The Markets	03/31/16 Close	12/31/15 Close	1st  Qtr. Change	03/31/15 Close	12 Mo. Change	YTD Change
Dow	17,685	17,425	+1.49%	17,776	-0.51%	+1.49%
NASDAQ	4,870	5,007	-2.74%	4,901	-0.63%	-2.74%
S&P 500	2,060	2,045	+0.73%	2,068	-0.39%	+0.73%
MSCI EAFE	1,652	1,716	-3.73%	1,849	-10.65%	-3.73%
10-yr Treas. yield	1.83%	2.27%	-0.44%	1.93%	-0.10%	-0.44%
Fed funds rate	0.25% to 0.50%	0 to 0.25%	n/a	0 to 0.25%	+0.25%	n/a

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

The slide in stock markets in December continued into January, with the Dow having its worst opening day of the year in 84 years and the Chinese market experiencing such steep declines that it closed for the day after being open for a total of 14 minutes. The S&P 500 had its worst 5-day start since 1929 and then the Dow had its worst two-week start ever. Markets then turned around sharply in February and first climbed out of “correction” territory (more than a 10% fall from the recent high) and eventually into positive territory for the year. But as noted in the chart, markets were still slightly in the negative for the prior 12 months (before dividends). In a bit of a surprise, gold had its best quarter in 3o years, up over 16%.

Interest rates pretty much mirrored the stock market, which is fairly unusual. Rates feel even more sharply than stocks at the start of the year and also bounced back in early February but then leveled off. Foreign governments sold the most US debt since 1978 as they raised cash to stimulate their own economies but total foreign holdings still increased as US government debt is seen as a safe haven. As noted in the prior quarter’s review, interest rates have headed lower since the Fed raised short-term rates in December. Indeed, the Fed’s last comments were that they would remain cautious about more rate increases as global economic conditions have gotten “sloppier”. This is quite a change from the earlier consensus opinion that there would be four rate increases in 2016.

The Fed was silent on the prospect of negative interest rates but elsewhere in the developed world government debt with negative rates increased to over $8 trillion. Over 70% of the debt of Japan, Germany and Switzerland now has negative rates and in Denmark, which has spent nearly four years in a negative rate environment, mortgage borrowers are receiving an interest credit rather than an interest charge. The European Central Bank in January signaled there were no limits to potential action to boost the Eurozone economy. In March, the ECB added corporate bonds to its monthly bond-buying program, cut interest rates to zero from 0.05%, lowered the rate on deposits at the central bank further into negative territory and offered long-term loans at zero or negative interest rates for up to four years to support banks. (Yes, that means it will cost banks to keep deposits at the central bank but they can make money by borrowing.)

The housing market continued to improve in fits and starts. Existing home sales were up over 2% and median prices were up over 4% from the prior year and inventory remains low. Median prices for new homes were over the $300k mark and also up 2.6%. More apartments were added in 2015 than in the last 16 years and rents were up 4.6%, straining renters’ budgets and possibly topping out.

Durable goods activity showed some life but core business expenditures (excludes defense and aircraft) were mostly flat. Core inflation measures were still benign at 1.7% and consumer spending was weak but personal incomes began to increase ever so slightly at 0.2% for February and 0.5% for January. Jobless claims were below 300k for the 56th week but unemployment nudged up to 5% as more workers re-entered the job market and the labor participation rate was the best in a year. All in all, growth for the fourth quarter came in at 1% and was 2.4% for all of 2015.

There were significant geopolitical developments, beginning with a possible hydrogen bomb test by North Korea. After all the hand-wringing, Chinese economic growth was down for the fourth quarter but met expectations, calming markets; growth for all of 2015 was the lowest in 25 years. Russia largely pulled out of Syria amidst attempts at a cease-fire, allowing Putin to cast himself as a peacemaker. After pressing Apple to create a “key” for the iphone of the San Bernardino shooters, the FBI found a workaround from an unnamed private source. Terrorists struck again in Brussels, renewing concerns about radicalized citizens in western countries.

Looking Forward

A year ago there was great concern that Greece would exit the European Union (the EU) as it repeatedly flirted with financial default. Since Greece uses the euro as its currency, the impact on the euro and the other euro countries if Greece had to return to its own currency was a matter of great speculation, ranging from a mere blip in the road to the ultimate demise of the euro itself. Eventually Greece made just enough headway with its finances and the European Central Bank extended enough loans to avoid a Grexit, at least for the time being. The focus on Greece has become the waves of immigrants trying to reach the euro zone from the Middle East.

But the EU is not out of the woods quite yet. Great Britain will be voting in June to determine whether to stay in the EU. Although they have maintained the British pound and don’t use the euro, the financial burden of shouldering part of the EU’s obligations, as well as the loss of autonomy in making those financial decisions, is increasingly unpopular. There is also concern over the immigration crisis and the ease of getting to the UK as long as the UK is part of the EU. Only 48% of UK exports go to other EU countries, the lowest percentage of any EU member. On the other hand, London has become the financial center of Europe because of the ease of working in all the EU countries as long as the UK is a member. It is a complex relationship and if the UK votes to leave the EU it could still have huge and unpredictable effects on both the UK and the EU. At this point the vote appears too close to call.

It’s also hard not to comment on the presidential election since it has dominated the media the last several months. At least both parties are providing plenty of fodder and we are learning more about the parties’ delegate procedures than we ever imagined. But short of the most extreme positions of any of the candidates being enacted in full, the reality is that changes will likely be incremental and there will be little noticeable impact on the markets and investment returns. Any seeming impact will be coincidental.

Our Portfolios

Many pundits maintain that it is impossible to get “rich” by investing in a broadly diversified portfolio. Of course, many of these same pundits then follow up with their big idea about how to make lots of money. These ideas are always speculative, to put it mildly.

If “rich” means that wealth is catapulted far beyond making funds available for investment and a reasonable return, then this contention is true. To really get rich requires taking high risk and making big bets. Plenty of people have done that and succeeded, ranging from many real estate developers to even Warren Buffett, who combines a remarkable eye for value with extraordinary patience and a willingness to make big investments. Of course, there are just as many others, if not more, who have swung for the fences and failed.

Though not as common as in the past, 401k investors can become overly concentrated in their employer’s stock if it is an investment choice in the plan; some employer contributions still go automatically to the company’s stock and the employee never gets around to moving those funds to other options. Even long-term investors have concentrated positions because they are loath to take and pay taxes on capital gains so they sell others holdings and hold on to the one with the biggest gain.

Even mutual funds, which are intended to offer diversification by design, can become overly concentrated. Gordian’s Denis Smirnov has a great blog post on how the Sequoia Fund, which had a terrific long-term performance record, ended up with 30% of the fund in one stock, which then lost over 70% of its value. (Read the entire post here.)

We have never felt the potential gain was worth the significantly higher risk of big bets and concentrated portfolios. We prefer to rely on the broad markets to produce gains over the long term and to manage portfolio allocation to meet investor goals. We do this through broad index funds and well-diversified managed funds and if any fund is more concentrated than its peers we balance that fund with another that is more diversified and has a different style. It’s not particularly exciting but it certainly avoids those nasty surprises.

Always Some Bad Apples

It is no news that there are always some financial advisers who run afoul of the rules in various degrees, from simple incompetence to outright theft and everything in between. The law firm of Sutherland Asbill & Brennan LLP released its annual study of disciplinary actions reported by the Financial Industry Regulatory Authority (FINRA) for 2015. The overall sanctions increased significantly, with the amount of restitution ordered three times the level of 2014 and the number of cases increasing for the first time since 2012. (FINRA regulates advisors who sell securities; Gordian Advisors is a registered investment adviser. RIA’s are overseen by either their state of the SEC, depending on size.)

Restitution (reimbursement of financial damages) was $96 million while fines (penalties for misbehavior) were $94 million. In 2008, restitution was only $8 million and fines were $28 million, and FINRA claims the increase is due to better enforcement. Disciplinary actions filed by FINRA grew from 1,073 in 2008 and 1,462 in 2015. (Keep in mind these are actions taken by FINRA, not due to complaints or arbitrations pursued by investors themselves.) Over 90% of enforcement actions are settled prior to a formal complaint being filed, which means the respondent does not have to admit or deny FINRA’s findings.

FINRA expelled 25 firms in 2015, prohibiting them from ever providing securities services again. Sanctions for individuals included 737 suspensions (a temporary prohibition) and 492 being barred forever.

The top enforcement issues (based on total fines) included trade reporting (necessary to maintain orderly and fair markets), anti-money laundering failures, suitability of investments sold, disputes over the accuracy of broker regulatory records and improper advertising.

Except for advertising, these top issues are internal procedures that are not apparent to investors. So, what about complaints brought by investors themselves?

In 2015, 3,435 complaints were filed, with 2/3 filed by customers and the remaining 1/3 being intra-industry complaints. The top controversies in customer complaints were breach of fiduciary, failure to properly supervise brokers, negligence, misrepresentation, breach of contract and suitability of investments (a complaint may involve multiple charges). More egregious offenses such as outright fraud, unauthorized trading and churning (excessive trading) are farther down the list.

Similar to FINRA actions, 2/3 of customer complaints are settled, with 9% being withdrawn and only 24% going to arbitrators. And it is easy to see why customers may be less inclined to go to arbitration – only 42% of customers who went to arbitration were awarded damages.

Still, given the sheer size of the industry (FINRA oversees over 4,100 brokerage firms with over 160,000 branch offices and over 600,000 representatives) and the horror stories of really bad characters, all these disciplinary numbers seem pretty low.

So, while many industry practices may be questionable as to whether they are really in the best interests of the investor, they are usually within the rules. Unfortunately, this leaves the onus on the investor to become educated and avoid falling into a legal but disadvantageous investment situation.