2014 Fourth Quarter
"Will (oil) prices continue to fall? Answer: If supply stays where it is, and demand remains weak, you better believe it is gonna go down more. But if some supply is taken off the market, and there's some growth in demand, prices may go up. But I'm sure we're never going to see $100 (per barrel) anymore. I said a year ago, the price of oil above $100 is artificial. It's not correct." - Saudi billionaire businessman Prince Alwaleed bin Talal in a January 11th interview with Maria Bartiromo for the USA Today.
Prince Alwaleed believes oil over $100 will not be reached again. I wonder if the President of Russia, Vladimir Putin, would agree? I recently read an article in a financial advisor newsletter written by Richard Vodra that stated, "Russia's budget is based on an average oil price of $100." Iran also is dependent upon high oil to meet the obligations they have promised to their people. Mr. Vodra continues: "U.S. shale efforts need prices well above $80, and many operating companies were already under severe cash flow pressures with $100 oil." If Prince Alwaleed is correct and oil stays cheap for a while, you can expect this cheap oil to impact Russia, Iran and any other country that has not diversified their country's main revenue source. The same goes for the fracking companies that have dominated the U.S. shale deposits or electric car manufacturers who are somewhat dependent upon higher oil to sell their products like cars and batteries. However, I would guess that most Americans believe cheap oil is not going to stick around forever. Thus, there probably will not be a line to buy Hummers anytime soon.
While cheap oil may have a negative effect on some of the oil stocks held within our mutual funds, the overall impact will be a boon to the U.S. economy. If gasoline prices are a tax, then there should be a lot more dollars for the average American to spend on something other than gas. Thus, we should see a boost to the overall economy in the next several months or years as that would-be oil money is spent or invested elsewhere. As long as corporate earnings keep up, I believe the stock market is still one of the better places to invest over the next five to ten years.
After some pretty rocky times at the beginning of the fourth quarter, October and November ended up being great months for the S&P 500. For the year, the S&P 500 ended up 13.69%. The small-cap index, or the Russell 2000, was up 4.89% during 2014, but had a convincing 9.73% turbo charge in the fourth quarter after being in bear market territory (a decline of 20% or more from its peak) earlier in the year. The foreign index was down 4.91% for the year, but our international funds combined to breakeven or managed a small gain depending upon the portfolio. The one area we lagged was our fixed income. As you will recall, I kept 75% of our fixed income in the "short-term" category only to find that intermediate bonds were not as volatile as I thought they would be going into 2014. Thus, our fixed income trailed the intermediate benchmark, the Barcap Aggregate Bond index.
At the end of the third quarter, Bill Gross departed from one of our main fixed income managers: PIMCO. This departure came as a shock to many in the investment community. Over the past couple of months, I have looked into some alternatives that I believe will help change a potentially difficult situation into a great opportunity. At this point, I would like to spend some time discussing the changes I made and why I made them.
As many of you have seen with the plethora of Schwab trade confirmations arriving in either your inbox or mailbox over the past several weeks, I have begun to sell all of the PIMCO Total Return and purchase Metropolitan West Total Return in its place. The managers at Metropolitan West are former PIMCO managers who broke away in the early 1990's to form their own firm. While they ran into some bumps in the early 2000's, they certainly seem to have their act together right now. Over the past ten years they have outperformed the Barcap Aggregate Bond index by 1.99%.
In some, but not all, portfolios, I have also added DoubleLine Total Return bond fund. This fund has also done quite well. Over the last three years, DoubleLine beat the benchmark by 2.57% per year. I have been a follower of the manager, Jeffrey Gundlach, for quite awhile and have been impressed with his fixed income commentary.
I also added the PIMCO Income fund in many portfolios. This fund is run by Dan Ivascyn and Alfred Murata who, like the other two managers I mentioned before this, have a great track record. In fact PIMCO thinks so highly of Mr. Ivascyn, that he is now the Chief Investment Officer at PIMCO. He also won the Morningstar Fixed-Income Fund Manager of the Year (U.S.) for 2013.
Depending upon the amount you have under management, you may not have all three funds listed above in your portfolio. In addition, some of you will see changes to your underlying short-term fixed income funds. Everyone who had PIMCO Total Return now has Metropolitan West Total Return - that was my top priority. The overall allocation between short and intermediate-term bonds in most portfolios is now 60% short and 40% intermediate. I will remain vigilant in watching these managers and will not hesitate to sell one or all of them if I feel I can do better elsewhere. Since no one knows definitively how the Fed's potential rate increases will impact short, intermediate and long-term bonds, I have taken the stance that our fixed income should be spread over several of the top managers in the bond management business. Should any of them falter and if I think I can do better elsewhere, I will not hesitate to sell one or all of them. Moreover, I continue to believe that our fixed income is best served in managed funds and not index funds. Over the long-haul, good managers should beat the index after all fees are accounted for.