Lake Tahoe Wealth Management Quarterly Commentary Q4, 2014


The U.S. economy continues to exhibit strength, yet the global economy continues in an economic malaise.  The global economy, including the United States, still relies heavily on aggressive monetary policy; including zero percent short term interest rates and asset purchase programs (quantitative easing or QE) around the world. Job creation and workers exiting the workforce have moved the U3 unemployment rate down to 5.8%, close to the same level in January 2004 (view 10 year chart below from  However, the U6 underemployment rate has remained stubbornly high at 11.4% (down from 13.1% one year ago). 

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The markets find the mixed messages on economic recovery unsettling.  There are two primary reasons for this stock bull market to end: recession and rising interest rates. Investors in the U.S. are expecting the Federal Reserve to raise the overnight lending rate sometime later this year. The stock market suffered a 10% pullback in October and another rapid decline at the beginning of December but both times the Fed responded with accommodative language and stocks continued their bullish run. It is difficult to expect a recession when job creation keeps the unemployment chart on a downward trend as shown above and there is a upward sloping yield curve (see our educational section regarding the yield curve in last quarter's newsletter).

However, a major concern behind the current stock market decline is the continually declining price of oil (and to increase the concern, the declining price of commodities such as copper). West Texas Intermediate (WTI) has dropped from a peak summer price of $107 a barrel to $48 at the time of this writing.  This is a jaw dropping decline of 55% in just 6 months. The fallout from such a price change is difficult to predict and depends on how long oil prices stay this low. Corporate budgets (energy sector), state budgets (N. Dakota, Texas, Alaska) and entire country budgets (Russia, Venezuela, Norway, Nigeria, Iran, Iraq, visit for more details) cannot adjust quickly to the loss of revenue associated with this massive price change. The energy sector in the U.S. accounted for close to 40% of the job growth since the U.S. came out of the last recession, and has been a driving force behind our confidence in U.S. economic recovery over the past few years. The energy boom in the U.S. was funded by $550 billion in low rate bonds issued since 2010 (, much of it non-investment grade.  The high yield spread between junk bonds and treasuries widened from a low of 3.4% this past June to 5.2% (visit link to see high yield spread:  The trend in oil continues to point down with no apparent price support; and the rhetoric from Saudi Arabia and other producers is similar:  they are going to continue to pump oil.  The stock market followed the price of oil, waiting for the price of oil to stabilize so the damage can be assessed on all risky assets. The energy sector represents 8.5% of the S&P 500 and the sector is down 23.6% in the last 6 months (price change only). While it is true that consumers have slightly more discretionary income with savings at the pump, it is unclear whether the increase in consumer spending due to the decline in the price of gasoline will offset the decline in spending and investment in U.S. drilling operations.  

The other dominating headline affecting stocks in December is the political maneuvering in the Euro zone between the European Central Bank (ECB), Germany, and Greece.  Greece is preparing for yet another vote for yet another new government on January 25 that could lead to an attempt to renegotiate Greece's bailout package, which mandated an austerity program.  Many would argue that the mandatory austerity program is a large reason Greece cannot exit their deep recession.  It is likely that Greece no longer has leverage in negotiating with the Euro zone (namely, Germany), since enough time has passed since the last contagion of Greek debt, allowing the banking sector to become more prepared. Political brinksmanship has spooked the Euro Zone, with Germany posturing that they would accept Greece's exit from the Euro Zone; termed the "Grexit" by many pundits.  More important than Greece is the possibility of deflation in the Euro zone, given the large drop in energy prices and an already stalled economy. The Euro has lost 12% against the dollar in the last year, a very large amount in currency terms. Markets are waiting to hear about the ECB’s bond buying program at their next meeting January 22 to combat the forces of deflation or disinflation.  The U.S. led sanctions on Russia are also affecting the Euro zone, since Russia is such a large trading partner with European companies, dampening growth more in the Euro zone than the U.S.

In the bond market, with the short end of the yield curve anchored at zero and the recent decline in yields of the 10 and 30 year bonds, the yield curve is flattening. However, this is mostly due to the recent flight to safety with the drop in oil prices and stocks. The yield on 10 year treasury bonds is back below 2% and may continue to decline until we stabilize oil prices and assess default rates in the high yielding energy sector bonds. It is up to the strength of other sectors of the economy to stabilize GDP growth above 3%, and the energy boom may be over.  The decline in the 10 year treasury yield meant that mortgages have become cheaper, with 30 year mortgages below 4% for qualified borrowers.



World Asset Class Fourth Quarter 2014 Index Returns

REITs, particularly in the US, had higher returns than most asset classes in the fourth quarter, outperforming equity indices. US equities performed better than non-US developed and emerging markets. Many equity markets outside the US declined in US dollar terms. Currency movements played a role; the dollar appreciated against most currencies. Small caps outperformed large caps in the US. In developed markets outside the US, small caps slightly outperformed large caps but underperformed in emerging markets. Broad market value indices outperformed growth indices in the US but underperformed in developed markets outside the US and in emerging markets. The results were mixed across size ranges in the various markets.



Fixed Income Fourth Quarter 2014 Index Returns

Interest rates across US fixed income   markets generally declined during the   quarter. The yield on the 10-year Treasury note ended at 2.17%, a dip of 34 basis points. (One basis point equals one-hundredth of a percentage point.) Long-term US Treasury bonds gained 27% in 2014.  While intermediate- and long-term rates declined, short-term rates increased. The two-year Treasury note was up 10 bps to 0.68%.  Long-term corporate bonds returned 3.98% for the quarter and 15.73% for the year. Intermediate-term corporates gained 85 bps for the quarter and 4.35% for the year.  Municipal revenue bonds (+1.54%) again slightly outpaced municipal general obligation bonds (+1.11%) for the quarter. Long-term munis continued to outperform all other areas of the curve.



The Future Looks Volatile, Again

Volatility is back. Just as many people were starting to think markets only move in one direction, the pendulum has swung the other way. Anxiety is a completely natural response to these events. Acting on those emotions, though, can end up doing us more harm than good.

As outlined above, there are a number of theories about why markets have become more volatile. In many cases, these issues are not new. The US Federal Reserve gave notice it was contemplating its exit from quantitative easing (an unconventional monetary policy used by central banks to stimulate the economy when standard monetary policy has become ineffective). Much of Europe has been struggling with sluggish growth or recession for years, and there are always geopolitical tensions somewhere.

In some ways, the increase in volatility could be just as much a reflection of the fact that volatility has been very low for some time.

Markets do not move in one direction. If they did, there would be no return from investing in stocks and bonds. And if volatility remained low forever, there would probably be more reason to worry.  But for those who are still anxious, here are six simple truths to help you live with volatility:

1.  Don’t make presumptions.

Remember that markets are unpredictable and do not always react the way the experts predict they will. When central banks relaxed monetary policy during the crisis of 2008-09, many analysts warned of an inflation breakout. If anything, the reverse has been the case with central banks fretting about deflation.

2. Someone is buying.

Quitting the equity market when prices are falling is like running away from a sale. While prices have been discounted to reflect higher risk, that’s another way of saying expected returns are higher. And while the media headlines proclaim that “investors are dumping stocks,” remember someone is buying them. Those people are often the long-term investors.

3. Market timing is hard.

Recoveries can come just as quickly and just as violently as the prior correction. For instance, in March 2009—when market sentiment was at its worst—the S&P 500 turned and put in seven consecutive months of gains totalling almost 80%. This is a reminder of the dangers for long-term investors of turning paper losses into real ones and paying for the risk without waiting around for the recovery.

4. Never forget the power of diversification.

While equity markets have turned rocky again, highly rated government bonds have flourished. This helps limit the damage to balanced fund investors. Diversification spreads risk and can lessen the bumps in the road. 

5. Nothing lasts forever.

Just as loading up on risk when prices are high can leave you exposed to a correction, dumping risk altogether when prices are low means you can miss the turn when it comes. As always in life, moderation is a good policy.

6. Discipline and patience are rewarded.

The market volatility is worrisome, no doubt. But through discipline, diversification, and understanding how markets work, the ride can be made bearable. At some point, value
re-emerges, risk appetites reawaken, and for those who acknowledged their emotions without acting on them, relief replaces anxiety.


It is important to recognize that one cannot time the markets, and that investors should always expect the unexpected.  After all, even the best and brightest economists in the world are terribly poor at telling the future (but very good at explaining what happened in the past).  One also cannot fully remove investment risk; as the risk is the reason that there is a return!  One can diversify away certain risks (deemed "unsystematic risk"), but one cannot diversify away "systematic risk".  In a capitalist global economy we will always have a business cycle, or periods of economic expansion and contraction.  Our portfolio methodology takes into consideration the factors of investment performance; and combines the different asset classes to give our clients the best chance at achieving their goals over the long run.  In other words, when we design portfolios for efficiency and the create financial plans for clients, we are taking into consideration the ups and downs of the markets in our analysis.  We cannot fully eliminate negative returns.  What we can do is reduce the statistical spectrum of potential returns and tighten that spectrum around the targeted long term average return.  In other words, we can manage the portfolio for efficiency and resiliency, reduce volatility, and take into consideration the knowns about the market (instead of trying to guess about the unknowns). When the perceived risk in the market increases, it is never a fun time period.  However, Patience and Discipline are virtues that the market rewards over time.

Footnote 1.  Adapted from “Living with Volatility, Again” by Jim Parker, Outside the Flags column on Dimensional’s website, October 2014. Dimensional Fund Advisors LP ("Dimensional") is an investment advisor registered with the Securities and Exchange Commission. Diversification does not eliminate the risk of market loss. There is no guarantee investment strategies will be successful. The S&P 500 Index is not available for direct investment and does not reflect the expenses associated with the management of an actual portfolio. Past performance is no guarantee of future results. All expressions of opinion are subject to change without notice in reaction to shifting market conditions. This content is provided for informational purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, products, or services.

1.  Standardized Performance Data and Disclosures

Russell data © Russell Investment Group 1995-2014, all rights reserved. Dow Jones data provided by Dow Jones Indexes. MSCI data copyright MSCI 2014, all rights reserved. S&P data provided by Standard & Poor’s Index Services Group. The BofA Merrill Lynch Indices are used with permission; © 2013 Merrill Lynch, Pierce, Fenner & Smith Inc.; all rights reserved. Citigroup bond indices copyright 2014 by Citigroup. Barclays data provided by Barclays Bank PLC. Indices are not available for direct investment; their performance does not reflect the expenses associated with the management of an actual portfolio.

Past performance is no guarantee of future results. This information is provided for educational purposes only and should not be considered investment advice or a solicitation to buy or sell securities.  Diversification does not guarantee investment returns and does not eliminate the risk of loss.  

Investing risks include loss of principal and fluctuating value. Small cap securities are subject to greater volatility than those in other asset categories. International investing involves special risks such as currency fluctuation and political instability. Investing in emerging markets may accentuate these risks. Sector-specific investments can also increase these risks.

Fixed income securities are subject to increased loss of principal during periods of rising interest rates. Fixed-income investments are subject to various other risks including changes in credit quality, liquidity, prepayments, and other factors. REIT risks include changes in real estate values and property taxes, interest rates, cash flow of underlying real estate assets, supply and demand, and the management skill and creditworthiness of the issuer.

Lake Tahoe Wealth Management, LLC is an investment advisor registered in the States of Nevada, New York, North Carolina, South Carolina, and Texas.

Principal Risks:

The principal risks of investing may include  one or more of the following: market risk, small companies risk, risk of concentrating in the real estate industry, foreign securities risk and currencies risk, emerging markets risk, banking concentration risk, foreign government debt risk, interest rate risk, risk of investing for inflation protection, credit risk, risk of municipal securities, derivatives risk, securities lending risk, call risk, liquidity risk, income risk. Value investment risk. Investing strategy risk. To more fully understand the risks related to investment in the funds, investors should read each fund’s prospectus.

Investments in foreign issuers are subject to certain considerations that are not associated with investment in US public companies. Investment in the International Equity, Emerging Markets Equity and the Global Fixed Income Portfolios and Indices will be denominated in foreign currencies. Changes in the relative value of these foreign currencies and the US dollar, therefore, will affect the value of investments in the Portfolios. However, the Global Fixed Income Portfolios and Indices may utilize forward currency contracts to attempt to protect against uncertainty in the level of future currency rates (if applicable), to hedge against fluctuations in currency exchange rates or to transfer balances from one currency to another. Foreign Securities prices may decline or fluctuate because of (a) economic or political actions of foreign governments, and/or (b) less regulated or liquid securities markets.

The Real Estate Indices are each concentrated in the real estate industry. The exclusive focus by Real Estate Securities Portfolios on the real estate industry will cause the Real Estate Securities Portfolios to be exposed to the general risks of direct real estate ownership. The value of securities in the real estate industry can be affected by changes in real estate values and rental income, property taxes, and tax and regulatory requirements. Also, the value of securities in the real estate industry may decline with changes in interest rate. Investing in REITS and REIT-like entities involves certain unique risks in addition to those risks associated with investing in the real estate industry in general. REITS and REIT-like entities are dependent upon management skill, may not be diversified, and are subject to heavy cash flow dependency and self-liquidations. REITS and REIT-like entities also are subject to the possibility of failing to qualify for tax free pass through of income. Also, many foreign REIT-like entities are deemed for tax purposes as passive foreign investment companies (PFICs), which could result in the receipt of taxable dividends to shareholders at an unfavorable tax rate. Also, because REITS and REIT-like entities typically are invested in a limited number of projects or in a particular market segment, these entities are more susceptible to adverse developments affecting a single project or market segment than more broadly diversified investments. The performance of Real Estate Securities Portfolios may be materially different from the broad equity market.

Fixed Income Portfolios:

The net asset value of a fund that invests in fixed income securities will fluctuate when interest rates rise. An investor can lose principal value investing in a fixed income fund during a rising interest rate environment. The Portfolio may also be affected by: call risk, which is the risk that during periods of falling interest rates, a bond issuer will call or repay a higher-yielding bond before its maturity date; credit risk, which is the risk that a bond issuer will fail to pay interest and principal in a timely manner.

Risk of Banking Concentration:

Focus on the banking industry would link the performance of the short term fixed income indices to changes in performance of the banking industry generally. For example, a change in the market’s perception of the riskiness of banks compared to non-banks would cause the Portfolio’s values to fluctuate.

The material is solely for informational purposes and shall not constitute an offer to sell or the solicitation to buy securities.  The opinions expressed herein represent the current, good faith views of Lake Tahoe Wealth Management, LLC (LTWM) as of the date indicated and are provided for limited purposes, are not definitive investment advice, and should not be relied on as such.  The information presented in this presentation has been developed internally and/or obtained from sources believed to be reliable; however, LTWM does not guarantee the accuracy, adequacy or completeness of such information. 

Predictions, opinions, and other information contained in this presentation are subject to change continually and without notice of any kind and may no longer be true after the date indicated. Any forward-looking statements speak only as of the date they are made, and LTWM assumes no duty to and does not undertake to update forward-looking statements.  Forward-looking statements are subject to numerous assumptions, risks and uncertainties, which change over time.  Actual results could differ materially from those anticipated in forward looking statements. No investment strategy can guarantee performance results. All investments are subject to investment risk, including loss of principal invested.

Lake Tahoe Wealth Management, LLC is an investment advisor registered in the States of Nevada, New York, North Carolina, South Carolina, and Texas.

Volatility is back

Lake Tahoe Wealth Management Quarterly Commentary Q3, 2014