October 2013

Kreitler Financial:

It has been a tumultuous summer for financial markets, politics and even international relations. We have trouble recalling a period when uncertainty was so high, a seemingly constant state since 2008. In spite of this, as investors, we need to make sound decisions. We try to step back from the day to day events in order to understand the broader trends. This exercise is helpful in separating the noise of the cable television or internet news cycle from the real and more important trends that are occurring.

For the last few years, we have been generally optimistic on the state of the US economy and US stock markets. This view has been rewarded. Today we remain generally positive on the US economy. It continues to grow at 2% rate, which is certainly sluggish but it is growth. Dominating everything is the question of how we will unwind the massive credit expansion since the financial crisis, a policy experiment that has never been attempted before. We have to acknowledge the risks remain very elevated. On top of this, the strong stock market performance of the past year makes us somewhat more cautious in the near term even while we remain optimistic looking further out.

The most significant event of the past several months, notwithstanding the news on Syria or the US Government shutdown (more on those later), was the more than 1.5% increase in the interest rate on the 10-year Treasury bond and all associated rates. In the world of stocks change is common. In the world of bond yields, this was the equivalent of an earthquake. From May to early September, the broad Barclays aggregate bond index dropped over 5%. Municipal bonds were also affected. Government bonds linked to inflation saw even larger declines. Bond investors are not used to seeing losses and many were surprised to see losses on their summer statements. Recently bonds have rallied, alleviating some of the decline but contributing to additional volatility.

This is potentially a trend change in the 30-year bull market in bonds, and investors should structure their portfolios accordingly. We must have the humility to recognize that we do not know the future. It is still likely true when (not if) the stock market goes through a severe drop that bonds may provide some diversification. On the other hand, we expect returns from bonds to be lower in the intermediate term than the average return of the past 30 years. We have been proactively managing bonds in anticipation of a potential rate increase for over two years. While we were early to make changes, we’ve generally been pleased with the results and we hope our clients agree. A combination of strategies—using unconstrained or unconventional bond managers, holding higher amounts of cash, and modestly increasing exposure to stocks over the past couple years—mitigated the impact of the rate changes.

Meanwhile, the news has been dominated by the U.S. Government shutdown. As we write, the outcome of the shutdown and the upcoming debt ceiling debate are unknown.

In making portfolio and financial planning decisions, we find it helpful to put current events into a broader context. There are really two budget debates, one short-term and one long-term.

The short-term budget debate is focused on government discretionary spending. It’s further aggravated by polarized views on the Affordable Care Act or ObamaCare. It encompasses the sequester, the October 1 government shutdown, and the upcoming October 17 debt ceiling deadline. These are a part of a messy political process. We must remember that the politicians are reflecting the views of their constituents, and the views of the voters are divided. We think most people outside of the Beltway are annoyed with political gridlock, but they are continuing on with their lives.

We expect that the debate, at least this round of it, may crescendo around the October 17 debt ceiling debate. We assign low-probability to a true default on U.S. government debt, as we don’t think anyone in Washington wants to bear the blame for it. Still, stranger things have happened. Longer-term, we think volatility induced by the current budget debate may be a buying opportunity.

The long-term budget debate involves tackling the challenging issues of Medicare and Social Security, where promises made greatly exceed identified funding. The good news is that the issue is now more frequently discussed, although the debate has yet to begin in earnest. There is time to address it if politicians can ever get functional.

The news has been full of other events, and one of our challenges is sifting through the voluminous amount of information to figure out what really matters.

  • Syria— The debate on U.S. involvement in Syria is complex. We are reminded that all courses, action or inaction, have consequences. As investors our responsibility is not to decide what should or should not have happened, but to try to understand what is likely to happen and how this might affect our investment strategies.
  • The largest potential consequence in the Syria debate is that foreign powers, both friends and adversaries, perceive that the relationship between the U.S. and the rest of the world has changed. This opens the possibility that nations will attempt to test the new boundaries, which raises the odds of a crisis or international incident. Although non-specific, this kind of risk is something that investors need to anticipate.
  • New Fed Chairman— This summer President Obama announced Ben Bernanke’s departure as the Fed Chairman, setting off a firestorm of speculation over who would assume the post and what the impact to interest rates and the markets would be. We are taking a wait and see approach. Although an increase in rates could be hard on asset prices, it could foster a healthier economy in the long run.

The climate of uncertainty affects strategies we use to manage portfolios. A major observation is that we have moved from a period where all asset classes moved together, either up or down, to having diverging returns. If this continues, then diversification of asset classes may again help to reduce volatility. Through September 30, 2013, we’ve seen high variation on returns.

  • US Stocks have outperformed most if not all markets, with the S&P 500 hitting new records this summer and up 19.8% year to date.
  • Global stocks also had good performance, with the MSCI EAFE up 13.4%.
  • Emerging markets, as measured by the MSCI Emerging Market Index, were down -6.0%.
  • Bonds, as measured by the Barclay’s Aggregate Bond Index, declined -1.9%.
  • Gold, which had performed so well in the 2009-2012 period, dropped sharply in the face of rising interest rates and a rising dollar. We dropped our positions this summer as we felt the cost (the high volatility) of maintaining this hedge was too high.

Some may wonder why we don’t shift more into U.S. stocks if they have outperformed in the recent past. Historically asset class performance has gone in cycles. Rather than overweighting what worked well in the past, we try to maintain a diversified portfolio that will be able to benefit from the next asset to outperform. An example is emerging markets, where we continue to maintain an allocation in spite of recent returns. We continue to think the opportunities for growth in these parts of the world are significant.

In working with our clients to achieve their major personal and financial objectives, we try to get a reasonable return for the risks one is willing to take. A diversified portfolio should benefit from this because the whole portfolio typically has lower volatility than the individual asset classes within it. We believe the mix of asset classes is the largest driver of portfolio returns and risk.

News at Kreitler Financial

  • In March, we wrote that we began an initiative to improve what we do for clients at Kreitler Financial. We hired an industry consultant to help guide us in this process. We have been actively talking with clients to discuss what areas we do well in and where we have opportunities to improve our service. Additionally, we have closed the office one day per month for ‘development days’ where the entire Kreitler Financial team gathers to assess virtually every aspect of what we do and how we can improve it. This investment in time and energy is a part of our commitment to serve our clients to the highest standards possible.

    We are talking with clients individually to give a preview of some of these improvements. Most importantly, we want to continue to hear your thoughts on how we are doing and what we can improve.
  • In January this year, we provided clients with an annual consolidated statement covering all the accounts that we advise on regardless of the institution where they are held. A number of clients gave us feedback that it would be great to receive these quarterly. Clients will begin receiving these in October, with the first covering the period through September 30. Thank you for the suggestion.
  • Bob and Charlie attended two training conferences, the Raymond James National Conference for Professional Development and a Raymond James Asset Management Service conference on portfolio construction. Bob also attended the Raymond James Chairman’s Council Retreat, a two-day mix of study group open sessions and expert speakers.
  • Kim spent several days in San Francisco at the Advent Connect conference to improve some our technology best practices around portfolio management.
  • Bob has been named to the Raymond James Chairman’s Council for the 9th consecutive year.1 This recognizes Raymond James’ top advisors and provides us with wonderful access to all parts of Raymond James.
  • Charlie and Bob were both named Five-Star Wealth Managers by Five Star Professional and Connecticut Magazine for another year in 2013.2

We appreciate the excellent suggestions we have received from our clients and friends, and we look forward to keeping this open dialogue ongoing.

Bob and Charlie

Robert P. Kreitler, CFP®
Registered Principal
Charles F. Kreitler, CFP®
Financial Advisor

The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Any opinions are those of Robert and Charles Kreitler and not necessarily those of RJFS or Raymond James. Individuals cannot invest directly in any index. There is an inverse relationship between interest rate movements and bond prices. Generally, when interest rates rise, bond prices fall and when interest rates fall, bond prices generally rise. Every investor's situation is unique and you should consider your investment goals, risk tolerance and time horizon before making any investment. Investing involves risk and you may incur a profit or loss regardless of strategy selected. Diversification and asset allocation do not ensure a profit or protect against a loss. Investing in emerging markets can be riskier than investing in well-established foreign markets. Investing involves risk and investors may incur a profit or a loss. Past performance may not be indicative of future results. Please consult with a qualified professional regarding your particular situation before making any investment decision.

1 Membership is based mainly on assets under management, education, credentials and fiscal year production. Re-qualification is required annually.
2 Five Star Award is based on advisor being credentialed as an investment advisory representative (IAR), a FINRA registered representative, a CPA or a licensed attorney, including education and professional designations, actively employed in the industry for five years, favorable regulatory and complaint history review, fulfillment of firm review based on internal firm standards, accepting new clients, one- and five-year client retention rates, non-institutional discretionary and/or non-discretionary client assets administered, number of client households served.

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