1. Art and Diseño

INVESTMENT BRIEFING
Fourth Quarter, 2014
Explaining performance in the fourth quarter depended on which global market you looked
at. Generally, it was a very nice quarter in the U.S. and poor elsewhere. Stocks of small
companies reigned supreme while emerging markets suffered due to an appreciating dollar
as capital flowed to the U.S. As illustrated by the table below, 2014 is an excellent example
of why we diversify because the stocks of large and small companies traded places
dramatically last quarter. Looking to the longer term, emerging market stocks still have the
best performance.
Asset Class
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U.S. Stocks (Russell 3000)
Small Cap U.S. Stocks (Russell 2000)
Foreign Stocks (MSCI All Country World
ex USA)
Emerging Markets Stocks (MSCI EM)
Real Estate Investment Trusts (MSCI
World REITs)
Taxable Bonds (Barclays 1-5 Year Gov)
Municipal Bonds (Barclays Muni 3 Year)
4th
Quarter
2014
5 Years
(annualized)
10 Years
(annualized)
12.56%
4.89%
-3.87%
15.63%
1.78%
12.69%
8.43%
8.96%
-2.19%
21.54%
0.45%
-0.13%
1.18%
1.22%
1.75%
3.12%
2.97%
5.24%
9.73%
-3.87%
-4.50%
15.55%
4.43%
1.93%
7.94%
7.77%
5.13%
3.59%
Advisory services offered through Vista Wealth Management LLC, a federally registered investment advisor. Securities also offered through ValMark
Securities, Inc., member FINRA, SIPC. 130 Springside Drive, Suite 300, Akron, OH 44333. 800.765.5201. Vista and ValMark are separate companies.
United States: Living Large
The U.S. economy continued to pull away from most of the others in Q4, with employment
growth reaching levels last seen in 1999. Most employment numbers continued to improve,
although a large and important one, labor market participation, showed that more people
dropped out of the workforce. The data showed that while the drop was due mostly to
demographics (aging baby boomers), there were still discouraged workers who gave up on
their job searches. The Federal Reserve continued to say that interest rates would likely
increase in 2015 based on their reading of the unemployment numbers, although they too
are concerned about participation. Setting employment aside for a moment and just looking
at growth, U.S. GDP expanded at healthy rates both in the 2nd and 3rd quarters.
Given these positive numbers, the stock markets shook off their earlier fears and came back
strongly, as the numbers in the table show. At the same time, commodities, which have
mostly been struggling for the last few years, continued their rout with the price of oil
dropping almost in half. The reduced cost of oil should eventually give different sectors of the
U.S. economy a nice boost as consumers redirect their energy expenditures to other goods.
Looking forward, there are many positives that may continue to benefit our economy:
 Relatively low interest rates and a still mostly accommodative central bank
 An inflation rate that is under control
 Continued improvement of consumer balance sheets as their debt continues to
drop
 Improving government deficits
Negatives to keep in mind for the U.S. include:
 A rather expensive stock market
 An energy sector that may struggle as it adjusts to much lower oil prices
 A still-struggling Europe and Japan, who are important trading partners, and
whose economies affect U.S. company profits
 The possibility of continued legislative gridlock in Washington
Interestingly, the best performer across domestic and international segments was real
estate, which was represented separately in your Vista portfolio as global REITs (Real
Estate Investment Trusts). They returned more than 20% for the year overall.
Everyone Else: Living Less
There isn’t much mystery in the numbers: with the exception of the U.K. (who has mimicked
many of the U.S.’s moves) much of the world’s economy is still struggling to recover from the
financial crisis. Here’s a summary:
 The European monetary union did pull out of its double-dip recession, but just barely.
There are three large positives on the horizon, however:
 Since Europe is a heavy importer of energy, cheaper oil could give them a
nice boost.
 The European Community Bank (ECB) is ready to start its own version of
quantitative easing, which could boost borrowing.
 A much cheaper euro, in dollar terms, should also boost their exports.
 Japan tried its version of quantitative easing also, named Abenomics, after their
prime minister. Their actions initially helped, but an increase in Japan’s sales taxes
put a serious crimp on the effort, resulting in an eventual reversal of the tax increase.
Looking forward, as in Europe, their cheaper currency (yen to dollar) and oil may give
them a nice boost.
 Emerging markets, which produce many of the commodities that have suffered lower
prices, generally stumbled through the quarter (and the year). This included China,
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who continued dealing with reduced growth. While their currencies are also cheaper,
the fact that many of their commodity exports are worth less means that they may
continue to struggle. However, the long-term growth prospects remain good,
especially in countries like India and China that continue building their middle classes.
Living Large or Less: Currencies in Our Global Economy
What is interesting to note, is how global stock markets did in terms of their own, local,
currencies. Currency values tend to be strongly related to the interest rates being paid by
their host countries. For example, if rates are higher in the U.S. than they are in the U.K.,
the dollar will typically be more valuable than the pound because investors are buying
dollars to get our higher rates. Today, as the Federal Reserve talks about increasing rates
while the European Community Bank talks about lowering theirs, the dollar has
appreciated against the euro rather drastically.
Currencies Reversed 2014's Returns
15.0
10.0
5.0
0.0
-5.0
-10.0
Local
France
Germany
Dollar
Japan
UK
Switzerland
Australia
What if we look at how foreign
markets performed in terms of
their own currencies? Here’s a
graph showing, in the left set
of columns, how a few major
foreign stock markets did in
terms of their home currencies
(the euro for France, the yen
for Japan, etc.). They were all
positive. On the right are the
returns that we experienced,
as U.S. investors, holding their
stocks in dollars. They were
almost all negative. Note that
this graph is only for one year:
2014.
Interest rates change currency
values sporadically. However,
a stronger force over time are the values of goods and services, which tend to converge
over longer time periods (what economists call “purchasing-power parity”). For example, if
the price of a French bottle of wine drops enough in Europe, when compared to its U.S.
price, more businesses will import wine from France, taking that profit for themselves.
Eventually, French vintners will either increase their price in Europe or decrease their
price in the U.S. to offset this, because they want to maximize their own profits rather than
letting someone else take them. In this way, parity eventually results (according to the
economic theory).
Source: FTSE Indexes, Morningstar Direct
Looking at the broader economy, with most of the goods and services being subject to this
result, we see parity over time in the prices of stocks as well. The following chart looks at
those same economies over longer time periods. What we’re showing here are the
differences in returns between the dollar and each stock market’s home currency (and we
threw in 2007 to show that there are years when the dollar lost value as dramatically as it
gained value last year). As the chart shows, what were differences in returns of between
about 2% and 14% for one year (either 2007 or 2014), were all less than about 2% over
the entire 10-year period that began in 2005.
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Effects of Different Currencies Lessen Over Time
2007
2014
3 Years
5 Years
10 Years
Return Differences - Dollar vs. Local Currency
15.0
10.0
5.0
0.0
-5.0
-10.0
-15.0
-20.0
France
Germany
Japan
UK
Switzerland
Australia
Source: FTSE Indexes, Morningstar Direct. Returns for 2014 and longer periods were through 12/31/14.
For this reason, most stock investors, including Vista, do not hedge currency risk in order
to minimize this. We are long-term investors and currencies should eventually align for the
most part. That said, because bond returns generally aren’t as high nor as volatile as
stock returns, currencies are hedged in our global bond funds. This action creates
additional safety in our bond portfolios.
Bonds: Still Alive and Headed for a Change
Despite many professional predictions (a bit of an oxymoron, we know), interest rates on
long-term bonds dropped during 2014. Although the Federal Reserve said that it would let
rates increase in 2015, investors still bought bonds in droves rather than waiting. With
inflation continuing to be low, the return that some bonds provide is attractive to investors
regardless of the fact that rates will most likely rise sometime in the future.
The Fed has been very clear that it will let rates rise in 2015 because the U.S. economy
has continued to improve. Given this, we have decided to increase the maturity range of
Vista’s bond portfolio during 2015. We should note that our portfolio maturity was longer
before the Fed decided to strongly intervene in the bond market. Since the Fed has made
it clear that it will let interest rates go back to more normal levels in 2015, we will also be
moving to our normal, longer maturity, portfolio.
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We refer to our bond portfolio’s normal maturity as “intermediate” meaning bonds that
generally mature within five to 12 years. While we currently have an average maturity of
around three years, we will adjust the portfolio to an average maturity of approximately
five years. This will reflect the longer planning horizon that is consistent with most of our
clients’ financial plans. This will not change other aspects of our bond portfolios, for
example, we will still be focused on high quality bonds (generally an average rating of
AA). Our bond portfolio will also continue to be diversified across the globe, capturing
interest rates from investment-worthy countries all over the world.
Predicting interest rates is a fool’s game (just like predicting the stock market), so we will
lengthen the average maturity of our bond portfolio during the next nine months, with 1/3
of the change being implemented each quarter. This will smooth the change, which is
important when we’re making changes to our bond portfolio.
We hope this briefing brings a little more light to the numbers you see in your reports. As
always, we look forward to any questions you may have. Thank you for your trust in Vista.
Your Vista Wealth Management Team
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