Supported by an accommodative Federal Reserve, U.S. economic fundamentals continue to grudgingly improve.  Unemployment is slowly falling, home prices are rising, and corporate earnings and profitability are near record highs.  Stimulative Fed actions appear to be supporting strong U.S. stock market gains.  U.S. stocks posted a robust 10.6% gain in the first quarter, beating both developed international stocks—which overcame ongoing issues in Europe to return 3.8%—and emerging-markets stocks, which lost 3.5%.  Meanwhile, the bond market was nearly flat.

Looking ahead, significant uncertainty surrounds fiscal and monetary policy.   With respect to fiscal policy, the markets digested the sequester’s spending cuts without much drama, but the sequester’s impact is small potatoes compared to the debt and fiscal policy challenges still confronting the nation.  While there is not an immediate federal budget crisis, there is clearly a debt/deficit crisis in the longer term since federal spending vastly exceeds tax revenues.  On the monetary policy side, Fed Chairman Ben Bernanke continues to state that the Fed is not close to ending their stimulative policies (quantitative easing), which involve purchasing $85 billion per month of Treasury bonds and mortgage securities.  However, there is significant uncertainty surrounding the longer-term consequences of these policies.

What Now for U.S. Stocks?

With U.S. stocks hitting new highs, we are naturally getting two questions:

1. With stocks up so much, shouldn’t we reduce our exposure (to lock in gains, given all of the big-picture risks)?
2. With stocks up so much, shouldn’t we increase our exposure (since the economy must be much better than people expected)?

The short answer to both questions right now is, “no.”  Overall, our outlook for U.S. stocks has not improved.  The sharp run-up in stock prices, which implies lower future returns, suggests we could be moving closer to reducing our U.S. equity exposure rather than increasing it.  Emerging-markets stocks continue to be more attractive, and we have strategically added exposure.  This sector appears more reasonably priced and the potential return over the next few years should be stronger.

Our actively-managed bond funds continue to add value over the index.  The bottom line is U.S. Treasuries offer less than 2% annualized return for the next 10 years.  Thus, our portfolios remain underweight to these core bonds.  In their place we have larger allocations to strategic and absolute-return-oriented bond funds that we expect to continue to outperform the bond market.

While this market environment does not foster a relaxed approach to investing, it does offer up opportunities to those willing to do the research and take advantage of the volatility.  As always, our motivation is to stay clearly focused on making money and managing risk.  If your portfolio is not being actively managed to take advantage of today’s opportunities, talk to one of our dedicated Advisors at 1-800-492-1107.