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Taking the Market’s Temperature

In this week’s post, Accretive Wealth’s CEO, Faraz Sattar, continues his conversation with Daniel Kern, president and chief investment officer at Advisor Partners, LLC, Accretive Wealth’s new partner. They discuss world economic trends as well as market opportunities and challenges.

Faraz: Let’s start with your take on the US economy. Where do we stand?

Dan: The domestic economy is doing okay. It’s certainly not great, but we have come off the bottom. First-quarter earnings actually beat expectations, even though revenue fell a bit short. The housing market is rebounding nicely; employment appears to be improving. We don’t expect the Fed to take any dramatic measures any time soon, although it will likely taper off liquidity measures in the second half of 2013.

Faraz: So while the US economy looks likely to continue on its path of moderate growth, what’s the outlook for the rest of the world?

Dan: The Eurozone is still very weak; we’re really troubled by it. The budget situation has stabilized to some degree but, for the most part, the region’s economies are still struggling. And, unfortunately, we’re seeing a fair amount of complacency but not much in the way of real structural reform. Unemployment is really awful. In Spain, the unemployment rate is more than 25%, and the jobless rate for youth is double that.

Faraz: What will it take for the Eurozone to pull itself out of the hole it dug?

Dan: We think the German elections in September will be an inflection point. Of course, a major challenge is whether France and Germany will be able to broker some kind of banking union, delinking the banks from the sovereign governments. At that point, Eurozone economies and markets should improve.

Faraz: What opportunities do you see in emerging markets?

Dan: China is still growing, albeit at a somewhat slower rate. We believe it will strengthen as the leadership transition continues and it focuses on stimulating the economy. However, many other emerging markets are struggling because of slow growth in Europe and the US.

Faraz: How do these shifts in the global economy affect your view of the financial markets?

Dan: Frankly, we don’t see any major changes ahead. We continue to favor equities over bonds, and remain more positive about the US than about Europe. We continue to be overweight on large-cap stocks relative to small-caps, although we do still allocate to small-cap stocks.

Europe is very cheap right now, and we’re looking for opportunities there as well as in emerging markets. We have been invested in high-yield bonds, and will continue to be, but we’re cutting duration to reduce risk—we’ve seen some credit deterioration in recent months.

On the real asset side, gold is still a hedge against inflation, but we’ve reduced our exposure to gold in recent months.

Faraz: Are there particular sectors where you’re especially bearish … or bullish?

Dan: We feel that utilities have gotten very pricey because investors are demanding yield. We also tend to think that consumer staples have gotten ahead of themselves, expensive relative to historic norms.

As far as what we like, we’re always looking for value. We see it in some areas of technology as well as in pockets of some industrial sectors that we think are currently undervalued.

Faraz: What’s your overall view of the equity markets?

Dan: There’s a definite possibility for a pullback in the US market, and although we believe that market will continue to move up at a pretty steady pace, we wouldn’t be surprised to see a pullback, particularly since earnings estimates for next year are probably overly enthusiastic. That’s an opportunity for dollar-cost-averaging into the market.

When and if the economy turns around in Europe, there is room for expansion in the market multiples. Of course, the big question there is “when?” We think it might happen by the end of the year or the beginning of 2014.

Faraz: That brings us to commodities. Is now the right time to start investing in oil and some of the hard commodities?

Dan: We think that those commodities will be interesting later in the year—but obviously we don’t know exactly when. We do know that we’d rather be a little early than late to the party.

And that, in turn, speaks to our philosophy of a broadly diversified asset allocation based on both quantitative analysis and judgmental factors. That philosophy determines not only what we invest in, but also how we invest. For example, we use both passive and active investment strategies. If we’re investing in a broad sector of the stock market, a passive investment in an ETF may be the cheapest and easiest solution. In contrast, if we’re interested in a less efficient segment of the market— emerging markets or small cap for example—we may seek an active manager with deep experience in that particular area.  We may also use active managers for segments of the market that require specialized risk management and credit expertise, such as high yield and emerging markets debt.

Faraz: What advice do you have for investors interested in active trading?

Dan: Don’t. Individuals tend to outsmart themselves by trading too frequently. As a rule, they buy too late and sell too low. They don’t have the necessary analytical tools at their disposal and they don’t have the clout that institutional investors wield.

Philosophically, we seek out fair value, reducing exposure to things that are too expensive. Our preference is to rotate to investments that are out of favor, and buy them before they become popular. That’s precisely the opposite of what most individual investors do.

If you have any questions, please feel to call (925) 365-1533 or send an e-mail to lifeplan@accretivewealth.com.

Daniel S. Kern, CFA, is the president and chief investment officer of Advisor Partners. He is responsible for establishing and driving the overall company strategy and oversees all aspects of company operations. Prior to joining Advisor Partners, Dan was managing director and portfolio manager for Charles Schwab Investment Management. He managed asset-allocation funds, including target funds, from October 2008 to July 2011, and before that he headed product development and served as CFO of the Laudus Funds. Earlier, he was managing director and principal for Montgomery Asset Management. Dan is a graduate of Brandeis University and earned his MBA in finance from the University of California, Berkeley. He is a CFA charterholder and a former president of the CFA Society of San Francisco. 

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