Asset Class Summary: Second Quarter 2015
As we mentioned at the beginning of the year, we still believe that stocks will outperform bonds and cash this year. Low money market rates and low bond yields help make stocks look relatively attractive.
U.S. stocks as measured by the S&P 500 are up only 1% through the first half of the year. The Price to Earnings (P/E) level of the S&P is above its long-term historical norm, meaning stocks aren’t’ cheap and that returns going forward probably will not be outsized. However, historically low interest rates boost the value of equities and earnings are expected to continue to grow. We are expecting earnings growth in the 6% range for the full year, or about $126 per share.
Although a strong performer in 2014, Berkshire Hathaway had negative performance in the second quarter and is down year-to-date. The biggest contribution to our equity returns was health care stocks (VGHAX). Health care stocks were up (3.8%) for the quarter and are up 4% year -to-date. One nice boost to the health care sector during the quarter was the Supreme Court’s decision in support of the Affordable Care Act. Healthcare stocks seem to be in a sweet spot, up about 10% year-to-date, and at or near the top sector for much of the last several years. Aging baby boomers make health care a demographic play, but Obamacare also makes it a government policy driven investment.
While looming Fed Funds rate increases are a concern for stocks, we believe they are more of a threat to bond returns. Chart 4 below shows that while the S&P 500 historically does take an initial hit when rates begin to rise, they quickly recover and perform well. In fact, for the past three and a half decades, stock prices have been able to withstand up to about three percentage points of higher rates before weakening. In this fragile global economy, we believe that raising rates a full three percentage points will take years.
International stocks are cheaper than U.S. stocks on a P/E basis and outperformed for the second quarter and year-to-date. As a result, we continue to maintain our traditional allocation to intentional stocks, which is about one-third of a typical client’s overall equity exposure.
In our opinion, bonds remain expensive despite prices falling somewhat in the second quarter. The Barclays aggregate bond index fell about 2% for the quarter. Our bond portfolios generally outperformed due to our shorter-term duration and emphasis on high quality. We will remain conservative for the time being and continue to position portfolios in anticipation of higher interest rates.
Hedged Equities and Alternatives
Our Hedged Equities and Alternatives holdings are less correlated to and generally less volatile in aggregate than an investment in the stock market. Looking forward, as interest rates start rising, we believe Hedged Equity and Alternative funds can provide greater returns than the bond market.
While the specific amount of Hedged Equity and Alternative exposure varies by client profile, in general we remain more heavily exposed to these asset classes and lighter in bonds due to the extremely low yields available in bonds these days and due to pending rate increases. For the second quarter, our overall performance in these asset classes was mixed with the Hedged Equity trailing the benchmark, and Alternative Investments beating it.
Our current asset allocation for the typical SHWM client is shown below:
Other articles that appeared in the Second Quarter issue of Your Family CFO Report includes Economic Overview and Market Overview. Please call us anytime with questions at 404-874-6244 and feel free to pass our message along to friends.
All references in this publication referring to our average allocation or “typical portfolios” reflect those of the fully discretionary accounts of clients with moderate risk profiles. Actual client portfolios are tailored to individual client circumstances and asset allocations may vary. Any reference to returns reflect the performance of asset classes, are for illustration purposes only, and do not reflect the returns of any specific investment of Smith & Howard Wealth Management. No representation is made that any investment decisions discussed herein have been profitable in the past or will be in the future. Past performance is no guarantee of future results. A list of all recommended investments is available upon request.