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SIA PERSPECTIVES
Stegner Investment Associates, Inc.
First Quarter 2015
Following solid returns posted in 2014, the 1st quarter of 2015 provided another reason for investors to cheer as
they review additional increases in the market value of their portfolios. The gains posted by most financial
markets to date in 2015 were generated with great volatility as returns bounced month-to-month from negative
to positive or vice versa.
These sharp movements in the 1st quarter serve as a reminder that trying to guess the direction of the markets on
a short-term basis is not an appropriate approach for investors. Instead great investors recognize that a
disciplined, patient, unemotional investment approach is required to reach long-term financial goals.
What Happened to Stock Prices?
Internationals stocks rallied in the first quarter with Japan, Germany and France leading the way in developed
markets, after posting declines in 2014. The MSCI EAFE Index finished the 1st quarter higher by almost 5% as
good news of stimulus measures from central banks in Japan and Europe fueled hope that these moves would
stimulate global economic growth. The MSCI EM Index also moved higher by over 2% as stocks in emerging
market countries, such as Russia, rebounded from huge declines posted in 2014. China and India also
contributed to the gains.
The U.S. economy appears to be on a solid growth trajectory despite short-term forces that have clouded the
picture. Some forces are very temporary, such as the impact of the harsh winter weather, but other forces, such
as the rising dollar and significant decline in oil prices, have investors worried about spillover effects on the
broader economy. Because large U.S. based companies are more at risk due to these forces, their stocks lagged
all other stock market segments in the 1st quarter as listed in the table below:
2014
STOCKS*
13.7%
13.2
4.9
Large Cap
Mid Cap
Small Cap
-3.0%
-1.6
-3.2
5.7%
5.5
5.9
-1.6%
0.1
1.7
1.0%
4.0
4.3
0.5
0.6
6.0
3.1
-1.5
-1.4
4.9
2.2
-4.9
-2.2
International
Emerging Markets
Feb
2015
Mar
2015
1st Qtr
2015
Jan
2015
*Representative benchmark index total return
What Happened to Bond Prices?
The European Central Bank (ECB) announced a quantitative easing program in January and then launched its
bond buying in early March. With this increased demand, prices moved higher and yields on European debt fell
to all-time lows. In turn, the benchmark U.S. 10-year Treasury issue looked relatively appealing at a low yield
of only 2.2%.
The table on the next page shows that U.S. based taxable and municipal bonds provided volatile, yet impressive,
returns for the 1st quarter, after posting strong results in 2014. Despite the rally in global bond markets, U.S.
based investors earned negative returns from foreign exposure as the dollar strengthened against most other
currencies.
While money market funds play a significant role in a diversified portfolio by providing stability, the current
interest rate environment is providing investors with virtually no return on this investment.
2014
6.0%
6.4
-3.1
0.0
BONDS &
MONEY MARKET*
Jan
2015
Taxable Intermediate Bonds
Municipal Intermediate Bonds
Global Bonds – ex US
Money Market Funds
2.1%
1.5
-1.8
0.0
Feb
2015
-0.9%
-0.9
-0.8
0.0
Mar
2015
0.5%
0.2
-2.1
0.0
1st Qtr
2015
1.6%
0.8
-4.6
0.0
*Representative benchmark index total return
Why is Janet Yellen Always in the News?
Janet L. Yellen took office as Chair of the Board of Governors of the Federal Reserve System (Fed) in February
2014 for a four-year term ending in 2018. She also serves as Chairman of the Federal Open Market Committee
(FOMC), the Fed’s principal monetary policymaking body.
The term "monetary policy" refers to the actions undertaken by a central bank, such as the Federal Reserve, to
influence the availability and cost of money and credit to help promote national economic goals.
The Federal Reserve controls the three tools of monetary policy: open market operations, the discount rate and
reserve requirements. The Board of Governors is responsible for the discount rate and reserve requirements, and
the FOMC is responsible for open market operations.
Using the three tools, the Fed influences the demand for, and supply of, balances that depository institutions
hold at Federal Reserve Banks and in this way alters the federal funds rate. The federal funds rate is the interest
rate at which depository institutions lend balances at the Fed to other depository institutions overnight.
Changes in the federal funds rate trigger a chain of events that affect other short-term interest rates, foreign
exchange rates, long-term interest rates, the amount of money and credit, and, ultimately, a range of economic
variables, including employment, output, and prices of goods and services.
The FOMC holds eight regularly scheduled meetings per year. At these meetings, the Committee reviews
economic and financial conditions, determines the appropriate stance of monetary policy, and assesses the risks
to its long-run goals of price stability and sustainable economic growth.
The minutes of these regularly scheduled meetings are released three weeks after the date of the policy decision.
Upon release, investors pore over these minutes in an attempt to guess the Fed’s next steps: “Will they raise
rates, will they lower rates or will they stay the same?”
Attempts by investors to anticipate these decisions are causing significant volatility in the financial markets, as
evidenced by the month-to-month swings in performance in this year’s 1st quarter.
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Investors also scrutinize comments from Janet Yellen in an attempt to determine the path of interest rates.
These actions call to mind this classic scene from the Wizard of Oz - as Dorothy also comes to a decisionmaking crossroad and heeds the advice of the Scarecrow:
Dorothy: Now which way do we go?
Scarecrow: Pardon me. That way is a very nice way...[pointing]
Dorothy: Who said that?
Scarecrow: It's pleasant down that way too!...[pointing in another direction]
Dorothy: That's funny. Wasn't he pointing the other way?
Scarecrow: Of course, people do go both ways [pointing in both directions]
That's the trouble. I can't make up my mind.
On one hand, recent statements from the Fed
indicated that strong job growth and a decline in
the jobless rate had improved the employment
picture. Investors interpreted this as meaning
“interest rates will go higher soon” and stock
and bond prices dropped.
```
On the other hand, the Fed has also mentioned
that inflation persists at below-target levels.
Falling oil prices further contain inflation and
wage growth remains anemic and worrisome.
Investors interpreted this to mean “interest rates
will stay at historic lows” and stock and bond
prices rallied.
These quick changes in investors’ interpretations occurred in just the past three months! Our disciplined
approach to investing does not focus on variables that are unknowable and uncontrollable, such as the direction
of interest rates.
Interest rates may move higher, they may move lower, or they may just stay where they are. It is important to
note that a diversified portfolio will benefit in each of these scenarios.
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Why Disregard Short-Term Forecasts?
To prove that trying to guess the direction of short-term interest rates is not worthwhile, we offer the results of a
recent study from Legg Mason. This study tracked the semi-annual average interest rate forecast from The Wall
Street Journal Survey of Economists from December 1982 through December 2013. This forecast was then
compared to the actual direction of interest rates.
Overall, the economists’ forecasts were wrong in 40 of the 63 time periods measured – or 63% of the time.
These 30 plus economists are leaders in the investment industry and, in total, they have been wrong more often
than they have been right over the past 31 years. Our advice is to focus on variables that are controllable, which
includes determining true time horizons and setting realistic rate of return expectations.
An Educated Client is Our Best Client
This SIA Perspectives is being written on April 15th and we acknowledge that most investors are feeling the
financial impact of higher tax rates made effective in January 2013. We have mentioned often in our SIA
Perspectives that the impact would result in higher tax bills for most investors. Adding to this tax burden is the
significant appreciation generated by most financial markets during the past five years.
The chart below outlines the federal tax rates at the maximum levels for wage income, capital gains, dividends
and payroll for the past two years.
We are very conscious of the higher tax rate burdens
and attempt to manage portfolios to be as taxefficient as possible. Because capital gains, plus
dividend and interest income are being taxed at such
high rates, we focus on the appropriate placement of
certain asset classes in taxable versus tax-deferred
client accounts.
When possible, we attempt to minimize the impact
of these tax increases with our investment strategies,
but we acknowledge that most clients faced a higher
tax bill for 2014.
We are proud to enter our firm’s 22nd year and we know that this achievement could not have been possible
without the trust you have placed in SIA and your willingness to share our story with personal and professional
acquaintances. Thank you for contributing to our success.
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