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Reducing Volatility

Posted by Jeremy Merchant on Aug 3, 2015 5:00:00 PM
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It has been almost nine years since the Federal Reserve (Fed) last raised short-term interest rates. In fact, it has been six years since the Fed lowered rates to 0.00%. After more than six years of recovery and expansion, the Fed is now trying to find the optimal time to increase interest rates.

Over that same six-year period, RAA has largely remained overweight equities as equities remained cheap relative to bonds and other investable assets. Those compelling valuations are now beginning to diminish. As you can see in the graph below, earnings have actually contracted this year relative to last year.


It must be noted that much of this contraction in earnings is due to the energy sector which comprises 7.9% of the index. Earnings within the energy sector have been decimated as oil prices have fallen more than 50% over the last year. Another contributing factor to poor earnings growth has been the strong dollar, which has hurt domestic multi-national corporations. Nonetheless, even after excluding energy, earnings growth is projected to grow only 1% year-over-year, compared to 5% - 6% over the last 3 years. With both earnings growth and revenue growth below trend, equity valuations have now grown to greater than 18x forward earnings. And while a multiple of 18x is not extreme, it is still considerably higher than the historical median of 15x -16x earnings.

Portfolio Adjustment

The combination of valuations above their historical averages and a Fed that is determined to raise interest rates later this year led our Investment Policy Committee to move the portfolios to a slight equity underweight in late July. Overall, the portfolios are now considered to be at a 2.5% equity underweight. During this late July adjustment, volatility within the portfolios was further reduced via a reduction within our emerging market equity allocation. 

Within our fixed income allocation, we reduced the duration of our bond allocation (increased our short-term bond exposure) in anticipation of a potential rate increase in September. Duration is defined as the measurement of the sensitivity of a fixed income instrument to a rise in interest rates. A shorter duration within our fixed income allocation should help reduce price volatility as the Fed raises interest rates. 

As always, please do not hesitate to give us a call at (800) 321-9123 if you have any questions.


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Disclaimer: This blog is intended for informational purposes only and should not be construed as individual investment advice. Actual recommendations are provided by RAA following consultation and are custom-tailored to each investor’s unique needs and circumstances. The information contained herein is from sources believed to be accurate and reliable. However, RAA accepts no legal responsibility for any errors or omissions. Investments in stocks, bonds and mutual funds may increase or decrease in value. Past performance is no guarantee of future results. Any of the charts and graphs included in this blog are not recommendations for the purchase and sale of any security. 

Topics: Investment Updates