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• The Federal Reserve and other monetary authorities globally are maintaining a very accommodative monetary policy that’s still very supportive of earnings growth.
• With low interest rates, it’s easier than ever for U.S. companies to raise money in the debt market to finance growth. Even the junk bond market is flooded with money seeking higher yields (the record for junk bonds issued in the U. S. in a single year was broken on October 18, according to Dealogic).
• Enterprises can still keep labor costs low – in the range of a 1.8% annual increase in the latest reading. Labor costs represent about 70% of U.S. company expenses.

• The continued eurozone crisis and a slowing of emerging-market economies hamper demand – probably the main culprit of the recent slowdown in sales growth.
• The aging population in some emerging countries like China gradually reduces the cheap labor source for multi-national companies.
• Right now domestic U.S. profit margins stand more than 50 percent above their long-term average. Some argue that the law of “reversion to mean” will eventually drive margins, and profits, down.

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These adjustments, at the asset-class level, can have great impact. How has our process worked? A visit to our website to review recent Investment Highlights offers a glimpse.
 

• On June 11, 2011, in a piece titled Reducing Exposure to Small Cap Stocks, we wrote, “After a recent update of our forecasts for future earnings streams, we’ve decided to reduce our exposure to small cap stocks, which we feel are expensive relative to traditional small cap fundamentals (e.g., earnings and P/E multiples). In exchange, we’re further increasing our investment in larger companies.” What’s happened since? From June 13, 2011 (June 11 was a Saturday) through August 31, 2012, the Russell 2000 small cap index provided a total return of 6.4% while the S&P 500 large cap index has provided an 13.6% total return.

• On October 10, 2011, in a piece titled Short-Term Correction: Strong Opportunity Over Next 24 Months, we wrote, “In fact, with the recent correction, the S&P 500 is now trading at its most fundamentally attractive level since the U.S. economic recovery began. We estimate that prices are now more than 30% below their intrinsic values, creating opportunity for the patient investor.” In this case, from October 10, 2011 through August 31, 2012, the S&P 500 provided a 20.1% total return.
  

 Balance Volatility With Expected Performance Across Many Alternatives

The path is never smooth and we are keenly aware of daily volatility. We read the same headlines and CNBC is a constant in our break room, so we’re hearing all the hype, too._¹ We often find the hype revolves around specific investment ideas which, not surprisingly, seem to be ideas offered by “expert” guests who either benefit from selling the idea or already own it and benefit if more investors buy in. More often it’s simpler than that. If it’s bad news, it sells. As the old news business adage goes, “If it bleeds, it leads.”

Pitches to investors in the current media range from individual securities to portfolio management processes to specialized asset classes to new investment products and more. Take Hedge funds. A few years ago, many claimed they were the answer to volatile markets. Fast forward to today and many have failed to do their job, leaving many investors either forced to remove principal when the fund closes or locked out of withdrawing their now-depleted money. 

Another idea stemmed from the observation that many economies are growing faster than the U.S.  Assumptions were then drawn that every investor should always maintain an international exposure. That worked for a while, but markets aren’t static. Our research, after a detailed assessment of many non-U.S. developed and emerging market alternatives, currently has us favoring the U.S.   As of August 31, the S&P 500 has a total year-to-date return of about 13.5%, while the MSCI World Excluding United States index has posted an approximately 7.1% total return.^₂ Sure, the volatility sometimes feels like it’s going to drive you to drink.  But, in spite of it, the U.S. equity market is one of the top-performing markets not only on a year-to-date basis, but also over the past 12 months.    

While we boast every now and again, we actually remain very humble in our portfolio management process. We remember the ‘pain’ of incorrect decisions, too.  But, by applying our ongoing research discipline and seeking to improve it every day, we believe the gains from our correct decisions will out-weigh the impact of the others over the long-term.

Footnotes:

^₁ News outlets make money selling time and/or space, so to fill both they tend to sensationalize everything whether it deserves it or not.  

^₂ In strategies where we invest in equities, Hamilton Capital is currently overweighting large cap U.S. equities relative to our neutral allocations per strategy. However, in an effort to reduce long-term volatility, we also are currently allocated in U.S. mid cap, U.S. small cap, and emerging markets, which have not performed as well as large cap U.S. equities in the time frames mentioned in this piece. Relative to our neutral allocations, we are underweight in these asset classes. Performance of individual asset classes is available upon request.