Staying focused on equities with an eye on valuations
- In general, we have been re-concentrating the Fund’s portfolio this year because of our views on the current environment.
- The Fund’s cash position may remain elevated in this market as we continue to be selective in investments.
- We think a gold position still is warranted in case investors become less confident in the effectiveness of central bank actions.
The steady rise in equity markets in 2013 lifted the asset class and active stock-picking was less rewarded. The S&P 500 Index* soared to record highs and was up 32.4% for the year. While equity markets regularly have reached new highs this year, too, we maintain they are more attractive relative to other asset classes. However, the steady market gains are concerning, given valuation levels at this point in the cycle and what we consider a sense of market complacency.
Fund allocations reflect market views
Beginning in late 2012 and often since then, we have said that we intended to use cash defensively in the Fund as valuations rise. We also have said we expected the allocation to cash gradually would increase over time. We have stayed consistent on these points during the last 18 months and the cash position has increased gradually, although more quickly since mid-May. The cash allocation at May 31 of 36% of net assets in the Fund was the peak for the year to that point and has since declined to 29% as of June 30.
In general, we have been re-concentrating the Fund’s portfolio this year because of our views on the current market environment. There were fewer than 100 equity names in the Fund as 2014 opened, but that total was down to less than 70 by June 30. We reviewed each holding as the year progressed and eliminated any in which we thought the investment story had changed, or thought the holding’s value was near a peak or was likely to reverse.
We think the companies in the Fund’s portfolio have the ability to generate a high level of cash flow with relatively unlevered balance sheets; return capital to shareholders in the form of higher dividends or share repurchases; or offer a good or service that either has a unique factor or has pricing power in a competitive, low-growth environment. In general, our review process contributed to the Fund’s increased cash position, which may remain elevated in the current environment as we continue to be selective in our investments.
Central bank policies overhang markets
A key factor in our decision to increase the cash position in the Fund relates to the monetary policies of global central banks — particularly in the midst of a five-year equity bull market — and their unknown long-term effects. These actions have resulted in higher financial asset prices without a commensurate improvement in economic fundamentals.
We believe central bankers have relied excessively on unorthodox monetary policies since the onset of the global financial crisis. We think these policymakers have focused on stimulating demand in order to increase gross domestic product (GDP), but they have postponed confronting the potential inflationary implications of these actions until growth is stronger. Globally, we think we remain in a low-growth, lowinflation and low-rate environment. We think this seems an inadequate foundation for sustainably higher valuations.
Underlying global growth remains modest, and we do not think there is much evidence of a broad return to growth in the near term. In fact, the latest data from the U.S. have indicated GDP growth for the full year may be below earlier forecasts after a downward revision for the first quarter.
The economy in the eurozone has improved, but continues to grapple with low inflation and a weak lending environment. The European Central Bank (ECB) in June announced reductions in interest rates and the availability of an additional 400 billion euros for low-cost loans to companies having difficulty getting credit. The ECB said it also is considering using quantitative easing (QE) by purchasing asset-backed securities in the European market. GDP in Japan has been somewhat stronger than expected, as has economic growth in India, which we believe is a positive indicator. A change in leadership in India also has made many investors more optimistic about the prospects for economic reform and growth there. China’s economy has shown signs of slowing, but we still believe the growth in the emerging middle class there will steadily move that country toward an economy driven more by domestic consumption.
From a long-term perspective, we think areas in the world that have the ability to generate above-average real GDP are likely to be in Asia in general and China, India and Southeast Asia in particular.
A careful use of gold
We have slightly reduced the Fund’s gold holdings in recent months — one of the ways we have added cash. As we have said in the past, we consider gold to be an alternative to fiat (paper) currencies. We still believe a gold position is warranted in the event that market psychology changes and investors become less confident in the effectiveness of central bank actions.
There is a looming question of how quickly the markets will anticipate and adjust to the prospect of an increase in the discount rate and its effects on future cash flows, since investors and consumers have benefitted from an extended period of low interest rates. The Federal Reserve (Fed) over the last five years has kept interest rates artificially low — reaching zero in real terms. Investors, on some level, understand that even a small increase in the discount rate will represent a significant change for the economy and markets.
There is a long list of active central banks — including the Bank of Japan, the Peoples Bank of China, the Bank of England, the ECB and the Fed — that are contending with a decision of how loose or tight their monetary policies should be, given their economic growth rates and currencies. The global economy has grown since early 2009 but not as much as policymakers expected, based on the level of economic stimulus they have provided.
If the Fed becomes more concerned about the slow pace of the housing recovery, the modest rate of capital expenditures and the lack of more significant wage growth, it is possible we could see it reverse its less-accommodative rhetoric and actions — such as the tapering of bond purchases and raising interest rates in 2015 — and instead engage in further QE. We therefore want to maintain some exposure to gold as we watch how currency markets react to further announcements from policymakers. We also will watch investor reaction to central bank moves that may be good for equity prices if the underlying economy is not as robust as it might otherwise be.
* The S&P 500 Index is an unmanaged index of common stocks that generally is representative of the U.S. stock market. It is not possible to invest directly in an index.
Past performance is not a guarantee of future results. The opinions expressed are those of the Fund’s portfolio manager and are not meant as investment advice or to predict or project the future performance of any investment product. The opinions are current through July 1, 2014, and are subject to change due to market conditions or other factors.
Risk factors. As with any mutual fund, the value of the Fund’s shares will change, and you could lose money on your investment. The Fund may allocate from 0 to 100% of its assets between stocks, bonds and short-term instruments of issuers around the globe, as well as investments in precious metals and investments with exposure to various foreign securities. International investing involves additional risks, including currency fluctuations, political or economic conditions affecting the foreign country, and differences in accounting standards and foreign regulations. These risks are magnified in emerging markets. Fixed-income securities are subject to interest-rate risk and, as such, the net asset value of the Fund may fall as interest rates rise. Investing in high-income securities may carry a greater risk of nonpayment of interest or principal than higher-rated bonds. The Fund may focus its investments in certain regions or industries, thereby increasing its potential vulnerability to market volatility. The Fund may seek to hedge market risk on various securities, increase exposure to various markets, manage exposure to various foreign currencies, precious metals and various markets, and seek to hedge certain event risks on positions held by the Fund. Such hedging involves additional risks, as the fluctuations in the values of the derivatives may not correlate perfectly with the overall securities markets or with the underlying asset from which the derivative’s value is derived. Investing in commodities is generally considered speculative because of the significant potential for investment loss due to cyclical economic conditions, sudden political events, and adverse international monetary policies. Markets for commodities are likely to be volatile and the Fund may pay more to store and accurately value its commodity holdings than it does with the Fund’s other holdings. These and other risks are more fully described in the Fund’s prospectus. Not all funds or fund classes may be offered at all broker/dealers.