January 2015 Newsletter

Submitted by Academy Wealth Advisers on January 2nd, 2015

By Rick Welch January 1, 2015

We are pleased to provide you with a quarterly perspective featuring the status of our investment class weightings, our interpretation of recent data, an outlook for the future and watch items for the coming months. If you have any questions about any topic, we hope you will not hesitate to contact us.

Status of our Investment Class Weightings

Changes from our October 2014 Quarterly Perspective are noted in italic.

US Large Cap Sectors – No changes; consider Financials for upgrade and Materials for downgrade.

No Weighting - Utilities

Underweight – None

Neutral – Consumer Staples, Energy, Financials and Healthcare

Overweight – Consumer Discretionary, Industrials, Technology and Materials

US Mid and Small Cap – Maintain all weightings.

International Developed Markets – Maintain all weightings; consider for upgrade.

Emerging Markets – Maintain all weightings.

Alternative Strategies – Maintain weightings in multi-asset funds and REITs.

Multi-sector Bond Funds – Maintain all weightings.

Investment Grade US Corporate Bonds – Maintain all weightings.

High Yield US Corporate Bonds – Maintain all weightings.

Convertible Bonds – Maintain all weightings.

Investment Grade Municipal Bonds – Maintain all weightings.

Data – The 4th quarter of 2014 was a challenging one for investors. From a technical perspective, US Large Caps just missed entering correction territory falling 9.83% between September 19 and October 15. US Small Caps (Russell 2000) did correct, falling 14.26% between July 1 and October 15. In late October and then through November we saw improved conditions, which lasted only until December 5. Over the next seven trading days we then saw the S&P 500 sell off again erasing 4.94%. By month end, most indices had recovered with the most plausible explanation being a Santa Claus rally. During the quarter, US Large Caps (S&P 500) rose +4.39%, while US Small Caps (Russell 2000) climbed +9.35%. International equities (ACWX) disappointed with a loss of -5.40% during the quarter. The Barclays US Aggregate Bond Index rose +1.07% during the quarter. GDP growth for the 3rd quarter came in at a robust +5.0% (the best GDP report since +6.9% in Q3 2003), which followed an equally impressive +4.6% in the 2nd quarter. The national unemployment rate fell from 6.7% to 5.8% in 2014, with strong monthly job gains of 243,000 and 321,000 reported in October and November, respectively. New weekly unemployment claims averaged just 287,500 during the 4th quarter showing a firming of the domestic job picture. Consumer confidence remains near record levels and the November Business Outlook Survey by the Federal Reserve Bank of Philadelphia showed optimism in the manufacturing sector. Inflation remains well below the Fed target of 2.0% as shown in the November CPI reading which reported a 12-month increase of just 1.3%. New residential construction was relatively flat during the quarter, though monthly privately owned housing starts remain at a seasonally adjusted rate over 1.0 million. Earnings season for the S&P 500 will begin soon with an estimated earnings growth rate for Q4 2014 of 2.6%. We should note that on October 1 the estimated earnings growth rate for the same Q4 2014 was 8.4%. It is no surprise that the energy sector has been hit hard by declining crude prices; the sector is now expected to report a 17.0% decline in earnings compared to an expectation of 8.1% growth in earnings at the start of the quarter.

Outlook – After 4 years of recovery, marked by uneven and even halting progress, the US economy is now hitting its stride marked by a recent acceleration in growth. This momentum is rooted in a strong manufacturing sector, improving labor market conditions, near record levels of business and consumer confidence and accommodative monetary policies, all of which should translate into a period of above trend GDP growth of 2.5% to 3.0% in 2015. This momentum should provide the foundation for strong corporate earnings growth and allow the prices of risky assets, like stocks, to move higher next year. Stock price valuations which by many metrics are historically high should nonetheless receive additional support from below target inflation and low bond yields. The big question is will the US economy remain resilient in the face of a continued global slowdown and stay immune to the downside (and growing) risks in Europe and key emerging markets, particularly China, Russia and Brazil? We believe that world economic growth will begin to improve in 2015, but, will remain frustratingly below trend and fragile for some time. In 2014, the euro area economy struggled with a renewed slowdown and escalating deflationary pressures. We expect that the ECB will provide the long awaited policy response in 2015, a likelihood that could occur as soon as the next ECB policy meeting on January 22. Any new initiatives will further highlight the divergence in monetary policies between the US economy (US Fed will begin tightening in 2015) and the ECB, which without easing could face many years of economic stagnation across the continent.

Watch Items – Volatility should increase in 2015 as the financial markets adjust to less accommodative US monetary conditions. Managing interest rate expectations has become increasingly difficult for the Federal Reserve, which risks derailing economic growth if it raises rates too far or too fast. Chairman Yellen has made clear the Fed’s intention to exercise caution and move rates up, once they start, along a very gradual path. She has also indicated that the Fed will not even begin to raise rates until it is confident that the economic recovery can withstand such a move. At the December FOMC Meeting, we learned that the Fed “will be patient in the beginning to normalize the stance of monetary policy and sees this guidance as consistent with its previous statement that it likely will be appropriate to maintain the 0 to 0.25% target range for a considerable time following the end of the asset purchase program in October.” It appears that the timing of the initial rate hike is at least two FOMC meetings away, or until after the March 17-18, 2015 meeting. Investors can expect that bond yields will follow short-term rates upward or that they will move in anticipation as a date for an initial rate hike by the Fed becomes more certain. These conditions suggest that returns for intermediate and longer-term bonds could be impacted negatively. Though tightening will also impact short term bonds, it is longer duration instruments that are the most vulnerable to capital losses. We will continue to focus on individual issues and multi-sector bond funds with an average duration of between 5 and 9 years.