(PUB) Investing 2015

The Independent Adviser for Vanguard Investors

•

January 2015

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LOOKING BACK

2014 Report Card

LIKE MANY BEFORE ME, my predictions about the course of long-term

interest rates and the dangers in Treasurys and bond funds that owned

them, like

Total Bond Market Index

, were way off the mark. I did bet-

ter when it came to the stock market, and to the active managers that

put index funds to shame.

As always, I feel it’s my duty to look back and give an honest apprais-

al of just how close my thinking was, or how wide of the mark I ranged

when I wrote to you one year ago. You may not agree with all of my

grades, and I am sure to have made some other boneheaded comments

over the course of the year that you’ll hold me accountable for, but usu-

ally I own up to them pretty quickly. One can always hope that the light

will finally shine through on the myriad financial advisers, writers, pun-

dits and glory-chasers who make wild and wacky predictions all year

long, yet I still seem to be one of the few who actually fesses up on an

annual basis. Last year, I gave myself two thumbs-up, one thumbs-down

and one up-and-down rating for my 2013 predictions and comments.

This year, well, take a read.

“Just because stocks were strong last year doesn’t mean we

can’t make more gains in 2014—but prepare for a bumpier jour-

ney. While I think yields can still go higher, the pace of accel-

eration should slow.”

Well, had I just kept my prognosticating to the stock

market, I’d be able to show a big thumbs up on the

gains we earned in the stock market in 2014. But like so many others,

I also tried to extrapolate what was going on in the bond markets and

the economy and figured interest rates had further to rise. Wrong.

And while I can’t forecast the weather any better than the profession-

als (and we know how good they are), the U.S. economy’s surprising

contraction in Q1 certainly took the stuffing out of concerns that

speedy economic growth would send interest rates ever higher.

“The Federal Reserve is not going to raise short-term interest

rates in 2014. Period.…In fact, there’s a good chance short rates

could stay pegged to the floor through 2015 as well, but I’ll hold

off making predictions without a better sense of where the

economy is a year from now.”

Okay. While I thought long rates would go higher, I certainly was

right about the Fed keeping its throttle hand pushed well for-

ward. The market determines where long rates go, but the Fed holds

the policy key on short rates. As for 2015, I’ll go with the consensus and

suggest we’ll begin to see short rates rising around the middle of the

coming year.

“I remain a huge fan of Health Care…I think smaller-cap stocks,

which have outpaced larger ones this year, are significantly

overvalued when compared to larger fare…I know we’ll be

safer than the average bull (or bear) in Dividend Growth…I

prefer investment-grade corporate bonds, as well as funds like

High-Yield Corporate.”

I get a big thumbs up on this one. Small-caps continued to roar

early in the year and then collapsed. Large-caps were the win-

ners in 2014.

SmallCap Index

, for example, ended the year with a

gain of 7.4% while

LargeCap Index

gained 13.2%. And yes,

Health

Care

killed it with a gain of 28.5%.

Dividend Growth

gained 11.8%,

outpacing its index-fund competitor

Dividend Appreciation Index

which was up 10.0%. And despite tremors caused by falling oil prices

and worries about the strength of many energy companies in the junk

sector,

High-Yield Corporate

gave us a 4.6% gain—not as good as I’d

hoped, but still solid.

One last chart that gives a broad view

of the gains made by the U.S. economy

is the Conference Board’s leading eco-

nomic indicators index printed above,

which encompasses a number of for-

ward-looking measures in an attempt

to see where the economy is heading. It

currently points to continued growth in

the year ahead.

Overseas Values?

In comparison to the U.S., foreign

economies are currently beset by a bevy

of headwinds. Europe remains on the

edge of recession as its central bankers

promise action but struggle to imple-

ment a stimulus policy similar to our

own bond purchasing program. In stark

contrast to Europe, Japan’s “Abenomics”

implementation has seen the expansion

of a massive quantitative easing program

that has yet to find a way out of the coun-

try’s more than two decades of malaise.

China’s pace of growth continues to

slow. This doesn’t mean that whatever

growth China experiences isn’t mean-

ingful, because it is—even if China only

grows 3.5%, well below policymakers’

target of 7.5%, that would add enough

to GDP to equal the size of the Swedish

economy. It does, however, represent a

downshift in the pace of growth of the

second-largest economy in the world.

The decline in oil prices, while a

boon to some countries (like China,

Japan and Germany) is a serious head-

wind to others (like Russia, Brazil,

Venezuela and those in the Middle

East). That’s why I think that it’s impor-

tant to let an active portfolio manager

make decisions about where to invest

and what to invest in overseas, and why

I advise you to stay diversified and to

hold onto—or add to—foreign stock

holdings.

Leading Economic Index

11/60

11/65

11/72

11/78

11/84

11/90

11/96

11/02

11/08

11/14

Blue bars indicate recessions.

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