(PUB) Investing 2015

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4 • Fund Family Shareholder Association
recent past into the near-term future.
In simple terms, it means we think that
what has just happened will continue
to happen. If stocks went up, they’ll
continue to go up. If interest rates went
down, they’ll continue to go down.
Why am I concerned about recency
bias? Consider that 500 Index has gen-
erated double-digit gains in five of the
past six calendar years. The fund is up
103.6%, or 15.3% a year, over the past
five years, which is attractive enough
on its own but is downright seductive
next to the returns of foreign stock mar-
kets. 500 Index has outperformed Total
International Stock in four of the past
five calendar years, and its 103.6% gain
is four times that of the foreign stock
fund’s 23.6% return.
On top of the raw level of returns,
investors had a smooth ride to these
heights. While U.S. stocks have on
average experienced a correction of
10% or greater once every year and a
half, it’s been over three years since
large-cap stocks have pulled back that
much. Daily volatility has been muted
as well, with only nine days over the
past three years when the Dow moved
2% or more on a closing basis—two
of those were in 2014. The Dow hit 38
new highs this year alone and surpassed
18000 for the first time.
All of this is not to say that U.S.
stocks are headed for a tumble—in fact,
as I’ll get to in a moment, U.S. stocks
are poised to continue making gains in
2015. However, our tendency to look at
the recent past and extend it forward—
that recency bias—puts investors at risk
of veering away from a well-diversified
plan in favor of an overabundance of
U.S. stocks after a period of exception-
ally strong returns and low volatility. If
your long-term approach is to be glob-
ally diversified by holding some for-
eign stocks, continue to do so. If your
balanced approach includes an alloca-
tion to bonds, don’t suddenly change
that. It’s only a question of when, not if,
we’ll get a 10% correction or more in
U.S. stocks. I for one would welcome
it, as it would remove some of the
excess that creeps into any bull market.
I’m expecting a bumpier ride in
2015, but I still think U.S. stocks can
gain ground during the year. Why?
Interest rates and earnings. I’ll come
back to interest rates when I talk about
bonds, but suffice to say that interest
rates are low. Low rates make it easier
for businesses to borrow for growth, and
they also mean that bonds provide poor
competition for investors’ dollars. Plus,
valuations have historically been higher
when interest rates were lower—it’s just
a fact of investment life. Meanwhile,
earnings continue to grow, and those ris-
ing earnings will take the edge off what
are high valuations today.
Strong Man
The U.S. is once again the strong-
man on the global economic stage. It
may not feel like it in every part of
the country, but the U.S. economy is
no longer recovering, it is expanding.
GDP, whether you adjust it for infla-
tion or not, hit new highs through the
third quarter of 2014 and was growing
at a 5% annualized rate as September
ended (the most recent data available),
the fastest pace of growth in more than
a decade.
This expansion can be seen in met-
rics covering different components of
the economy. Let’s talk about manu-
facturing for a minute. The first chart
above shows that U.S. industrial pro-
duction, according to the U.S. Federal
Reserve, experienced a classic and
steep V-shaped recovery coming out
of the financial crisis, and has since
passed the level of production seen in
the prior cycle. The chart also shows
that capacity utilization, which is a
measure of how busy our factories
and plants are, has returned to levels
typically seen during a robust economy.
When spare capacity tightens, it can
create jobs, which can in turn increase
demand—a virtuous cycle.
The health of the U.S. consumer,
who drives economic growth, continues
to improve. In fact, by at least one mea-
sure, the Bureau of Economic Analysis
says that U.S. consumers haven’t been
in as good shape for a quarter cen-
tury. As the second chart above shows,
when you consider “household debt,”
which is the amount owed on mort-
gages and consumer debt (think credit
cards) relative to disposable income,
the U.S. consumer is a powerhouse.
Much-improved balance sheets mean
there is plenty of ammunition to con-
tinue spending, which in turn will move
the economy forward.
Another plus for consumers: During
the first 11 months of 2014 (December’s
numbers aren’t in yet) over 2.6 million
jobs were created—the best perfor-
mance in more than a decade. Going
hand in hand with that, the unemploy-
ment rate has dropped to 5.8% and the
U-6 rate, which is a broader measure
of unemployment, has edged down to
11.4%, further closing the gap between
those looking for work and those who
are not looking or are unemployed.
Greasing the wheel for U.S. con-
sumers are dramatically lower oil and
gasoline prices. Crude oil is down over
50% since June, and lower prices at the
pump are functioning like a welcomed
tax cut for the typical U.S. consumer.
OUTLOOK FROM PAGE 1 >
Production Rebounds While
Spare Capacity Abounds
11/0111/0211/0311/0411/0511/0611/0711/0811/0911/1011/1111/1211/1311/14
Industrial Production Index
Capacity Utilization
CapacityUtilization
IndustrialProduction Index
50%
60%
70%
80%
90%
100%
80
85
90
95
100
105
110
Households Are in
Good Shape
6/82 6/86 6/90 6/94 6/98 6/02 6/06 6/10 6/14
2%
3%
4%
5%
6%
7%
8%
9%
10%
11%
12%
13%
Consumer Debt Service
Mortgage Debt Service