Mission’s new formularized equity allocation processes, initially introduced in last year’s third quarter commentary, have produced increased profits for clients who have chosen to adopt them. Although this won’t always be the case, each transaction produced a profit in the first quarter. The full benefit accrued to those who adopted the processes in last year’s fourth quarter. Those who began at various points in the first quarter received more benefit the longer they employed the processes.
Economic conditions throughout most of the world continue to deteriorate. Europe’s recession is deepening. Emerging countries that have led the world recovery since 2008’s crisis are slowing perceptibly. Japan’s economy remains in the doldrums. The U.S. is experiencing its most sluggish recovery since World War II. Sluggishness prevails despite world central bankers pumping far more new money into the banking system than ever before. Despite years of aggressive stimulus, economies are not picking up steam. In fact, recent economic deterioration has provoked central bankers to even more virulent stimulus.
Most of the world’s major stock markets have performed poorly this year. The two striking exceptions have been the U.S. and Japan, whose central banks have each committed to unlimited quantitative easing. Aggressive stimulus has not revived their economies but has powered their stock markets. That divergence will not go on indefinitely. The open question is whether the economies will pick up or whether the stock markets will falter. The failure of stimulus elsewhere argues against the likelihood of economic revival, but it’s not impossible. Multi-century history similarly suggests that it’s unlikely that major nations will be able to print their way out of debt crisis without considerable collateral damage. Mission’s new equity allocation processes recognize the difficulty that faces the Fed, yet present opportunities to benefit should market strength continue, without assuming the risks that a permanent equity position presents.
The picture is similarly unattractive on the fixed income front. The Fed has directed its stimulus effort toward driving interest rates as close to zero as possible. That endeavor has provided artificially strong bond market returns for years. Rates on most fixed income securities are now at or close to all-time lows. While the Fed continues its commitment to hold rates near rock bottom for the foreseeable future, a growing chorus of critics is arguing that the unintended consequences of the policy will outweigh its benefits. Some of those critics come from the ranks of Fed governors themselves. Virtually all fixed income analysts agree that interest rates will rise from these levels sooner or later, doing damage to prices of all fixed income securities except those with the very shortest maturities. To earn anything more than a minimal interest rate return, rates must decline even further. While that remains possible, despite already historic low yields, the potential losses from rising rates far exceed the potential rewards from declining rates. Slightly rising rates in the first quarter led to losses on longer maturity fixed income instruments. Such losses could become far more severe should rates rise more aggressively.
As a hedge against the long-term inflationary effects of excessive money printing, we have held a small gold position for several quarters. As we have said throughout that holding period, there is no way to compute an “appropriate” gold price based solely on fundamental factors. Gold’s price is primarily determined by investor sentiment. We acquired a 3% gold position in late-2011, indicating at that time that we would add to that position only if prices declined further. Prices instead rose. When it appeared that gold prices were unlikely to break to new highs, we scaled back by taking profits on part of that position near gold’s 2012 high prices. Declining gold prices took a little out of first quarter performance. We will build a larger position if the current decline continues, especially if prices move significantly lower.
The year ahead will likely present a great many twists and turns. Most critical will be whether or not investors retain the belief that central bankers are capable of overcoming deteriorating economic fundamentals. Governments have been winning that battle over the last few years, but risk levels remain extremely high.