Our Quarterly Commentary
Information on this site is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor.
There are some positives, however. This is the largest global stimulus ever to occur in peace time. Strong emerging-markets economies are feeding back into the global economy, which is a positive for exports and manufacturing. Corporate balance sheets, outside of financials, are in good shape with the best liquidity in 50 years. Inventories are low and a rebuilding cycle is beginning, which will support growth. And, the severity of the economic contraction and corporate cost cutting may mean that businesses overreacted and will need to aggressively increase investment and hiring.

Return Expectations

The analysis we review assesses return potential via scenario analysis that incorporates an assessment of asset-class pricing and fundamentals and how they are likely to be impacted under various economic possibilities over the next five years.

The following conclusions are drawn from this analysis. With the run-up in prices of global equities, many valuation metrics suggest stocks are somewhat overvalued based on history, and more overvalued if subpar growth becomes a reality. Corporate and high-yield bonds are not overvalued but they are no longer cheap. U.S. government bonds are priced to deliver poor returns over five years, barring a severe deflationary world. With historically low dividend yields of less than 4%, REITs are also overvalued. Only emerging-markets local-currency (non-dollar) bonds look reasonably attractive but even they are subject to a fairly high level of short-term risk stemming from currency fluctuations. In short, no asset class appears priced to generate fabulous returns—though some asset classes will do better than others and there are specific investments that look somewhat attractive. 

Bad Odds and Not Much of a Payoff

Investing requires one to make decisions with incomplete information and therefore uncertain outcomes. For this reason we believe we must have an understanding of the odds and the payoffs. We use analysis to help understand the upside we gain in exchange for taking risk. Ultimately we want the odds heavily in favor of the decisions we make. But having the odds in our favor does not mean that we will be right immediately or even at all, especially in the short run. But over the long run our discipline, which implicitly requires us to be willing to be wrong in the short run, has added value by putting us in a position to be right far more than we have been wrong.

Given this view, we continue to maintain a conservative bias in our equity allocations. As we move into the New Year, we may continue to move more conservative by reducing our emerging market equity positions if the fundamentals in that asset class turn negative. We are likely to reduce our high-yield bond exposure in the near future following that asset class’s run-up in 2009. 

Getting Paid to Wait

As discussed above, we don’t believe stocks are cheap. Moreover, we are headed into a period of in-creased regulation and taxation which will add to growth headwinds. With respect to bonds, while it is true that rates are low and this will limit returns, much of the non-government bond market (corporate and agency mortgages), while no longer cheap, is priced to deliver mid-single-digit returns over the next few years with far less risk than equities.

So, we have built sizable bond positions while we wait for better opportunities. It is extremely unlikely that we will need to maintain these large bond allocations for most of our five-year horizon, but for now we are quite comfortable holding these positions. We should note that we are cognizant of inflation risk, which would be bad news for bonds, though we don’t see that risk as imminent.

Looking forward over the next five years we believe higher returns can be captured by patiently waiting for compelling opportunities and then making appropriate tactical moves when they appear. We will attempt to position portfolios to take advantage of these opportunities as they appear.

As always, we encourage you to let us know if there is anything we can do to address any specific questions or concerns you have about your portfolio. We also encourage you to continue to review the information and education materials we continually post at www.tufaviews.com and through Twitter (@ TufaViews).

We wish you the best for the coming year.


Tarpley & Underwood Financial Advisors, LLC      Fourth Quarter 2009
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