The strong stock market in recent months seems to suggest that things are pretty good, while our analysis warns us that serious risks and challenges remain.

Here are some of the short-term positives the market has been reflecting:

• The European Central Bank (ECB) is strongly signaling that it will “do whatever it takes to preserve the euro” thus reducing the risk of a financial crisis in Europe – at least for now.
• The Fed made an open-ended commitment to buy U.S. mortgage bonds (to the tune of $40 billion a month) in an effort to shore up the fragile recovery in our housing market. Additionally, the Fed stated that it expects to maintain near-zero interest rates through mid-2015. The markets liked this because it encourages risk taking, pushing stocks higher.

Longer-term, however, it is clear that significant problems and risks remain:

• The European Central Bank’s actions don’t solve the underlying structural problems in the eurozone, they just buy more time.
• Here at home, we not only face the uncertainty of a fiscal cliff (the automatic spending cuts and tax increases that start in 2013) but also longer-term debt problems of our own.

We continue to monitor and analyze the changing political and economic landscape as conditions remain unstable.  Regardless of how markets react, we will adjust client portfolios to take advantage of the future environment.

First, our goal is to capture a better return and to manage the risk of loss. We believe we can achieve better returns with much less interest-rate risk by shifting away from the core bonds held by most investors. Using strategies with flexible mandates allows us to pursue opportunities in niches of the bond market that offer better value and/or to be more active in managing their exposure to interest-rate risk. These positions are compelling relative to the core bonds because they are much more likely to generate better returns.

Secondly, our overall allocation to stocks is below what it would be in a normal environment because we remain concerned about the longer-term risks related to debt problems in the developed world. While U.S. stocks look more fully valued, our return expectations for other parts of the world are higher, and as a result we have tilted our stock allocation accordingly.

Volatility brings us to our last point – we expect alternating periods of fear and relief to continue driving markets in this highly uncertain environment.  We have taken advantage of these opportunities in the past and expect similar opportunities over the quarters and years ahead as the developed world works through the challenge of unwinding massive levels of debt without damaging the economy.

If your portfolio is not in tune with the times, call us at 800-492-1107 to learn how we can provide you with confident progress to your retirement goal.