After a strong January, where do we go from here

Our investment team was fortunate enough this past week to travel to Boston to attend Charles Schwab’s Investment Outlook 2013 Conference. It was a great opportunity to hear the economic and investment outlooks from some of the world’s leading portfolio managers. The trip also afforded our investment committee an opportunity to meet for an extended period of time with no distraction to focus solely on our client’s portfolios and what our own outlooks were for 2013. We were pleased that our perspective on the year and what we see as the major macro drivers and risks to the global economy over the next 5-10 years was in alignment with the thoughts of many of the presenters.

Looking first at 2013, we start the month of February with the markets up more than 5 percent, one of the strongest starts to a year and an indication that consumer and investor confidence may be improving. The concerns over another combative debt ceiling discussion in February were somewhat alleviated when congress agreed to a temporary rise in the debt ceiling through the middle of May. We continue to believe that the uncertainty in Washington will cause volatility in the market but with continued underlying strength in housing, energy and manufacturing we are more optimistic than pessimistic at this point. Although the 4th quarter GDP numbers were negative, this unexpected number was largely driven by one-time events in inventories and defense spending than any weakening trend. January’s employment number of 157,000 new jobs shows the economy continues to improve albeit at a modest rate.

One of the main themes of the conference was, although the US economy continues to improve and the US markets are showing strength, it is important to keep portfolios diversified with international equity exposure. In Europe we are likely to see slow or limited economic growth in 2013 but the risk of contagion from the sovereign debt crisis has substantially declined and the current price to earnings ratio of the European markets is below its historical average and represent a good long-term value investment. The other area that was discussed is the continued strength in emerging markets. A number of examples were given to illustrate how these economies will be the engines to economic growth. One that stood out is the fact that although the China’s annual GDP growth has declined from 11-12 percent to 7-8 percent it is still growing at four times the rate of the US economy and at this growth rate they will require adding additional electrical power equivalent to what the state of California consumes each year. These two themes on the international front are in synch with our thoughts on these areas and the adjustments we are implementing in portfolios.

Another session from the conference was on behavioral finance and how we as humans are not hard wired to be good investors because we have been trained from years of influence all the way back to our early ancestors to flee environments of danger (i.e. sell when markets are down) and want to participate when times are good (i.e. buy when markets are up). For this and other reasons, it becomes that much more important to keep a disciplined investment strategy. Given the fundamentals of the market and the economy, we are okay with our current allocation but if things continue to improve, we will continue to be disciplined and capture gains in riskier asset classes as valuation become richer.

Finally, another consistent message from many of the managers at the conference and one that we have consistently repeated is that we are currently in a 30 year bond bull market and therefore it is important to have portfolios structured in a way to limit the impact of rising rates on the bond portion of a portfolio. This strategy includes gaining income from alternative investments such as REITs, emerging market debt, global macro strategies, equity dividends and preferred equity. It also requires trying to minimize the duration and maturity in the bond allocation of a portfolio. Issues such as these and the inefficiency of the bond market are the primary reasons we feel the need to have experienced, active managers for much of our bond allocations.

Our firm has always believed highly in being well educated on the current fundamentals of the economy and markets and understanding the macro trends that will impact our clients so it was great to be able to take part in the Schwab conference.