Just as we were about to enter the fall, as the kids start back to school, a shock has occurred in the markets. China, which has been the global leader in growth for the last decade has been experiencing a stock market crash. This has spilled over into the U.S. stock market which, at the time of this writing, has seen the DJIA drop 7 consecutive days for ~8.57% and is now off ~14.6% from the year’s highs. Fresh in everyone’s mind is the crash of 2008 and for those approaching retirement, market volatility such as this can create uneasiness to say the least. Unlike the last several years where we have seen headlines cause selloffs like the Euro crisis or the taper tantrum; this is not a headline with an inevitable end point. Because of this, we are likely to continue to see volatility rear its ugly head for the coming months as both markets and expectations realign.
Outside of the current market swings, a number of recent global events have prompted us to make some slight changes to our outlook for the remainder of the year. The Fed so far this summer has taken a back seat to a potential Greek exit, wild swings in the Chinese stock market and a default by Puerto Rico (after some failed attempts at getting legislation passed that would allow the territory to file for bankruptcy). However as September approaches, we are zeroing in on the Fed’s next meeting where they have telegraphed their intent to raise rates which will begin to normalize monetary policy after nearly 7 years of near 0% short term interest rates. Given recent events, the Fed may be rethinking their strategy amid global concerns. Even if the Fed stands pat in September, a rate hike of 0.25% could still occur by the end of the year. Most of the bonds in our portfolio are positioned in short term debt which will be impacted by a rate hike, although less so than intermediate or long term bonds, especially if rates rise across the entire yield curve. Although an increase in rates is widely thought to drag on the performance of the stock market, a gradual normalization of rates shouldn’t have a significant impact nor should we see a repeat of the taper tantrum from 2013.
Domestic equities continue to show signs of improvement albeit at a very slow pace. Value strategies have been dragged down relative to growth strategies due in large part to currency headwinds experienced by large multinationals as well as the poor performance of the energy sector which should continue to be impacted as commodity prices remain low. Oversupply (particularly for oil), coupled with a weakening Chinese economy, has been a major driver in commodity prices as global demand has slowed. As the U.S. is set to raise rates, the rest of the world continues to pursue easy monetary policy which should strengthen the dollar further. Given this, we still feel that the biggest benefactor in equity markets will be international developed markets.
For our current fund holdings, we have decided to make some small changes to help strengthen our portfolios through the remainder of the year. Our developing market fund (ODMAX) in particular has been impacted by the volatility in the Chinese stock market and we identified it as a screw that needed some tightening. We continue to feel strongly about the asset classes we have added for diversification in our previous model, but have decided to make a couple of changes to our allocations to put us in a better position going forward. The only new fund we are adding to our portfolios is an alternative fund that hedges some of our market exposure. The fund, Catalyst Hedged Futures Strategy (HFXAX), is a true alternative that has a very low correlation to the market and our other portfolio holdings. In order to make room for this fund, we are reducing our allocation in the tactical alternative fund, Meeder Muirfield (FLMFX), by 1% and our passive real estate fund (FRXIX) by 1%. The reduction in real estate exposure is centered on the imminent rise in rates that will make the income generated by real estate funds a less attractive proposition given the risk versus safer debt securities. That coupled with the premium that management plays in the selection of real estate properties has led us to reduce the passive portion of our real estate allocation. Lastly, we are removing the large cap long/short alternative fund (DIAMX) from our portfolio. It is our feeling that finding great value in stocks to buy while shorting others is least attractive in the large cap space and simply put, there are other alternatives available to improve the diversification of our portfolio.
As always, we continue to monitor changes in the market closely. We evaluate the performance of our fund selections on a daily basis. We also pay close attention to all of our funds, in order to stay abreast of any changes made to their management team and/or management style.
Diversification through an asset allocation strategy is a useful technique that can reduce overall portfolio risk and volatility. Diversification does not eliminate risk, does not guarantee a profitable investment return, and does not protect against loss. Past performance is no guarantee of future results.