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CLS: What will CLS do if the Feds raise rates?

12/16/2015

Week in Review
Last week, the majority of global markets were negative, with only the S&P 500 showing up in positive territory. The U.S. bond market dropped slightly, as bond yields rose, but is still positive year-to-date.

Major news last week came from two of the world’s most in uential central banks – the United States Federal Reserve (Fed) and the European Central Bank (ECB). On Thursday, the ECB announced it would lower its deposit rate by 10 basis points (bps), which was lighter than market participants expected. ECB president Mario Draghi announced further stimulus measures and the Euro rallied against the dollar as the divergence in monetary policies was not as extreme as most perceived. Friday brought another strong number in non-farm payrolls: 210,000 new jobs were reported, 20,000 more than estimated, and Fed Chairwoman Janet Yellen hinted at intentions to move rates in 2015. When the fed meets again in mid-December, the probability for a rate hike is about 80%.

In Search of the Interest-Rate-Proof Portfolio
As the Fed looks to finally raise rates, I’m getting a lot of questions on what we are doing to prepare for it and what works best in a rising-rates environment. First, when portfolios are fully diversified, not all parts will work in tandem; that’s the benefit of correlation. However, there are some moves we have implemented within our strategies in anticipation of tightening monetary policy.

For example, technology has been a very strong CLS Investment Theme for about two years now. This area of the U.S. market may continue to offer attractive returns even during a rate increase. Not only does the tech sector sport attractive valuations, but tech 94% companies also have large cash holdings on their balance sheets, much larger than any other sector. They have more than $690 billion in cash on hand, or more than 40% of the corporate cash accounted for. This means these firms will be much less vulnerable to rate increases than other debt-heavy sectors, such as utility companies. Financials is another sector we have significant exposure to. This one seems obvious. Simply put the large financial firms (mainly banks) should make more revenue from lending money at higher rates – makes sense right?

On fixed income, CLS has utilized bonds with a shorter duration, as well as floating-rate bonds. These two areas are key parts of our tactical fixed income theme.

Finally, a global philosophy is just as important to mention. While the U.S. is set to raise rates, many other regions around the globe are doing the opposite; they are cutting rates and easing monetary policy. Diversification to these international regions can potentially enhance returns in the years ahead.

Year-End Financial Checklist
We are only a few weeks away from a new year. This is the time for Christmas gift shopping, spending more time with loved ones, cold weather (at least for us in Nebraska), and of course tidying up financial accounts and records! This is a good time of year to take a look at your financial accounts and perform an annual “health checkup.” Here are some popular ways to do that:

  • Review your asset allocation. Has anything changed in your time horizon, goals, or ability to handle risk? If so, now is a good time to work with your financial advisor to update your investment policy statement.
  • Make a gift or charitable contribution.
  • If you are still in the accumulation stage, make sure you are taking advantage of your employer’s match in your 401(k). This is essentially free money. If you contribute 6% and your employer matches with 4%, that is 10% toward retirement! There are plenty of little things you can take advantage of now that will help you enjoy your retirement.
  • If you are retired, over 701⁄2, and have a tax-deferred account, make sure you withdraw your required minimum distribution (RMD). If you do not need your RMD, you may want to think about reinvesting them.
  • Tax Loss Harvesting. While it’s still yet to be seen if the equity markets will end this year in negative territory, there are likely some areas of your portfolio you can sell at a loss. By realizing, or harvesting a loss, you can offset taxes on both gains and income. Please consult your tax advisor for more information.

Ending the Stop-Loss Market Order
One storyline that seemed to fly under the radar these past couple months is the elimination of stop- loss orders on the New York Stock Exchange (NYSE). In November, the NYSE announced these orders would be taken away as market tools on February 26, 2016. Most investors view stop-loss market orders as a type of insurance. In theory they help prevent a stock from falling too far and being sold when it hits a certain price point on the exchange. In practice, there are several flaws in this system, as the events on August 24 of this year showed. That day, investors had stop-loss orders set on stocks they thought would protect them; but in reality, they didn’t. The market crashed on the open, and the Dow started the day down 1,000 points. The shares crashed through their perceived insurance with stop-loss orders and automatically sold at prices well below their orders. The market later returned to its fair value and investors who sold were worse off. As a consequence and partial solution, the NYSE eliminated all existing stop-loss orders on its books and will no longer accept them going forward. The hope is that this will raise awareness of risks during days of volatile trading patterns.

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