4th Quarter 2018: Quarterly Recap and Near-term Outlook

Hello Friends!

Following you will find, once again quite late this quarter, Lake Jericho’s look back at the prior quarter, some commentary about 2018 in total, and a bit about improvements to our process given tough lessons learned during the period. Once again, I might be an old dog. But I can learn new tricks.

This link is to a PDF containing our Q4 2018 Quarterly Recap and Near-term Outlook.  It follows the form of (1) What is it that we are most thinking about right now, (2) What happened during the past quarter from a big-picture perspective, and (3) What are we doing about it. Also, this Recap incorporates a series of directly comparable, globally diversified, balanced portfolio benchmarks constructed by Morningstar, Inc. This tabled data will, hopefully, help each reader evaluate performance in proper context with just a few numbers.

As always, I am available at any time, any day of the week, to discuss specific portfolio performance questions with all clients. Until then, be well, enjoy your week, and thank you!

A.J. Walker, CFA CFP® CIMA®
Founder, President, and CEO
Lake Jericho, LLC

4th Quarter 2017: Quarterly Recap and Near-term Outlook

Lather. Rinse. Repeat. Continued.

When opening last quarter’s Recap I commented about the Groundhog Day type of experience that had been 2017’s investment market through the end of Q3. And when closing Q3’s Outlook I encouraged investors to relax, to enjoy the market’s calm and persistent upward trajectory. With no meaningful roadblocks on the horizon, and with few meaningful exceptions to the market’s push higher, Q4 was a welcome continuation of 2017’s lather, rinse, repeat theme. However, I am not wholly confident that clients were able to wash away worry that what goes up potentially comes back down. The two conversations clients initiated the most during Q4 were (1) is it time to sell everything and wait for a pullback, and (2) should I be buying Bitcoin? I will get to the first in a couple of paragraphs. I will not touch the second. Here at least.

Q4 Review

2017 was a great year for investors, with Q4 the strongest of the four quarters for U.S. markets. The persistent upward trajectory of markets pushed U.S. stocks repeatedly to new all-time highs. For the first time since its inception, the S&P 500 Index (a broad measure of large U.S. companies) was positive for each of the 12 months during the year, providing a total return of 21.8%. Although small company stocks (as measured by the Russell 2000 Index) lagged their large company counterparts, they too delivered a better than historical average total return of 14.6% for 2017. As forecast in prior Quarterly Recaps and Near-term Outlooks, most regions across the globe are exhibiting some degree of economic expansion, and on average international economies exceed the rate of growth in the U.S. In its most recent update, the International Monetary Fund projects that the U.S. economy will grow 2.7% in 2018 (up from prior projections of 2.1%) and that the world economy will grow 3.9% (up from prior projections of 3.7%). Rising global economic growth helped to fuel strong equity performance across most major indices for both U.S. and international markets during 2017. And despite a bit of weakness in international developed markets during Q4, both international developed markets (+25.6%) and emerging markets (+37.8%) outperformed U.S. markets over the full year.

Interest rates in the U.S. and internationally had a meaningful mid-year reversal from falling bond yields/higher bond prices back towards higher bond yields/lower bond prices (bond yields and bond prices have an inverse relationship). Even so, most U.S. bond sectors posted gains for 2017 despite a challenging Q4 during which U.S. Treasury yields climbed steadily. The U.S. dollar, as measured by the ICE Futures U.S. Dollar Index (DXY), ended the year lower by about 11.4% despite rising Treasury rates. Corporate bonds capped a good year with positive total returns. International bonds also experienced healthy performance.

Another supportive factor of the improving global growth theme, the Bloomberg Commodities Index (a price index based upon a broadly diversified basket of commodity items) posted a robust return in Q4 of +4.7% that finally pushed 2017’s Index return into positive territory at +1.7% for the year. While a 1.7% total return might seem paltry, after many years of commodity price deflation Bloomberg commented that while commodity values were still compressed, they are now “less depressed” and “on sound footings for 2018”. West Texas Intermediate crude traded above $60 per barrel in December, extending that push to a three-year high in early January. Normalizing oil prices are certainly a harbiner of better things to come for the energy sector.

The fine folks at Novel Investor provide for us the box charts that follow. We thank them, greatly! The first, immediately below, demonstrates the annual relationship of returns across broad asset categories, both stocks and bonds, in the U.S. and internationally. I like to include this chart when updated as it provides an easy-to-understand visual representation of how the relationships between broad asset categories and markets change over time. The chart also includes a box for an Asset Allocation Portfolio that is broadly diversified, balanced, and fairly indicative of the types of one-size-fits-all portfolios built by other firms for the most typical investor. I have often heard feedback that the level of detail that I provide is nice, but that clients struggle to understand exactly how it should inform their performance expectations. The Asset Allocation Portfolio provided by Novel Investor gives clients an independent, broadly diversified, and balanced benchmark against which to evaluate their own portfolio performance. The Asset Allocation Portfolio described by Novel Investor aligns with Morningstar, Inc.’s Moderate Risk Target Portfolio total return and proves informative for most investors.

Click on the chart to embiggen and activate features.
Right-click to open in a new window. We don’t judge.

Novel Investor Asset Class Returns TableSource: Novel Investor.

The box chart above illustrates 2017’s positive performance adding to what is the second longest bull market on record, helped by a domestic economic expansion now in the 103rd month (making it the third longest in U.S. history). These strong returns have been amid an environment of historically low volatility as measured by the Chicago Board Options Exchange, Inc.(CBOE) Volatility Index (VIX). And while the length of the current expansion, the length of the current bull market, and so many new market highs may unnerve some investors, it is worth noting that bull markets have not historically ended suddenly at historical highs or simply due to advanced age. Rather, unsustainable policy action, extreme valuations in one or more market sectors, or macro shocks (like geopolitical events) typically bring about the end of bull markets runs and economic expansions. Although market expectations are high, they do not appear to be extreme. Rather than describing market expectations as euphoric or irrationally exuberant describe the current market environment as “amiable”, having or displaying a friendly and pleasant manner.

The Chicago Board Options Exchange, Inc (CBOE) Volatility Index (VIX)

Getting to the specific decisions that influence Lake Jericho client portfolios, let’s briefly cover each of the five levels of our portfolio construction process. And as a brief reminder, no client portfolio will match perfectly typical/target allocation decisions, or sector allocation percentages, as every client experience is unique. These unique factors (such as portfolio start dates, timing of asset transfers, timing of individual contributions or distributions, overall risk profile, etc.) certainly impact exact performance attribution of our strategic and tactical decisions. However, what follows will generally inform you of the nature and direction within your own personal portfolio. Clients should carefully review their individual performance information provided to determine and understand how their particular portfolio is impacted by these decisions and performance versus appropriate benchmarks.

U.S. versus International

On a total return basis the S&P 500 Index gained 6.6% during Q4, 21.8% for all of 2017. The Dow Jones Industrial Average (DJIA) gained 10.9% during Q4, 28.1% YTD. These are among the best quarterly numbers seen in fifteen years. The biggest YTD gains among U.S. diversified funds was among large-company growth-oriented funds thanks to red-hot, mega-cap technology stocks. Technology ended the year as the top performing industry sector. The tech-heavy NASDAQ clearly demonstrates this fact having returned 29.6%.

Improving international economic growth, increasing foreign interest rate expectations, the weaker U.S. dollar, and some uncertainty surrounding U.S. economic policy, drove the outperformance of international equity markets during 2017.  The MSCI All-country World Index (a measure of the world’s developed markets performance) finished 2017 higher by 25.6%. If excluding the U.S. from that developed markets index, then the measure of international stocks improves to 27.2%. Even better, the MSCI Emerging Markets Index finished 2017 higher by 37.8%. Our overweights to international investments (with small-company developed market and emerging market overweights imbedded in those investments) served as a meaningful contributor to client portfolio performance during 2017.

Stocks versus Bonds

Interest rates are on the move higher. As long as the move, or the trend in the move, is reasonably paced then the move over time can be deftly managed. Lake Jericho managed portfolios have been defensively positioned against the impact of rising interest rates since 2015, in terms of lower allocations to bonds than is considered typical, in how we constrain allocations to equity investments (real estate, utilities, heavily leveraged sectors) with high negative correlation with interest rates, and in how we position the bond investments that we do hold. We continue to believe that this defensive position is best in the current environment as current bond yields provide little protection from sudden and large adverse price-movements should rates move unexpectedly higher. While certain elements of our defensive position might not add to portfolio returns in many environments, our positioning provides relatively “cheap” risk insurance for a small piece of client portfolios that does not detract meaningfully from portfolio returns in the long run. While our bond positions have been a head-wind for clients during 2017’s outstanding equity market performance, the way in which we construct exposure has been less costly to portfolios than the way in which more traditional managers might implement bond investments. But our lower overall allocation to bonds (and higher allocation to equities) than is typical has been a positive contributions to client portfolio performance during 2017.

Small Versus Big

The small- and mid-sized company space was one that widely outperformed most other sectors immediately after 2016’s election cycle. That the space lagged most other sectors during 2017 is not entirely surprising. However, the persistence of that underperformance post tax reform in the U.S. is somewhat perplexing. Traditional wisdom tells us that tax reform in the U.S. would most benefit small- and mid-sized companies as those companies tend to pay most/all of their corporate earnings tax inside the U.S. (versus large multinationals that are able to shop the world’s most advantageous tax jurisdications). Significant tax savings should fuel significant earnings growth, leading to meaningful outperformance of those company’s stock prices. This has not been the case. We shall see during Q1 2018’s earning season if the weaker U.S. dollar and rising commodity prices are putting a strain on input costs and thereby suppressing earnings.

To fairly evaluate our process regarding the “small versus big” question, we look to the Russell 2500 Index for comparisons. The Russell 2500 Index is a broad measure of blended strategies in both small- and mid-sized U.S. company stocks. For Q4, the Russell 2500 Index returned 5.2% (16.8% for 2017). With the S&P 500 Index return of 6.6% for Q4 (21.8% for 2017), our “small versus big” strategy underperformed large-company peers by 1.4% for Q4 (-5.0% for 2017). And as we do tend to hold larger allocations than is typical in the small- and mid-sized company space, this was a significant drag on client portfolio performance during 2017.

Value versus Growth

U.S. value-oriented equity strategies also wildly outperformed growth-oriented strategies during 2016. As a value-biased portfolio manager, Lake Jericho clients certainly benefited from that differential during 2016. But with the overwhelming outperformance of value-biased strategies during 2016 and of certain elements of value-oriented strategies during Q1 2017, that value strategies began to lag growth-oriented strategies during 2017 is again not surprising. But our focus is on maintaining long-term, strategic positions and not on attempts to time trading patterns. As with small- and mid-sized company exposure, we also believe that investor portfolios should maintain exposure to, if not an ongoing overweight towards, value-oriented investment strategies. The basic premise of value investing is that certain securities are underpriced bargains and are likely to outperform once their “real value” is fully appreciated by investors. If for no other reason, it is a bit of common sense supported by the statistics that if you remain mindful of not overpaying for your investments then you are more likely to achieve superior returns over the long-run. Value-oriented investing is one method that helps investors achieve this objective. A gross over-simplification of an entire field of financial study, but that is the basic idea.

To fairly represent value versus growth factors in the markets we use Morningstar, Inc. measurements. During Q4, U.S. value funds as a group were up 6.3%, right on the heels of the S&P 500 Index return of 6.6%. However, for the full year U.S. value funds as a group were up 14.2%, trailing the S&P 500 Index total return of 21.8% by 7.6%. If we isolate large-company growth strategies within the S&P 500 Index during 2017, return increases to 31.1% and the differential swells to 16.9%. That degree of performance differential, though rare in the long run, surely feels painful in the short-run. But the tide will turn and the relationship will normalize. Luckily (or smartly) our value bias is constructed both domestically and internationally. During most of 2017, international markets simply outperformed U.S. markets. Putting both exposures together, our value bias internationally was essentially a wash for client performance returning a comparable 21.5% to 23.9% depending upon the manner of implementation versus the S&P 500 Index’s 21.8%.

Sector Allocation Decisions

Finally, strategic and tactical sector weighting, the fifth aspect of our portfolio construction process, is an important part of how we add real, long-term value for our clients. Our process of underweighting U.S. equity market-neutral benchmark allocations in favor of overweighting those sectors that we expect to outperform the market average have been a meaningful tailwind for client portfolios over time. If you look at the 2017 column of sector returns in Novel’s box chart below, you will see the S&P 500 Index return for 2017 sitting at #6. The 11 sectors that make up the S&P 500 Index are strewn about, above or below depending upon the sector finish relative to the Index. Our sector overweights are currently materials (#2), financials (#4), and healthcare via medical devices and technology (#5), each besting the S&P 500 Index for 2017. Finishing in second place behind technology was the materials sector at 23.8%. Finishing in fourth place among the 11 sectors was the financials sector at 22.2%. And in fifth place, the healthcare sector finished at 22.1%. Since we were overweight sectors outperforming the S&P 500 Index, and underweight to all of the other sectors underperforming the S&P 500 Index , our underweighting of the high-flying technology sector was muted at bit.

Click on the chart to embiggen and activate features.
If you are not a back arrow person, right-click to open in a new window.

Novel Investor Sector Returns TableSource: Novel Investor

Near Term Outlook

Amiable , admittedly, is a strange word to describe a market or to describe the expectations of market participants. But it fits for two reasons widely discussed in the financial media. First, analysts feel that the lingering impact of the global financial crisis caused market expectations during the past decade to be generally so depressed that proper attitudes are only now returning. So, have market expectations been unnecessarily low for so long that our new and proper expectations feel euphoric in contrast? Perhaps say the pundits. I say yes, absolutely. Second, and more tangible than “feelings”, increasing growth expectations are now seen in consensus forward looking estimates for domestic and international real GDP growth, meaning that market participants view global economic growth as supportive of higher equity prices. Further, the consensus among market participants is that room remains for yet more upside. And while domestically the U.S. has had a big run-up in the markets due to the growth impact of tax cuts, markets are continuing to climb higher because those tax cuts are already beginning to show up in household and corporate earnings. In even simpler terms, the economy is growing into these higher stock prices. And that is the historical norm. The stock market has been, and is now, a leading indicator of the health of the underlying economy. This first-mover behavior of equity markets is the market behavior that professional investors expect to see.

So there has to be something, right? Something for us all to fret about, and to wonder if now is the time to sell everything and wait on the sidelines for the reckoning that must come? If you are going to twist my arm and force me to say something unfriendly about this very amiable market then I am going to say that we need to watch the value of the U.S. dollar. The softening U.S. dollar (currently at about a 3-year low) has been a supporting factor for rising commodity prices, a supporting factor for rising international equity returns, and certainly has been a goal of the Trump administration with his focus on the trade deficit. The cheaper the dollar the more we can sell overseas, right? So a weaker dollar has some upside. In past quarter’s we have described our mindful process, carefully watching for imbalances between interest rates, currency values, and commodity prices. In 2015 and early 2016 we talked a lot about what happens when things get too expensive or too cheap. “Too” anything is never a good thing in markets. We might be getting close to a dollar that is “too” cheap. The small-company stocks might be the early warning signal. And if interest rates continue higher without a corresponding increase in the value of the U.S. dollar, then we might actually have a perception problem internationally related to government policy and impacts upon market stability. We shall see. If we do discover a fly in the ointment with respect to this market, it will come through one of the three windows; interest rates, currency values, or commodity prices.

We remain watchful and ready to respond should we see signs on the horizon of something awry. I encourage you once again to take a bit of time and enjoy what this market is providing. There will be time for worry later. As always, I am available at any time, any day of the week, to discuss specific portfolio performance questions. I will also be in touch with each of you in the coming weeks as Lake Jericho rolls out its new collaborative and interactive financial planning application. Until then, be well, enjoy the rest of your week, and thank you!

A.J. Walker, CFA CFP® CIMA®
Founder, President, and CEO
Lake Jericho, LLC


4th Quarter 2016: Quarterly Recap and Near-Term Outlook

The thing about crafting a useful Recap at each quarter’s end? When quarter-end is also year-end we have much more ground to cover. And if the combination of quarter-end plus year-end was not sufficiently broad, we also have the U.S. Presidential election to talk about. So I will get to work. My apologies in advance for the coming wall of text.

2016 Annual Review

You likely recall that as the year 2015 closed, financial optimists were in short supply with heightened anxiety over China’s economy and stock market, falling global demand for oil and commodities, fears of a potential U.S. recession, and negative interest rates in major world economies. On the first trading day of 2016 the U.S. equity markets began a steep decline creating the worst start of any year on record. The first 10 trading days of the year resulted in the biggest decline, about 8.25%, of the Dow Jones Industrial Average (DJIA) throughout the 120-year history of that index. The S&P 500 index, a far more broad measure of the market, fell about 8% in the first 10 trading days. Results in early January appeared to confirm the most pessimistic of views as markets around the world, seemingly in sympathy, fell sharply. Not one of the nine investment strategists participating in the Barron’s 2016 Roundtable expected an above-average year for stocks. In fact, six expected U.S. stock market returns to be flat or negative, while the remaining three predicted low single digit returns at best. Prospects for global markets appeared no better, according to this group. Two panelists were sufficiently bearish to recommend outright betting against emerging markets. Then things got worse.

Oil prices fell sharply. Worries about an economic debacle in China dominated the news cycle. Stock markets in France, Japan, and the UK registered losses of more than 20% from their previous peaks. Plunging share prices for leading banks around the globe had many worried that another financial crisis was brewing. By the time U.S. stock prices hit their bottom on February 11, shares of the five largest U.S. banks where down 23%.

U.S. markets began improving in mid-February and continued that pace through midyear, just in time for investors to then face uncertainty from June’s Brexit vote. While stock prices had generally recovered, as late as June 28th the S&P 500 Index was still showing a year-to-date loss. Throughout the year, observers fretted a lagging pace of U.S. economic recovery. The New York Times reported that “weighed down by anemic business spending, overstocked factories and warehouses, and a surprisingly weak housing sector, the American economy barely improved…”. A number of well-regarded professional investors argued that the next economic downturn was fast approaching while one prominent activist predicted a “day of reckoning” for the US stock market encouraging investors to “sell everything”, to “get out of the stock market.” As late as August a prominent Hedge Fund managed announced a doubling of his downside bet against the S&P 500 Index. It would appear that well-regarded predictions are worth exactly what one pays for them.

Despite the dire predictions, equity markets around the globe staged a nice comeback throughout Q3. Aside from a few industry sectors that got continuously caught up as fodder for bi-partisan vote-pandering during the U.S. election cycle, it was a very good quarter for investors. Each new bit of economic data implied an improving U.S. economy and employment market. Stabilizing oil prices and corporate earnings helped turn the market around prior to the later-days of Q3.

Q4 Review

After highlighting the good news that Q3 brought for Lake Jericho clients, when closing the Q3 Recap we highlighted our strategy to manage increased volatility (to the down side) leading up to the actual election. The increased volatility call was an easy call, no doubt, as most investors tend to sit on the sidelines in advance of big economic or political events. When investors are sitting on the sidelines, not bidding up prices on new investments, stock prices will fall. That is exactly what happened in the weeks after the end of Q3 leading up to election day, a period in which the S&P 500 Index gave back about 2% of its year-to-date gain. Then came the new elephant in the room.

Putting aside personal biases, we believed for some time that Donald Trump would win the Presidential election. While correct about the election outcome, along with many others we were surprised about the short-term market impact. Well, we were for a few hours. But then we was not. Either way, we decided well in advance of the election to more neutrally construct risk exposures in client portfolios. That is just a fancy way of saying that we hedged our bets. We positioned portfolios to mitigate some measure of the downside risk associated with either candidate’s victory even though it meant that we would forego some of the upside potential represented by each candidate.

On election night, as early results began to indicate a likely Trump victory, global markets and the U.S. futures markets (think pre-opening indication of where markets are going that day) went into a tailspin. Near midnight in the U.S. the futures market for the S&P 500 Index and DJIA had both fallen by more than 4%. Not unlike 2016’s surprise Brexit vote results, stocks tumbled on the unexpected outcome (unexpected based upon polling data at least). To repeat one of our most often stated market realities; uncertainty is worse for stock markets than certain, but bad news. While futures markets remained in chaos through much of that night, by morning, after Trump was declared the winner, investors shifted focus from unexpected election outcomes and policy uncertainty to a unified, seemingly instantaneous expectation that his plans for higher government spending, lower taxes and fewer regulations will create more economic growth, higher inflation and, potentially, rising corporate profits. This, to us, is where a disconnect occurred between markets and realistic expectations of what a Trump administration might bring. Our internal view is that markets have put the cart well before the horse.

Within a very short window of time, post-election markets priced to perfection flawless policy execution. Implying no value judgement on policy positions themselves, the immediate repricing of market as if the Trump administration would be able to immediately and fully institute those policies is a disconnect from the administrative reality of how the U.S. government functions. Donald Trump is many things, a remarkable showman for one, but a monarch ruling in a vacuum he is not. While he has much common ground with the GOP leadership in both houses of Congress, there are many challenges ahead to crafting mutually agreeable paths to achieve many shared goals. In many respects, such as the budget deficit impacts of increased fiscal spending, Trump’s vision of some policy matters are further removed from political reality than those faced by Barack Obama and GOP leadership.

Be that as it may, the result of the November election provided a kick that drove markets to new highs before settling slightly below those highs at year-end. The S&P 500 Index finished the year up 9.5% on a price-return basis (11.96% total return basis), an impressive 20% swing from the market lows in February. For Q4, the S&P 500 Index finished up 3.25%, essentially matching the Q3 2016 return of 3.31%, but about half of the Q4 2015 return of 6.45%. So is it true that the markets love Donald Trump? Maybe. Maybe not. Some sectors have been big winners since the election, while others have not fared well at all. Although there have been a few eye-popping headline numbers, the market rally has not been as widespread as those headlines imply. This is why we prefer to think of the post-election market as getting more of a Trump-bump than a Trump-rally. At Lake Jericho we spend a great deal of time helping investors look beyond the headline numbers to better understand what is happening in the market and in their portfolios. To understand why the post-election rally is not a clear-cut as the headlines make it appear, it is important to look at some specific sectors and styles.

Sector & Style Reviews

  • The Dirty Economy: Oil drillers, gas pipelines, coal, construction and industrial equipment, infrastructure, defense, and materials are all post-election winners . The Trump administration could take the lid off coal and fracking regulations, begin an extensive repair of the nation’s roads and bridges, and rebuild defense. Each of these are generally considered pro-growth, pro-inflation measures and the markets priced these possibilities fully into the post-election rally. Again, some of these are particular areas in which Trump will likely be fighting the establishment GOP when budget and deficit realities work their way into the discussions. Unless Paul Ryan and his budget committee experience a reversal in their long-communicated austerity position, many of these projects are likely to be the subject of long, protracted budget battles should they materialize at all. Our approach to this space throughout 2016 has been through portfolio overweights to the Materials sector. During 2016 the Materials sector bested the S&P 500 Index total return by nearly 10%, providing a significant tailwind for client portfolio performance.
  • Value Bias: We regularly discuss Lake Jericho’s “value” bias investment style, versus a “growth” oriented investment style. We use the term “bias” purposefully, as we are not a pure value investor, rather we tend to more heavily weight value-oriented investments more than the style itself represents in the U.S. equity market. During the past several years, particularly during 2015, stock market increases were driven in part by investor enthusiasm for fast-growing companies (“growth” oriented companies) with marginal, even no, profits. Many value-oriented strategies (which seek to buy and hold profitable businesses when they are trading at discounts to intrinsic value) did not fully participate in the market’s returns. This was part of the reason that some Lake Jericho portfolios underperformed the broader markets during 2015. However, as we regularly reinforce, when these types of environments persisted in the past they consistently ended with big rewards for value-oriented investors maintaining their discipline through the cycle. 2016 in total, and particularly post-election 2016, was a validation of this discipline. Each of the sectors discussed above (banking, financial services, infrastructure, industrials, and defense) have been considered “value” investments for a number of years.

Shifting benchmarks a bit (merely because Morningstar, Inc. does a better job of quantifying value/core/growth style performance differences), Morningstar reports that while a 100% U.S. large-company, core portfolio returned 13.75% for 2016, its value-oriented counterpart returned 18.91% while its growth oriented counterpart returned a meager 1.79%. These performance differences between value/growth styles become even more pronounced as one moves down in company size through mid-cap and into small-company stocks. These combinations of style bias provided a significant tailwind for client returns.

  • Small Company Bias: Small-company stocks tend to be more economically sensitive. Economic data has been strong the last two quarters. With the election over, Wall Street finally seems to finally be paying attention to our improving economy, and the potential impact of Trump positions on smaller U.S. firms. Investors are betting that a Trump administration will focus on policy changes positive for the U.S. economy but less so for the global economy. Since small-company stocks generate a larger portion of their revenue in the U.S., small-company earnings will be less affected by potential negative ramifications in foreign markets. Also, if Trump and a Republican-controlled Congress lower domestic corporate income taxes as many predict, small companies will benefit most. Further, large companies with a major international footprint could be adversely affected when Trump seeks to renegotiate global trade agreements. They could even find themselves subject to additional penalties if new laws are enacted adversely impacting companies that operate abroad and import products back into the U.S. market. Rising interest rates have already caused the U.S. dollar to strengthen, another headwind for large companies with global operations. Small companies operating exclusively in the U.S. avoid this problem.

In the weeks following the election, the Russell 2000 Index (a commonly used index for U.S. small-company stocks) gained 16.14% from the pre-election close to a new high-water mark. Although the Russell 2000 Index would give back about 2.25% before year-end, the spread in performance between small-company stocks and large-company stocks post-election was the widest it has been in about 14 years. Our approach to small-company investing bested the S&P 500 Index by nearly 15.00% during 2016. This excess performance combined with the fact that we overweight small- and mid-sized company stocks provided significant tailwinds for client portfolios during the year.

  • The Rolling Tech-Wreck: On the opposite end of the spectrum, the Technology sector (the biggest sector of our economy by market capitalization) was a complete wreck post-election. In fact, 2016 has been filled with mini-cycles within the various sub-sectors of Tech. Post-election, anything tech related was considered to have a giant target on its back for the industry’s nearly absolute support of the Clinton candidacy. Significant concerns loom in the background over whether Trump will expand the government’s surveillance powers and attempt to weaken security and encryption. Trump vowed to “penetrate the Internet” to prevent ISIS from using it to recruit fighters. He chastised Apple for refusing to create a back door that would let the FBI unlock an iPhone used by the attackers in San Bernardino, Calif. Each bit of rhetoric has sent chills through Silicon Valley and prompted a flood of responses from engineers and big company leadership. Reservations exist about staffing as during the campaign Trump attacked the H-1B visas program for high-skilled immigrants, only to walk back the statement in private conversation. During the campaign, many feared that Trump would serve to stifle competition via FCC appointments only to have him make later comments that were pro-competition. His campaign’s only policy adviser, Stephen Miller, seemed uninterested in tech and made little outreach to the industry. Lobbyists and officials from tech giants beaten down in the post-election market said they would need to watch closely for clues to Trump’s tech policies. But in fairness to the Trump administration, the difficulty expressed by many companies to know how Trump would act is largely because they had not had any contact with the Trump campaign. And some Silicon Valley investors and entrepreneurs acknowledged that he could be more friendly to business than Clinton, opening up some opportunities for start-ups in emerging areas, such as financial technology and the gig economy. Overall, the Trump campaign has said very little in absolute terms about issues affecting the tech industry and instead focused largely on manufacturing. In the end, client portfolios that were overweight to technology sub-sectors (such as cloud infrastructure and semi-conductors) did well during 2016 as the sector slightly outperformed the overall S&P 500 Index. But post-election and heading into the new year the sector dramatically underperformed the broader market. This is a space that appears to be stretched in valuation and is a space we consider to be a bit of a challenge for 2017.
  • Healthcare: The healthcare sector presents, currently, a confounding challenge. Fundamentally speaking, valuations are attractive across the sector. There are many great companies, doing great work, and achieving wonderful results. There are also some knuckleheads that can’t keep themselves out of the news for tone-deaf business strategies. While for 2016 the “healthcare” sector was the worse performing S&P 500 market sector, our portfolio overweights to the medical devices and technology sub-sector provided marvelous results for client portfolios. Unfortunately, portfolios with additional allocations to pharmaceuticals, and/or biotechnology, struggled to keep pace. During the presidential campaign, Clinton was often critical of the pharmaceutical industry when it was likely more appropriate to focus on specific companies and their pricing policies. It appeared that the market is incapable of differentiating between pharmaceutical companies and biotechnology companies so both sub-sectors would get taken to the woodshed. Her defeat suggested that the regulatory environment for drugmakers and research companies could be more lenient than many expected before the election. Not surprisingly, post-election the drugmakers did very well, although at the time it was more about what Trump had not said than what he had. Biotech and pharmaceutical stocks swung up sharply the day after the election and continued to climb for about a week. But then one prominent drug-company CEO noted in a speech that drug prices were a populist issue, implying that investors were getting ahead of themselves thinking Trump will leave companies alone. Days later, Time magazine published an interview with Trump in which he said he was “going to bring down drug prices”, a position he reiterated in a post-election news conference and in interviews. Sharp declines resulted.

In fact, Trump is not really seen as good news for anything in the healthcare space. His plan to unravel the Affordable Care Act has hit some healthcare stocks very hard. With the ACA unlikely to survive in its present form under a Trump administration, the future health insurance of some 20 million Americans is uncertain. If Congress and the incoming president roll back the ACA’s subsidized individual insurance exchanges and Medicaid expansion, many of those 20 million Americans insured under those provisions could lose coverage. Millions of potential patients for doctors would no longer be able to afford healthcare, and markets appear to think that could mean lost business for hospitals, medical service companies, medical technology, and even firms focused on R&D. Whatever the GOP “repeal and replace” plan might look like, it must be a comprehensive measure to soothe market fears about this crucial segment of the economy. This is the confounding part of the sector; attractive valuations with otherwise attractive prospects but subject to the greatest political risks in recent memory.

  • Interest Rates, Currencies, and International Markets: It should be no surprise to any Lake Jericho client that our typical portfolio will have significant allocations to international investments, both stocks and bonds. This past year in international investments is a bit difficult to get one’s head around without some discussion of currency values and interest rates. They are all connected in complex ways, but I can break down the complex relationship in one dangerously over-simplified, run-on sentence — When country A has a higher rate of inflation than country B, then country A will also have higher interest rates than country B, and those higher interest rates will incentivize investors to sell investments held in country B, use the proceeds to buy country A’s currency that they then use to buy investments in country A. That is the dynamic in post-election U.S., a bit of “which came first, the chicken or the egg” dynamic. But they are all countervailing forces at work against one another as they seek some long term equilibrium. Using this pattern (assuming that we are in a virtuous inflationary cycle rather than a destructive inflationary cycle) we can discuss how these moving parts are affecting client portfolios.

A number of Trump’s pro-growth items will demand much higher government spending (fiscal policy) to achieve. Expansionary fiscal policy is necessarily inflationary (growth=inflation). That is the whole point. Meanwhile, restrictive trade policies that make imported goods more expensive for American consumers, or a crackdown on immigration (possible labor shortage) would most likely also lead to higher inflation. Two things happen in an growth/inflationary period; (1) stock prices rise because stock investors assume corporations will earn more, and (2) bond prices fall because bond investors demand higher yields to protect them from inflation. Suddenly, the U.S. stock market and the U.S. bond market look much more attractive to the world’s investors. To capture the higher returns/yields available in the U.S., international investors start buying the U.S. dollar so they can make new investments in U.S. securities. Suddenly, again, you have a much stronger U.S. dollar, higher U.S. investment values, and lessened demand for international securities.

In local currency terms, equity performance in many international markets was stellar during Q4. Eurozone equities were stronger over the quarter, with the MSCI EMU index returning 8.1%. In the UK, even in the face of a looming hard BREXIT, the FTSE All-Share index rose 3.9% over the period. The Japanese equity market rose each month in the quarter to produce a strong total return of +15.0%. However, when one accounts for the affects of the strong U.S. dollar on currency adjusted returns, these areas of excess performance are much more muted and in some settings the currency affect resulted in negative returns. For example, the unhedged MSCI EAFE (Euro, Australasia, Far East) Index gained just 1.5% with dividends, or 10.5% less than its U.S. counterpart, the S&P 500 Index. Aware of this heightened risk, Lake Jericho executes our international allocations using multiple strategies. In some situations currency exposure is unhedged, while in others the exposures might be partially or even fully hedged. Regardless, on average our higher-than-typical international allocation was a drag on client portfolio performance during 2016. Our mix of strategies did result in net gains for clients for the year, but the return did lag the broad U.S. market.

  • Interest Rates and Bonds: Without diving into the specifics, one can view bond markets as a mirror for growth expectations. Despite the volatility in both the domestic and the global bond markets, expectations for global economic growth tentatively grew more optimistic during Q4. It appears that others are beginning to increase their global growth outlooks and are now more in-line with the expectations that we have had internally for about 18 months. We were correct in our Q4 Outlook that the U.S. economy was on sure enough footing that the Federal Reserve’s FOMC would take the next step in rate normalization. Of course, we actually believe that they should have taken that step at least four times by now. So it isn’t that we think we are smarter than other folks, rather we tend to embrace the data in our decision-making earlier than other folks.

For much of the year, we have talked about how our lower-duration bond portfolios lagged the returns of the broad bond market as long-term interest rates continued to fall. Our preference to use domestic bond allocation as a ready source of liquidity and as dampener of stock volatility means that we are not chasing returns from longer duration bonds. Anticipating the affects of rising interest rates was as much of a reason as well. As previously stated, during Q4 bond yields moved higher and the yield curves steepened much as we had anticipated for much of the year. As the tides turned, post-election, and rates rose quickly, our bond portfolios held up much better than the broad bond market. In the end we were able to provide lower volatility and higher returns for clients than traditional long-duration bond funds for 2016.

Like domestic bond markets, global bond market movements were overwhelmingly driven by political factors. At the forefront of the political dynamics stood the victory of Donald Trump, but upcoming elections in Europe also rose in prominence as potentially destabilizing influences. The uncertainty surrounding the UK’s negotiations to withdraw from the European Union also impacted bond portfolios significantly. Some level of global bond exposure is standard for Lake Jericho managed portfolios. Not surprisingly, it is also an allocation that we use differently than most managers. As such, while most global bond allocations disappointed during Q4, our allocations bested broad market bond indices by nearly 11%, and even beat the S&P 500 Index by more than a full percentage point.

So what does all of this mean for us going into this new year? The Trump-bump has left stocks historically expensive relative to their intrinsic valuations. The Shiller Price-to-Earnings Ratio is a commonly used, though not without flaws and limits, measure of how expensive stocks are relative to their intrinsic values. It shows the ratio of S&P 500 Index company stock prices to their earnings, after adjusting for a set of macroeconomic factors. As 2016 closed, the Shiller Ratio was 28.8. The only times the Shiller Ratio has been higher were right before the 1929 crash, the dot-com bubble of the late 1990s, and the run-up to the 2008 financial crisis. I am NOT implying that a stock market crash is imminent. I am NOT implying an abiding faith in the Shiller Ratio. It is NOT even part of the set of metrics that we use internally. All I am saying is that stocks have generally gotten very pricey lately and most popular, independent, simple measurements do tend to agree. It creates an uncomfortable time to make new investments for a value-biased firm like Lake Jericho.

This is also a bit of a double-edged sword for us and our clients. While existing investments enjoyed a nice run-up in value, it has become increasingly difficult to get cash positions and new deposits invested. We suspected that there will be a period of downward pressure on markets after the December FOMA meeting through the end of the year and perhaps into the new year’s earnings reporting season. This did happen and created a few opportunities for us to get the majority of cash and new deposits invested. As for the remaining cash, new deposits, and the remaining inverse positions we hold, we remain constantly on watch and are being very careful about allocation and timing decisions of new investments.

Generally speaking, we are continuing with our long-term global economic growth estimates for both domestic and international markets. Our targets, generally, remain the same as those we have held for the past year with higher expectations for both foreign developed and emerging markets than for the U.S. market. As such, we will maintain our healthy allocations to international investments, less so despite the period of underperformance but more so because the period of underperformance leaves international investments as one of the few places where valuations remain attractive. For the near term we are expecting reduced market volatility. We are not alone. A wait-and-see attitude persists in the markets right now, a breather as it were, to see exactly how fast, or slow, or how much of the Trump agenda might materialize. We suspect that any hiccups along the way will have immediate impacts upon securities prices.

Most importantly, we are still formulating our sector strategies for 2017. We typically have these matters settled and executed by this point in the new year. However, the Trump presidency (more specifically the Twitter presidency) has added additional complexities that we are still sorting out how to properly evaluate and manage. In a time when a single Tweet can send an entire industry group into a tailspin, we are revisiting some aspects governing how “long-term” our sector outlooks and strategies should rightly be. As is typical, a more simple framework of embracing sensible asset allocation and broad diversification is likely the best strategy in what could be a more volatile environment. In the final analysis it is possible that for some time we will simply be more “core” focused than in the past in the hope that the Twitter-in-Chief settles more calmly into his new role. As 2016 closed, the U.S. market reached new highs, and stocks in a majority of developed and emerging market countries delivered positive returns for the year. The 2016 turnaround story highlights the enduring importance of diversifying across asset groups and regional markets, as well as staying disciplined despite uncertainty. Although not all asset classes had positive returns, most broadly diversified portfolios logged attractive returns in 2016, a reality most could not imagine early during the year. Maybe 2017 will be just like that.

We are available at any time, any day of the week, to discuss specific portfolio and performance questions that you might have. I will also be in touch with each of you in the coming weeks to discuss any changes in strategy that should be considered, or to walk through any administrative tasks that might be needed. Until then, be well, enjoy the rest of your week, and thank you!

A.J. Walker, CFA CFP® CIMA®
Founder and Senior Consultant
Lake Jericho, LLC

4th Quarter 2015: Quarterly Recap and Near-Term Outlook

The thing about crafting a useful investment review at each quarter’s end? As each quarter-end approaches I spend a lot of time thinking about the messages most important to reinforce with clients. Then without fail, within days after each quarter-end any manner of hell will break loose that deserves equal coverage. The 4th quarter of 2015 and the 1st week of 2016 are no exception.

The single, most striking theme during 2015 was that although the U.S. economy continued its pattern of economic recovery, not much in the investment arena worked really well. Although the S&P 500 Index (basically the largest 500 U.S. companies) managed to eek out a modest positive return (1.36%) thanks to stellar returns of a few companies, most asset classes ended the year in negative territory with highly positive correlations. This lock-step movement of asset classes provided few safe havens for investors during 2015. It was a year that reminded us that when we talk about a strategy, or a tactic, that works to our benefit “over time” that it does not mean that it will work to our benefit every year.

S&P 2015 Total Return
S&P 500 Index: 2015

A year like 2015 is why we remain committed to a long-term course of action for client portfolios. Every quarter we remind clients that Lake Jericho is an investment firm and not a trading firm, and as such we remain invested in our decisions rather than playing the game of speculation and short-term trading.

As for the past week, I am reasonably certain that by now everyone is aware of the dumpster-fire that was the first week of 2016. The multitude of various sector and style indices aside, the first trading week of 2016 goes into the history books as the worst opening of a new year’s stock market. In the coming years it will no doubt be the subject of much review and ivory-tower analysis. The factors driving the past week are many and complex, but are simply a continuation of the challenges endured throughout most of 2015. Therefore, I choose to roll it all up into the following discussion. I am going to break down just a few of the most important elements that have had the greatest impact on Lake Jericho client portfolios. I will also briefly talk about how these factors impact our strategy for 2016.

  • Math.

Last quarter I used a few hundred words to describe how we look at the value of a thing (what an investment is worth to us) versus the market price of that thing (what that investment is worth to someone else). If an investment is of more value to us than the price the market is offering to purchase that investment, then we hold that investment until the market price and our value converge. Many circumstances can cause our value of holding any investment to change over time. But why does the market price of investments change all the time? Simply stated; math. It is a cheeky response, but true.

The market price of an investment is nothing more than a momentary consensus of willing buyers and willing sellers estimation of the future value of a company’s expected cash flows. We take some rate of growth, grow that exponentially over some period of time, multiply that by expected cash flows. Easy breezy. Even if you hate math you know that when you exponentially grow some number that the result grows really quickly. You also know that if you make little changes in numbers grown exponentially (grow 2 by 3 and you get 8, but grow 3 by 3 you get 27, grow 4 by 3 you get 64) your result increases dramatically. Small changes, over time, have big results.

Very simply, this is what is happening with stock prices and why they have been moving so much. Small changes in a company’s earnings, or small changes in growth rates, over time, result in large (exponential) changes in stock price. Some more math (known as discounting) happens in the middle of that, but you get the idea. This idea is fundamental to understanding what is happening in the stock market these days.

Last quarter I suggested that uncertainty is worse for stock markets than certain, but bad news. Uncertainty is driving this market volatility. In the investment arena, there exists a razor-thin line between something being too expensive, and that thing being too cheap. Markets are in perpetual motion trying to maintain equilibrium on the edge of that razor attempting to discern what, based upon corporate earnings and growth rates, is too expensive and what is too cheap.

  • The U.S. Dollar.

The U.S. Dollar (in relation to other currencies) is an example of something that has become too expensive. One example of the effect is pretty easy to see at work. The second example is more complex. Unless you are an accountant or analyst it is one you likely never think about.

First, a strong dollar is good for U.S. consumers (we can buy more stuff from other countries), but not so good for U.S. businesses (they can not sell as much of their stuff to other countries). So while the consumer-based parts of the U.S. economy are doing well, U.S. businesses that do a large percentage of their business abroad are not doing so well. U.S. companies are earning less internationally.

Second, when a U.S. business generates earnings in foreign markets, those earnings have to be converted back into U.S. dollars for financial reporting and tax purposes. When the value of the U.S. dollar is high relative to foreign currencies, those foreign earnings, simply by exchanging them back into U.S. dollars, are suddenly not worth nearly as much. U.S. companies, already struggling to maintain sales/income in international markets (because their goods and services are now more expensive) are hit with a double-whammy. The earnings that they fought to achieve are simply worth less because of exchange rates.

Both of these examples illuminate the math discussion above; how big changes in corporate earnings (in this example due to the strength of the U.S. dollar) occur in unanticipated ways and how those changes in earnings impact stock prices.

U.S Dollar Index
Strength of U.S. Dollar to Major Currencies: 2015
  • Stuff that goes into other stuff.

Americans have bemoaned the high cost of gasoline and our lack of energy independence for the last 15 years. The country almost elected a different President because some thought it cost too much to fill up their truck. We have been punching holes in the ground and pumping in fluids to extract so much oil that the U.S. is now an exporter of the stuff. And for the last 25 years the world’s largest mining companies were digging big holes, with big machines, to get tiny, important, rare, expensive stuff out of the ground to help fuel our demand for smaller, faster, cheaper stuff.

Gas is now cheap. Every house has something like 10 bagrillion-inch flat screens TV’s. We all get new phones, tablets, or laptops with every refresh cycle. We love this part of the global slowdown! But if this is so good, then why does it look so bad? It looks bad because there is cheap, and then there is too cheap.

Oil, commodities, and other factors of production have now become too cheap. As a leading indicator of global growth rates, falling prices in the factors of production is interpreted as purely a reflection of demand and therefore a harbinger of slowing global growth. One tangible example of a direct effect is pretty easy to see at work in our daily lives. But when we extend this effect into the markets? The result is more complex, and unless you are an accountant or analyst you do not think about it much.

Materials Index 2015
Industrial Materials Index: 10-Year Price Level

First, cheap oil and low commodity prices are GREAT for the average U.S. consumer. The money we save due to cheaper energy and lower priced good means that we can save more or buy more. Saving more or buying more must be a good thing, right? In the long run, perhaps. But it takes a long time (and usually a lot of economic pain) to get to a new normal based upon changes in consumption and savings habits. Again, it is about markets in constant motion trying to maintain equilibrium on the edge of the razor.

While cheaper energy and commodities might be good for the average American consumer, the cyclical (business cycle change) or secular (a permanent change) friction upon energy companies (upstream or downstream), mining companies, heavy equipment manufacturers, transportation (railroads, shipping, trucking) companies, has been devastating to earnings. Having made significant investments in capacity for the past couple of decades using assumptions of much higher prices, these companies now have excess capacity and overhead that they can not support. Many companies are being forced to slash production, lay off workers, shutter wells, close mines, and even seek bankruptcy.

In these industries, you are not simply seeing a reduction in the rate of growth. Rather, you are seeing negative growth rates. Negative growth is just an economist’s way of saying “shrinking”. Again with the math, but when you have exponential negative growth, earnings quickly disappear. In short order, debt overwhelms these companies and the assets are forced into liquidation.

Many companies in these industries are small- and mid-sized companies. The energy, commodities, and materials sectors are a big part of the reason that the small-cap and mid-cap sector indexes (represented below by the Russell 2500 Index) have significantly underperformed big-company stocks during 2015.

Russell 2500 Index: Small- and Mid-Cap Performance
Russell 2500 Index: Small- and Mid-Cap Performance

Lake Jericho overweights both small- and mid-sized companies in our portfolios. This adds the potential for more price volatility in our portfolios. However, the potential for additional return afforded by this overweighting more than compensates long-term investors for the additional risk. Only during a few, short-term, investment horizons, have small- and mid-sized company investments under-performed large-company only portfolios. 2015 happened to be one of those years. We maintained these overweights throughout 2015 and will continue to do so during 2016.

We did move to purposefully underweight the energy sector in our asset selection throughout the year. However, it is nearly impossible to completely shield a portfolio from the influences as energy permeates every part of our economy.  Towards year-end 2015 and into 2016 we have chosen to add additional weight to the materials sector of the U.S. economy as we believe this category should benefit from lower factor costs and recover quickly following recent underperformance. We believe the material sector is likely to be a leading indicator of a larger global turnaround later during 2016.

  • New kids on the block.

Our discussion of U.S. Dollar strength and the cost of stuff both feed into the corporate earnings part of our math discussion. What follows is a discussion about the growth part of the discussion.

Developed economies don’t manufacture stuff. Developed economies own stuff, consume stuff, and get served stuff. Emerging economies manufacture stuff in the hopes of earning enough money to also just own, consume, and get served stuff. Frontier economies get plundered for resources but that is another story for another time.

We need not rehash the transformation of the U.S. from a manufacturing economy into a consumer/service-based economy. For a long time, the saying was “as goes the U.S.A., so goes the world” when referring to the engines of economic growth. And we need not rehash the transformation of the Chinese economy from a largely rural and agrarian society into the world’s fastest growing manufacturing economy. That growth transformed China into the world’s second largest economy by 2003. Indeed, that saying can arguably be expanded to “and also as goes China, so goes the world”.

In working with clients, we have spent much of the past three years cautioning others to be mindful of exposure to emerging markets and the Chinese economy. From its founding, Lake Jericho has been thoughtful and purposeful with exposures to emerging markets generally, and China specifically. Emerging market exposure is an important part of a portfolio’s long-term asset allocation. However, we knew that the lofty rates of growth, specifically in China, could not be maintained sustained.

As 2015 progressed we took several steps to either underweight emerging market and China exposures in our portfolios, or have the exposure actively managed by another top-tier firm. We were keenly aware of the tie between European developed markets and China, yet we underestimated the degree to which the Chinese and the U.S. economies are inextricably weaved. Our overweighting of international markets and the inherent exposure to emerging markets, inclusive of China, adversely affected our investment performance for clients during 2015.

China has, rightfully or wrongly, become the idiomatic “Canary in the Coalmine” for global growth. Manufacturing growth? Maybe. But I have a problem with China being the proxy for all global growth. Nonetheless, during the past year manufacturing output data from China has been weakening and investors have interpreted that to mean that economies around the globe must be slowing. Falling energy and commodities prices also were used to foretell of China’s slowing economy.

In my estimation, there is a bit of “cart before the horse” going on. I think that the markets have reacted too strongly to suspect data from the Chinese markets. While it is true that China is slowing, other emerging manufacturing economies are experiencing higher rates of growth (India, Malaysia, Indonesia, Nigeria, Ethiopia, etc.) and are simply producing more stuff now. Only time and more data (which China releases with a great lag) will tell the full story of the secular or cyclical frictions within these evolving economies. Regardless, the result is the current oversold conditions in the markets and the negative impact upon our client portfolios 2015.

  • Raising interest rates does not always increase interest rates.

One final thing to touch upon briefly, as it did guide allocation decisions heavily this year, is the non-action of the U.S. Fed for most of the year regarding the normalization of interest rates. With certainty I predicted that the Fed would begin raising rates in the summer of 2015, leading to underperformance of the bond markets versus stocks. When interest rates increase, the prices of bonds fall. At high rates of interest, the price movement does not represent much of the total return from bonds. But in the current environment of low rates, small increases in yield could have a dramatic impact upon the price return of a bond portfolio. This is the reason for our cautious allocation to bonds for most portfolios. And for those portfolios for which we are holding meaningful allocations, we are doing so at very short maturities.

While I stand by my belief that the Fed could have acted in June, they did not do so until December. The chart below demonstrates the yield of the 2-year Treasury Notes (our average maturity for clients) throughout 2015. You will notice that well in advance of the Fed’s move, rates began to climb. As well, you will see (as the chart extends through the first week of 2016) that changes of the Fed’s target rates might not have a long-lasting effect. Yields had already started to fall once again due to a “flight to safety” by many market participants during the past week’s volatility.

2-Year CMT: January 1, 2015-January 8, 2016
2-Year CMT: January 1, 2015-January 8, 2016

Although the returns provided by bonds during 2015 were nothing to cheer about (and in real terms were actually negative when accounting for inflation), bond allocations did protect investors from some degree of the stock market’s move lower. When compared to many advisors, Lake Jericho does maintain lower allocations to traditional bonds and this did adversely affect portfolio performance during 2015. Our underweighting of traditional bonds will continue into 2016. Our continued analysis maintains that an overweighting to equities in the current interest rate environment is the best approach to meet long-term investment objectives for clients.

Trust that we are keeping our eyes on all of the moving pieces across the globe and across the markets. While 2015 did not favor many of our portfolio biases, we remain committed to our strategy for the long haul. The year has just begun. And while January is a fair statistical indicator of the markets direction for the coming year, we will sit tight for the near term. As significant events unfold you can be certain that we will provide updates as needed and advance notice of any deviations in portfolio strategy should market forces warrant them.

Each of you can expect to receive your account-specific quarterly statements in the coming days. We are available at any time and any day to discuss specific portfolio performance. Until then, be well and enjoy the final few hours of your weekend!

A.J. Walker CFP® CIMA®
Founder and Senior Consultant
Lake Jericho, LLC