INVESTMENT OUTLOOK – 2nd Quarter Heritage Market Brief


Second Quarter 2016


  • Despite a number of positive economic releases, the Fed made an unsurprising decision in March to leave the Fed Funds rate at a target of 0.25%-0.50%, citing spillover risks from weakness in global economic growth.
  • The U.S. labor market continues to improve as 215,000 jobs were added in March, and the labor force participation rate finally made a move in the right direction to 63% from a cycle low of 62.4% in September 2015.
  • Despite recent interest rate increases, the FOMC remains committed to gradual increases while balancing long-term goals of maximum employment and inflation of 2%.
  • While average hourly earnings increased 2.3% year-over-year, Fed policy makers believe increases of 3%-4% would have to be seen before materially impacting prices.
  • The U.S. consumer remains healthy with real disposable income increasing 2.9% year- over-year; however, this has not yet translated to a considerable increase in spending.
  • Thin inventory and strong demand continue to push housing prices higher, with many markets rising to pre-financial crisis levels.
  • The March ISM Manufacturing Index reversed a contractionary trend in place since September 2015 as it posted a reading of 51.8, driven largely by new export orders.
  • Inflation remains below target as indicated by the year-over-year Core Personal Consumption Expenditures Index (PCE less food and energy) reading of 0.96%.
  • The Fed’s median forecast for 2016 GDP growth is 2.4%; however, this may prove difficult if consumers continue to save increased disposable income rather than increase spending.



  • While interest rates remain range bound, individual bonds held to maturity should continue to provide downside protection.
  • It is likely that volatility will continue as the Federal Reserve is expected to continue raising interest rates, S&P 500 stocks no longer appear cheap relative to earnings, and revenue growth remains challenging.
  • Emerging market economies remain at risk to rising U.S. interest rates; however, the asset class should be additive to long-term returns as demographics are favorable and the sub- asset class remains attractively valued at less than 11 times next year’s estimated earnings.


Even after the Federal Reserve raised interest rates for the first time in nearly a decade in December 2015, we expect the central bank to remain committed to an accommodative monetary policy which should keep current yields low relative to historical levels. Thus, we believe an overweight in stocks relative to bonds is appropriate from a risk/return perspective. Our focus on valuations has led us to believe that U.S. small-cap stocks are becoming more attractive after underperforming their large-cap counterparts for the last two calendar years. We are still maintaining our underweight to U.S. small-cap equities
but to a lesser degree than over the past couple of years. Despite weaker growth outside the U.S., we remain disciplined and maintain a strategic allocation to foreign markets, especially emerging markets where valuations appear much more attractive. Foreign small-cap stocks should be additive to the portfolio return in the long-run as small-cap companies tend to enjoy higher earnings and cash-flow growth relative to large-cap companies. Since, much of our small-cap exposure is in European small-cap companies, European accommodative policy should prove to be beneficial in the long-run as well. While our fixed income exposure remains underweight due to the current risk/return profile, we continue to purchase individual fixed income securities as bonds play a vital role in the portfolio.

We believe alternative exposure remains vital to portfolio diversification. While
we maintain a position in U.S. REITs, we have taken the opportunity to trim where necessary due to our belief that the asset class has potentially reached overvalued territory after outstanding growth throughout the recovery.

These views represent the opinion of the Security Selection Committee which are based on qualitative as well as quantitative factors. These quantitative factors are primarily driven by valuation research which then forms our subjective assessment of the relative attractiveness of asset classes and subclasses over a 3- to 5-year time horizon.