In BSW Blog, Economic Outlook, Portfolio Commentary, Quarterly Newsletter

Central Bank policy dominated first quarter economic and investment dynamics. The US Federal Reserve signaled its intention to raise rates, but also made adjustments to their “data driven” metrics regarding unemployment measures and subtly acknowledged the potential influence of global exchange rates on the pace of rate increases. Meanwhile, the European Central Bank took steps to combat indications of deflation, sending the Euro plunging to its lowest level in 12 years. Oil prices, responding to a glut of supply, have given bank policy makers greater latitude for stimulative measures while bolstering consumer discretionary incomes.

US Outlook & Positioning:

At first blush, a soaring US Dollar and the prospect of rising interest rates may appear dour for US markets, but looking deeper tempers that negativity. On the surface, S&P 500 companies generate 46% of their revenue from sales to consumers outside of the US. As the US Dollar has risen, these non-US revenues are worth less to US investors. Dig deeper, though, and you find that the vast majority of US exports are to Canada and Mexico. Indeed, just 6% of S&P 500 revenue is derived from European consumers, for instance.

Likewise, while equity markets usually abhor an initial interest rate hike, that abhorrence typically subsides. Further, US consumers hold more interest-bearing assets than interest-bearing liabilities, so an interest rate hike will actually boost passive incomes and could also stimulate both personal and corporate action on rate-dependent transactions (as in the housing market and capital spending).

For many reasons (including return-on-equity, energy production, unit labor costs, etc.), prospects for US companies remain reasonably bright. From a valuation perspective, by all standard metrics US equities are trading at a premium to non-US equities. This premium is warranted for cyclical and structural reasons, from my perspective, but selectivity is becoming increasingly important. For instance, utilities has been the sector I most loathed, as yield-chasing investors piled into the sector pushing valuations to more than two standard deviations of historical levels. Following the Fed’s hint of a rate hike, utilities are already down -6.3% year-to-date.

The US economy is growing at a relatively lackluster, but consistent, 2% rate and profit margins are at or near all-time highs. Consequently, companies (and their shareholders) that can consistently grow their dividends via positive operating leverage will be rewarded. In essence, the US market faces headwinds from first quarter earnings misses due to currency effects, as well as a likely interest rate hike, but the fundamental drivers of the US expansion remain intact and valuations are not excessive.

International Outlook & Positioning:

While US fundamentals remain sound, foreign markets also display attractive metrics and dynamics that have rewarded investors. In Europe, leading indicators for both manufacturing and services are signaling expansion. Retail sales are soaring and private sector lending has sharply rebounded.

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In Japan, exports have gotten a boost from a falling Yen and wage growth should produce some long-awaited inflation. Both should prompt Japanese consumers to start spending the $10 trillion of cash idling in their savings accounts earning nothing. Most importantly, from my perspective, is an article I read in the Japan Times that more than 80% of new college graduates have unofficial job offers. This is unheard of in the past 20 years and may finally provide a tipping point to end the tragic “lost generations” of Japanese young people, spurring household formation, and helping the world’s third largest economy get out of the proverbial mud.

Conclusion:

BSW Growth Portfolios are off to a solid start in 2015. Our focus on valuation and diversification yielded positive results in unloved or under-appreciated markets and sectors. The global economy is once again displaying nascent signs of a synchronous and self-sustaining expansion, which should benefit globally-oriented investors. As always, if you have any questions or would like to discuss you portfolio in greater detail please contact us, we are happy to help. Finally, please be sure to check out Meera Meyer’s post below regarding the Unreasonable Institute’sUnreasonable Labs” for Colorado social and environmental entrepreneurs. Thanks for reading.

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-David Wolf, Chief Investment Officer

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