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3 Investments Jeffrey Gundlach Loves In 2015

Summary This article summarizes Jeffrey Gundlach’s “2015 Market Outlook” webcast. He spoke favorably about the underlying fundamentals in the strong U.S. dollar despite its rapid ascent last year and how currency trends can be “persistent and long lived”. Gundlach also spoke favorably about gold as a flight to quality instrument. Yesterday I listened to Jeffrey Gundlach’s “2015 Market Outlook” webcast along with much of the financial community. Gundlach has certainly peaked in his notoriety as one of the most prestigious bond fund managers and continues to draw fascination for his timely insights into global economic machinations as well. For full disclosure: I have owned the DoubleLine Total Return Fund (MUTF: DBLTX ) for myself and my clients for many years now as well as various other Doubleline funds along the way. I have found Gundlach’s team focus on security selection, duration exposure, risk management, and overall total return to be a far more attractive value proposition than owning a passive index such as the iShares U.S. Total Bond Market ETF (NYSEARCA: AGG ). One of the themes that Gundlach noted throughout his call is that the U.S. consumer is focused on the positive impact of the oil space, while Wall Street has yet to fully embrace the impending negative aspects. He noted that currently 35% of the S&P 500 capital expenditures are represented in energy companies, of which there is a probability this spending could completely evaporate later this year. That could ultimately lead to employment cuts, potential bankruptcies for leveraged energy companies, and deeper impact across the high yield bond spectrum. The Energy Select Sector SPDR (NYSEARCA: XLE ) has certainly been pricing in some of those eventualities as it continues to decline with crude oil prices. Despite some modest rallies, XLE now stands at more than 25% off its 2014 high and recent probed down to new lows as angst sets in. The one thing I have noted recently is how much buying has been on throughout the energy complex since the decline began. At this juncture you would typically expect widespread distribution rather than accumulation in energy ETFs. He also spoke favorably about the underlying fundamentals in the strong U.S. dollar despite its rapid ascent last year and how currency trends can be “persistent and long lived”. However, he candidly stated that “I know it’s a crowded trade. I’m as uncomfortable as everybody else.” The PowerShares U.S. Dollar Bullish Fund (NYSEARCA: UUP ) has been a big mover as declines in the euro and Japanese yen continue to fuel a flight to the dollar. The overarching themes of lackluster growth and quantitative easing efforts in these foreign developed countries make the U.S. dollar, and concomitantly U.S. treasuries, an attractive trade for overseas dollars. Gundlach also spoke favorably about gold as a flight to quality instrument. He thinks that gold will move higher as the stress to the financial system from the repercussions of oil deflation takes hold. We have already seen an uptick in the SPDR Gold Shares ETF (NYSEARCA: GLD ) since the beginning of 2015 as it comes off multiple years of heavy declines. This sector certainly bears watching as volatility in both stocks and commodities may favor investors seeking out hard assets with non-correlated returns as a hedge against other investments. On interest rates, Gundlach noted how far off economists were in predicting the outcome of the 10-Year Treasury note yield at the end of 2014. He believes that the trend in higher bond prices (lower bond yields) will continue in the first half of this year and will probably overshoot most investors’ expectations. The strong price trend in the iShares 7-10 Year Treasury Bond ETF (NYSEARCA: IEF ) has continued to stretch further than many believed possible, and has gone almost vertical since the beginning of 2015. On a relative basis the U.S. 10-Year Yield near 1.80% is still far more attractive than other developed nations in Europe and Japan. There is obviously no concern right now for a rate hike scenario being priced into the market. Instead, investors are focusing on sheltering their portfolio from low global yields and a volatile stock environment. Other bullets of caution worth mentioning: Gundlach did not speak favorably about bitcoin and noted it was virtually the worst performing asset class of 2014. (See what I did there with “virtually”?) The stock market has been positive for the last 6 years straight (2009-2014). Stocks never been up 7 years in a row since 1871. He still feel that Treasury inflation protected securities ( OTC:TIPS ) are for losers because near-term inflation expectations are actually pointing towards negative trends. He did note that they are cheap on a relative basis, but the overriding argument to own them is flawed in this market. Avoid the iShares TIPS Bond ETF (NYSEARCA: TIP ) for the time being. He is “afraid of mall REITs” due to more retail sales moving online and shrinking need for conventional shopping centers. He noted that “It’s a little late to buy the Shanghai (China)” after last year’s run and that you probably don’t want to own European stocks or bonds right now. Also beware of leveraged ETFs with respect to compounding and tracking error over time. He noted the big decline in the DirexionShares Daily Gold Miners Bear 3x Shares (NYSEARCA: DUST ) for 2014, despite the fact that the Market Vectors Gold Miners ETF (NYSEARCA: GDX ) was down heavily last year as well. The Bottom Line No one man knows the fate of the markets and most will probably take these comments with a grain of salt. However, those that take a wider macro view in their investment analysis may be intrigued by some of the correlations that were noted in this presentation. Many of the observations Gundlach made in his monologue mirror our own thoughts on the market at this juncture. Our most recent January 2015 client memo outlined several salient points on interest rates, volatility, and areas of perceived value as well.

A Value Approach To Rebalancing Out Of U.S. Stocks

Summary I will present an approach to use Shiller P/E to value-adjust portfolio weights when rebalancing for 2015. Interestingly, of 13 developed and 12 emerging market countries evaluated, the U.S. is the only country currently in the top quartile of its historic P/E range. With the exceptions of the U.S., Switzerland, South Africa and Thailand, every developed and emerging market country’s P/E ratio is currently below its historic median. 2014 was unexpectedly a solid year for U.S. equities. Many predicted that the multi-year bull market would not continue, but yet the Vanguard Total Stock Market ETF (NYSEARCA: VTI ) managed a 12.6% total return. The same fortune could not be said about the Vanguard FTSE Developed Markets ETF (NYSEARCA: VEA ) (-5.7%) or the Vanguard FTSE Emerging Markets ETF (NYSEARCA: VWO ) (+0.6%). In rebalancing, I have in years past kept things simple and diligently rebalanced my stock portfolio to the same target weights (note this is not my entire portfolio – I also hold bonds, REITs, and individual value stocks): Index Stocks Wt. Total U.S. 50% International Developed 25% Emerging Market 25% The S&P 500, as mentioned in my previous article on market valuation, is ridiculously high. Using a few valuation metrics, history would suggest the U.S. market is due for a correction. I will certainly reduce my exposure to U.S. stocks, as I would normally in rebalancing. However, based on the current relative level of the U.S. market, I consider the traditional rebalancing approach of reducing my U.S. total stock position down to 50% insufficient if not foolish. I have done enough comparisons over time and cross-sectionally to sit idle. Instead I want to reduce my U.S. allocation further, while maintaining the same stock exposure. In this article, I will present an approach to use Shiller P/E to adjust rebalancing weights for value in 2015. My intent is NOT to actively manage my ETF portfolio, but instead to set periodic weights (once a year) based on market valuations and rebalance to them. I encourage your feedback on this disciplined simple mix of passive rebalancing with value investing. Country Price-Earnings ratio boxplots I credit Research Affiliates LLC for providing the historic ranges of Shiller Price-Earnings ratios for developed and emerging market countries (all countries have at least 19 years of data). The chart below shows the range of P/E ratios for U.S. versus International Developed countries in a boxplot with the current value in blue, the line representing the lower 25% and upper 25%, and the box representing the middle 50%. The countries shown represent 90.1% of the Vanguard FTSE Developed Markets ETF. Interestingly, only the U.S. is in the top quartile of its historic range. Also note in absolute level, it has the highest P/E ratio. The U.S., at 27.1 times earnings is 2.2 times higher than the next highest developed country, Japan. Since I do not have the entire distribution to calculate the current percentiles (and create an average percentile), I instead rate each country with a number 1 through 4 that represents which historic quartile its current P/E ratio stands in (from top to bottom). Thus, the U.S. scores a 1 and the portfolio weighted average score for the International Developed countries is 3.32. (click to enlarge) Next I will show the U.S. versus Emerging Market P/E ratio boxplots. Note, these countries represent 94% of the Vanguard Emerging Markets Stock Index ETF. Once again the U.S. is alone in the 4th quartile of its historic range and is has a higher P/E ratio greater than the emerging market country with the highest P/E ratio (Mexico) by 6 times earnings. Using the same quartile scoring approach as the U.S. and International Developed countries, the Emerging Market average score is 3.26. (click to enlarge) Country P/E deviations from median Next, I measure the percent deviation from the historic medians for each country. I omitted adding medians on the boxplots to avoid cluttering them. The U.S. P/E ratio is currently 70% above its historic median. With the exceptions of Switzerland, South Africa and Thailand, every other Developed and Emerging Market country is currently below its historic median. Also note, these three are only modestly above their medians (within 20%). Brazil, Russia, and Italy are all 35% below their median P/E ratios or lower. (click to enlarge) (click to enlarge) Conclusion: New Portfolio Weights Using the three quartile scores, I recalculate my new portfolio weights by ranking them with adjustments of (-10%, 0, and +10%). Since the International Developed and Emerging Market scores are so close, I give them both weight increases: Stock 2014 weights Avg. P/E Quartile Weight adjustment 2015 weights Total U.S. 50% 1.00 -10% 40% International Developed 25% 3.32 +5% 30% Emerging Market 25% 3.26 +5% 30% Total 100% 7.58 0% 100%

The Swiss Remind Us Why You Should Always Own Some Gold

Swiss Franc moves throw a wrech in the global currency picture on Thursday. Gold rallies on the news. We think that some capital should always be allocated to gold. By Thom Lachenmann The overnight news about Switzerland left the markets in a frenzy this morning and were no doubt beacons of both fantastic and horrifying news for FX traders who missed the trade and woke up to mayhem. Switzerland’s central bank stopped pegging the franc to the euro, a move that we really can’t blame them for. In trying to “defend” the Swiss franc, the Swiss national bank had ran up quite a bill. So, they let the dam burst, and burst it did. It was a rule put in place in order to keep the currency from getting too strong, a concept that we find ridiculous to begin with. Currencies, of course, get stronger and weaker based on the overall health of the nation’s macro economy. Limiting the strength of your currency is a dopey thing to do, unless you’re an equity market trader with a full scale bullish position. Switzerland’s tactic of lowering interest rates on the franc while doing this didn’t seem to help at all and the franc skyrocketed to all time highs today. Euro to Swiss Franc Exchange Rate data by YCharts Of course, with the whole world expecting Europe to implement some type of economic stimulus, the Swiss Central Bank could have had a real quagmire on its hands trying to defend its currency if there was a flee from the euro. When countries stimulate the way the ECB could potentially do, it generally causes the currency to devalue in a sharp fashion. We were reminded of the benefits of having some gold in your portfolio today, as well. The commodity was up nearly 2% on Thursday after the Swiss news hit the wires. We think there’s a couple reasons that gold got the boost. First, obviously, people that are having “flights to safety,” as Reuters called it, are simply getting into the precious metal as a portfolio hedge or as a safe haven for capital. Secondly, we believe that the notion of Switzerland unpinning their currency from a major national bank reminds people about the true value of gold, when looked at as a non-recurring resource. Gold is held in reserves by these types of central banks for these reasons, and today’s move by the Swiss shows that not ALL countries have drifted into the “Keynesian Dream” that the US, China, and ECB are in. Swiss equities were crushed, down 11% when U.S. markets opened on Thursday morning. When countries take the “unpopular” but safe moves of thinking Austrian, gold flourishes. This type of move is a nice subtle reminder to note when we’re always going to think of gold as a great safe haven for investors and something that a well balanced investor should always allocate some portion of their capital too, whether it’s through funds or the physical commodity.