The Markets	03/31/15 Close	12/31/14 Close	1stQtr. Change	03/31/14 Close	12 Mo. Change	YTD Change
Dow	17,776	17,823	-0.26%	16,458	+8.01%	-0.26%
NASDAQ	4,901	4,736	+3.48%	4,199	+16.72%	+3.48%
S&P 500	2,068	2,059	+0.44%	1,872	+10.47%	+0.44%
MSCI EAFE	1,849	1,775	+4.19%	1,916	-3.46%	+4.19%
10-yr Treas. yield	1.93%	2.17%	-0.24%	2.72%	-0.79%	-0.24%
Fed funds rate	0 to.25%	0 to.25%	n/a	0 to.25%	n/a	n/a

(stock indices are before dividends; yield and rate changes are absolute changes)

The quarter was a bit of a bumpy ride, but the broad US market still eked out a positive return for the quarter (including dividends, which lifted the Dow into positive total return territory). The S&P 500 had its longest “down streak” – 5 days – in 13 months to start the year, which got investors’ attention. The NASDAQ was lifted higher largely by biotechnology, which caught fire on the back on deals and higher valuations and prompted talk of a possible “bubble” in the absence of specific new products. The big surprise was international stocks, which posted their best returns relative to US stocks in several years, despite the strong dollar. The London FTSE hit a new record after 15 years, and while the Japanese Nikkei is still at only 50% of its all-time high it did hit a 15-year high. The benchmark bond yield dipped sharply, recovered and then slid to another closing below 2%.

The price of oil dropped as low as $45 before a reduction in the number of oil rigs spurred a 20% rally but the price then slid again before recovering once more. Oil imports were down over 10% and exports were up over 6%, with the debate continuing regarding the current policy of not allowing the export of unrefined oil. To maintain its market share, Saudi Arabia cut oil prices to Europe. Copper prices also slid and commodities overall were at 12-year lows.

Bad winter weather, the strong US dollar, slowing overseas growth, concerns about Greece’s new government and possible default and the ongoing port strike in Los Angeles all contributed to sluggish economic reports. March job creation was about half of expectations, the worst in 15 months. The unemployment rate stayed at 5.5% and hourly earnings growth is still very low. Both services and manufacturing stayed in expansion mode although manufacturing slowed. The final fourth quarter growth figure came in at 2.2%, down significantly from the third quarter’s 5.0%. Consumer spending in the fourth quarter was up 4.4%, the best in nearly nine years, but imports were up over 10% and federal government spending was down over 7%.   Existing and new home sales crept higher with home prices up 4.6% from the prior year, but first-time buyers in 2014 were at a 30-year low. Consumer confidence was strong, with “present conditions” weaker but “future expectations” higher.

With each economic report, the market gyrated on its expectations of whether and when the Fed will raise interest rates. At the last meeting in March the Fed dropped the word “patient” from its outlook but said it would still be cautious. In a bit of a surprise, Walmart announced it would raise its minimum pay to $9 an hour and again to $10 in 2016.

After the Eurozone’s inflation figure for 2014 came in negative, the European Central Bank announced it would purchase 60 billion euros/month of bonds for 18 months to boost the economy and increase inflation, at the same time accepting that this activity would further weaken the euro. At the same time, the EU agreed to extend Greece’s rescue package for four months. Switzerland unexpectedly announced it was abandoning its purchase of euros to keep the Swiss franc at a steady level, and the Swiss franc soared while the euro fell sharply. Even the Bank of Canada cut its interest rate benchmark as its growth outlook was cut.

US bankers breathed a sigh of relief when large US banks cleared “stress tests” to determine how their capital base would react to another financial crisis. However, there were wide gaps between the Fed’s risk projections and the banks’ (as much as 50%) and as a result some banks had to cut back plans for shareholder dividends and stock buybacks.

Looking Forward

We usually try to identify upcoming developments that will have a direct impact on the economy and markets. Politics, while interesting, seldom has a readily identifiable or immediate impact. Likewise, foreign policy developments usually take a long time to make a noticeable difference for the general public.

Recent developments, however, have been too significant to ignore. First is the “thawing” of relations between the US and Cuba after more than 50 years. The Cuban expatriate community is of course strongly opposed to any relationship with Cuba as long as the communist regime is in power, but overall reaction was generally positive. (Some of the few beachfront properties that can be owned by foreigners are already for sale at high prices.) Subsequently there has been further concern that the US is making all the concessions while Cuba is making only demands. Of course, many other countries have long had an open relationship with Cuba; on a December trip to Quebec City, we noticed nonstop flights to five Cuban destinations and they all looked full.

Second is the last-minute agreement on a framework for Iran to roll back their nuclear program. There are time limits on the deal, with many of the provisions expiring in 10 or 15 years, but there are also stronger provisions for inspection as well. Already there are differences in statements from the US and the Iranians on some of the details and it is not a treaty, so Congress is upset about not being involved in its approval. There is also concern that relaxing economic sanctions will simply generate more income for Iran to sponsor terrorism and turmoil through more traditional means.

Finally there are the ongoing crises which are far from resolved even though they have been less on the front pages. Syria continues to devolve into a stalemate at best and a conflict which will draw in other interests at worst. Russia has apparently given up any illusion that they are not directly involved in Ukraine, and a showdown is brewing over the Black Sea city of Mariupol, which would give the Russians better access to Crimea. At the same time, the low price of oil and ongoing sanctions could topple the Russian economy.

There is plenty of uncertainty in these and other conflicts, such as Yemen, Iraq and Afghanistan. The ultimate solutions rarely develop in a straight line, and each could have lasting repercussions.

Our Portfolios

The performance of international stocks was a bit of a relief, since we have maintained an allocation to international stocks throughout and will continue to do so. So far, the small rally is due mostly to investors taking some money out of US stocks after years of outperformance; the lower valuations and higher yields of international stocks became just too hard to ignore. Economic recovery in many countries still has a way to go, but aside from Greece most of the other countries that teetered on the edge (such as Portugal) are far less likely to implode.

Staying the course with international stocks through the lackluster years brings to mind a couple of attitudes often expressed by investors. The first is that all the money in a portfolio should be “doing something”. This is particularly applicable to having any cash in a portfolio but it also applies to a holding that has been relatively flat or noticeably lagging other holdings. In a properly allocated portfolio, all the money is doing something; that is, it is presenting a risk/return profile that, in combination with the other holdings, meets both immediate needs and long-term goals. That is not guaranteed, of course, but the best we (or anyone) can do is create a reasonable likelihood of success.

The more dangerous attitude, which is perhaps a more honest version of everything doing something, is that the portfolio should only have investments that go up. This is not necessarily naiveté about the volatility of markets; it is more the seductive myth that there is a way to buy and sell investments so they are only owned when they go up in value. It could be argued that the time frame for performance is critical. If the time frame is short, no investment other than cash will meet the test; if the time frame is long, notoriously volatile US stocks would meet the test. And by attempting to only capture upside, much of any gain would likely be missed by avoiding any risk of a decline. The net result is worse, not better, performance.

Of course, both of these attitudes, and the second in particular, are fundamentally flawed. In practice, it is impossible to predict when an investment will turn course. We believe international stocks contribute to the risk/return balance over the long run, even though the last several years have been painful. The process of rebalancing a portfolio has meant that there has often been a slight selling of US stocks in favor of international stocks.

But we certainly aren’t dumping US stocks on the basis of one quarter, either.

Mea Culpa and Cave Lector (Reader Beware)

My March article, “Leaving Nothing But a Mess”, dealt with the problems that arise in the absence of estate planning. I stated that Arizona does not recognize same-sex marriages, leaving a same-sex partner low on priority lists even if they have been legally married in another state.

Readers immediately questioned that statement and pointed out that on October 17, 2014 the US District Court ruled that Arizona’s ban on same-sex marriage was unconstitutional. Arizona Attorney General Tom Horne did not appeal the ruling, noting that the probability of a successful appeal was zero. The 15 Arizona counties were instructed to immediately begin issuing marriage licenses to same-sex couples.

So, in matters of estate planning, a legally married same-sex partner will have the same status in Arizona as any other spouse. That means they would be first in line to serve as a health care surrogate in making medical decisions and would receive a deceased spouse’s estate in the absence of a will (taking into consideration the deceased’s children from another relationship).

This error creates an example to comment on financial reporting in general. First, be wary of any article that is overtly presenting an opinion. If it’s not clearly an opinion piece, a tipoff is if both sides of the issue are not evenly represented. Another flag is the overuse of punctuation, capital letters and inflammatory language. Some may feel that strong language is necessary to make a point; to the contrary, more descriptive, transitional language invites the reader to more fully consider and digest the message rather than swallowing it whole.

Second, consider any article as an opportunity to learn and expand your understanding. Resist the urge to blindly accept whatever instruction is involved and make the effort to determine whether the course of action even fits your circumstances. There are some pretty universal principles (e.g., live within your means, understand risk and return, have an estate plan, etc.) but more specific techniques seldom apply to everyone. I often have clients ask me what I think of strategy X. My response is that strategy X is fine for a particular situation, and invariably that situation does not apply to the client, eliminating Strategy X from further consideration.

Third, read more than one source of information and commentary. I wonder if the number of people who listen to only one source of news has contributed to our growing polarization. And take a critical eye to any source; if something does not seem right, do your own research.

Most of all, I am deeply gratified that recipients of my articles are paying attention and keeping me honest. I’ll continue to do my best to present balanced, helpful information.