your wealth.

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**Investment products are not a deposit or obligation of Texas Bank and Trust, not insured by FDIC or any other federal government agency, not guaranteed by Texas Bank and Trust, and may go down in value. **

Northern Trust
Texas Private Wealth Forum, Dallas, Texas, March 24, 2015


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