The List

"Events, dear boy, events."

          -British Prime Minister Harold McMillian when asked by a reporter what could blow his administration off course.

When I write these newsletters sometimes I have a single topic that I want to expound on like last month. Sometimes I have several different topics that I want to address and I try to tie them together into some kind of coherent narrative. Then there are months like this. Maybe it's snow blindness, or cabin fever, or shovel elbow that's affecting the creative writing side of my brain, but I have quite a few things to talk about and can't quite figure out clever transitions, therefore I will resort to the only thing that seems to pass for journalism these days - a list.

Before I dive too deep I want to address a change made to the Dow Jones Industrial Average, whereby they are replacing AT&T with Apple in the index. This isn't quite as monumental as it may sound since this isn't the widows and orphans AT&T stock from the '50s - '80s. That company was kicked out of the Dow in the 90's and replaced by the baby bell, SBC for about a month. Then when AT&T went belly up - SBC bought the name and was listed on the Dow as AT&T again. So don't listen to those people telling you AT&T has been in the Dow for 100 years- that's like giving the Indianapolis Colts credit for Johnny Unitis' records. What it does point out, however, is that these indexes are supposed to measure the markets as a whole or the economy as a whole. They were not designed to make money for investors. Using some of these indexes as guides to compare performance or as a core holding in a portfolio to give you overall economic exposure is fine -but just doing that and not diversifying around that core holding leaves you at the whims of the people who decide the index components. They don't make those changes because they are the best financial moves for you - they make them to keep their index relevant.

With that said, there has been a lot of disappointment with the returns on diversified portfolios during 2014. As has been mentioned in previous newsletters, the S&P 500 had a great year, but pretty much every other investment type had a mediocre to downright bad year dragging down the performance of portfolios that are designed for the long-term and for principal protection. If history is any guide, these divergences in performance tend to straighten themselves out over time and that has already been happening in the first quarter of 2015. As of this writing the S&P 500 is up 1.40% for the year, while the MSCI EAFE (International Index) is up just under 4% and the Russell 2000 (Small Company Index) is up 1.75%. Because of this, those same diversified portfolios that seemed to underperform in 2014 if you were comparing them to the S&P 500 are now outperforming so far this year.

What this year ultimately brings us for performance is anybody's guess. As I write this the markets are down about 1.5% for the day after having a similar downturn two days before with a pretty good upswing in between. The signal for this selloff seemed to be the really good economic news that the government released on Friday, March 6th. That news was in the form of the February jobs report, which showed almost 300,000 new job gains in February, revised up the previous couple months, lowered the unemployment rate to 5.5% and showed year over year wage growth of 2%. That wage growth number was the big market mover, as we've had good jobs reports for quite a while now but it didn't seem like people were getting paid more whereas this report showed wage increases slightly higher than inflation for the first time in a long, long time. But why would the markets go down if it looks like the economy is improving? The thought is that with these improvements the Federal Reserve no longer has any excuse to keep rates down and could start raising them as early as June. Meaning that the markets are more concerned on the downside with rates going up then they are on the upside with the economy getting better - that could get ugly in the short-term as money rotates out of certain areas of the markets and hesitates before cycling back into the other areas. But while on the topic of the Fed and...

The Fed Funds Rate doesn't so much control interest rates as it affects them. Before they stopped actually buying bonds on the open market last summer in what is known as Quantitative Easing, The Fed could actually affect the rates of bonds that aren't directly linked to the Fed rate. Since they are no longer doing that, bond prices in the open market have by and large been inching up even as the Fed itself hasn't done anything yet. Savings accounts, money markets and CD's are more directly affected by the Fed Funds rate so there won't be any real movement in those earnings until the Fed actually acts - but other rates like on corporate bonds or fixed annuity investments are higher than they were just a few months ago. Some of the downward pressure on bond prices that many are worried about when rates start to go up have actually started to happen, although we've been through that cycle a couple of times now where rates inch up temporarily then the Fed has its meetings and seems to stand pat and those rates go back down. This time may be different however, that downward pressure on bond prices may not spring right back up - it may instead be the beginning of the long march toward higher rates. At the same time the Eurozone and Japan as well as several smaller less important central banks have been following the Fed's easing example the same way Jaws was followed up with Jaws 2; more blood, more sharks, more of everything - but less effective. Due to this devaluing of the Yen and devaluing of the Euro, we've seen.....

Good news if you want to vacation in Europe. In just the last year the Euro has lost more than 20% versus the dollar - meaning that villa in Italy just got a whole lot more affordable. The same thing has happened to the dollar vs. almost every other currency in the world with the exception of the Swiss Franc. This means that while the U.S. economy does appear to be recovering, the increase in U.S. manufacturing and the competitiveness of U.S. products around the world are certain to take a hit. With a relatively weak dollar, increasing wage pressures, high energy prices and terrorism and piracy threats increasing insurance costs there has been a sneaky "on-shoring" of manufacturing. When that factory comes back to the United States it doesn't re-hire the 1,200 workers that it had twenty years ago, it's more likely to hire a couple hundred and do the rest of the work with robots and software programs - but that's still better than nothing. Now that these trends have reversed (except the piracy & terrorism issues) and it once again cost less to manufacture overseas and ship to the U.S. - what does that do to this "on-shoring" phenomenon? Certainly a company that abandoned an overseas factory and invested the money and man hours into moving back to this country is not going to reverse course over a six month shift in pricing - but it certainly will slow down the plans of other companies looking to do the same thing - not to mention the businesses that just outsource their manufacturing to the lowest bidder. Once the contract they signed with a North Carolina company is up - can they compete with the new pricing from China or India? It will be interesting to say the least. Not to mention the impact on the biggest source of job growth in our country over the last few years which is impacted by the dollar strength and ....

Low energy prices and a stronger dollar are not coincidences - they do go somewhat hand in hand. While oil and gas prices are down for everyone around the world, because of the dollar rising against other currencies in a global energy market, the cost decrease has been much more substantial in the United States. We've all seen gas prices bounce off those lows of in some cases under $2.00 / gal - but compared to this time last year we are still paying more than a dollar less. This savings is also felt in home heating oil and natural gas prices - we just don't drive by signs showing those prices every day so we are not as acutely aware of those changes as we might be gasoline. With energy prices going down, the stocks of companies involved in oil and gas exploration, extraction, shipping, refining and retail sale - as well as the subsidiary companies that make parts, provide insurance, etc. have suffered as a result. At the same time, the shale oil boom in Texas, Oklahoma, South Dakota and other various areas of the U.S. is still going strong and still employing lots of people at great salaries. The question is, how long can those enterprises continue to make money at current oil and gas prices? Much like the companies that have recently moved back to the country to make stuff - drilling projects already underway and pumps already producing oil and gas are too far along to simply cap and move on - and until recently the cost of production at these sites was not so much more than production in Saudi Arabia and other areas that it's worth just capping the wells and going away like we did in Texas in the mid-eighties. But how many new wells are going to be drilled with $40 per barrel oil? What happens to the drillers, and haulers and mechanics, and machinists and equipment operators that have been hired over the last half decade at $100,000+ per year when there are no new wells being drilled? Will it even get to that point?

These are the thoughts about the economy spinning around in my head. We are still overdue for a correction - and with all these various issues affecting different parts of the market some of which will see bad results and some which will blow right by without a worry, having a diversified investment portfolio is still the only way we have found to match long-term growth with some degree of price stability. None of our portfolios ignore these various issues; they are always positioned with the thought that any asset class could suffer terrible downward pressure or unheard of upward swings based on events we haven't even conceived of yet. That is what makes diversification so powerful and necessary as you plan for your future. As we always say, your investment should be about what you want to do first - and about what the economy and markets are doing second - and we plan to stick with that philosophy regardless of economic conditions. But that doesn't mean we don't pay attention or make changes when they are needed.