For most investors 2014 was a tale of two markets. The U.S. performed strongly, with the S&P 500 rising by over 13%, though the Dow was up a more modest 10% and the small cap index (Russell 2000) gained only 5%. While the rest of the world was essentially flat, with the MSCI All Countries Index up 2.1%, EAFE down 5%, Europe and Japan both down by approximately 6%, and emerging markets down by 2.2%, all in dollar terms.

On the fixed income side, the story was similar, as U.S. bond markets out performed foreign markets, with the Barclays Aggregate Index gaining 6%, while the Citi World Bond Index fell by 0.5%. Of course, much of the weakness in non-U.S. markets can be attributed to the strength of the dollar in foreign exchange markets, where it appreciated by an average of 12% against its main trading partners.

In Global Growth, our primary strategy, we achieved an average return (net of fees) of just over 6%. While behind our long-term average performance of 9.8%, we continued to substantially exceed our benchmark (70% MSCI World, 30% Barclays Aggregate Bond Index), adding close to 3% to that target in 2014—broadly consistent with our 370 BP average out performance since inception in 2002 (please see attached). So far we are off to a strong start in 2015 –up over 3%.

At year-end, our model portfolio was 71% invested in stocks, 14% in fixed income, and 15% in alternatives. On the equity side total US exposure was 42%, Europe was 14%, Japan was 5%, Asia excluding Japan was 6%, and other emerging markets were 4%.

Looking forward, we believe the U.S. remains well positioned economically but will face some head winds in 2015. First, the likely increase in interest rates remains a concern. We expect the FED to start tightening at the end of the second quarter or early in the third. While any rate hikes are likely to be gradual and have already been somewhat discounted by the market, after many years of negative real interest rates any increase will have a discernable impact on both stocks and bonds.

Countervailing this is the effect of falling oil prices, though in our view this is likely to be a short-term phenomenon, as the supply side starts to falter and demand begins to increase. We believe that 2016 will see energy prices rebounding, though not to the level that they were last year. This suggests that there is money to be made in energy, which, not surprisingly, was the worst performing sector in the U.S. last year.

In the interim, there is likely to be a J curve effect, as energy related capital expenditures fall substantially. Currently 33% of the Capex of the S&P 500 comes from the energy sector and this is likely to decline by 25%-30% in 2015. Fortunately, U.S. corporates are continuing to hold near record levels of cash (two trillion dollars), which should give the major energy companies reserves to weather the storm, though a number of smaller producers are likely to fall by the way side or get gobbled up by their larger brethren.

More importantly, after many years of robust growth, earnings per share are expected to grow by a modest 3% in 2015, which should have a moderating effect on stock prices. On top of this, the U.S. remains the most expensive major market in the world, whether measured by its price to earnings ratio (17), its price to book ratio or its dividend stream. In fact, no other large country currently has a P/E over 14. Having out performed the rest of the world for four out of the last five years, this valuation gap has only gotten larger.

There is already some evidence that the gap is starting to narrow, as Europe has substantially out performed the U.S. so far this year, with Germany and France both up roughly 10% in local currency, though less in dollar terms. The big issue for Europe, like the U.S., is the role of interest rates, and, in Europe’s cases in particular, the likelihood of deflation. Although recent months have witnessed a decline in consumer prices for the Eurozone, much of this reflects the impact of falling energy prices. Like consumers in the U.S., consumers in Europe will benefit from this and one can already begin to see the household spending rising in some European countries, with retail spending currently growing at a 3% clip as opposed to a negative 3% last year. High unemployment rates will continue to act as a cap on consumer spending but if the European Central Bank is able to deliver on its bond buying stimulus package, it should help spur economic growth. Additionally, the plummeting value of the Euro will spur trade, which unlike the U.S., accounts for a major part of the European economy—51% in Germany and 44% for Europe as a whole. This in turn should be a boon to European exporters, particularly those selling into the U.S. market.

Emerging markets have also started to look cheap, though, with such a disparate group, it is important not to generalize. Falls in commodity prices amongst the oil producing countries are obviously having a depressive effect on countries like Russia and the Middle Eastern nations, but for many developing countries such as Taiwan, India and Korea savings will be substantial. Over the past two years, emerging countries’ stock markets have cumulatively underperformed the developed countries by a massive 50%, and, according to Goldman Sachs estimates, the price per dollar of earnings in the developing countries is 44% of what you pay in the U.S. Of course, there are reasons for this, especially political risk, but it does suggest that there are bargains to be had.

In short, though our non-U.S. exposure did not help performance in 2014, both mean reversion and relative valuations indicate that there are opportunities outside the U.S. and we therefore intend to maintain a geographically diversified asset allocation.

Which is not to say that we will not continue to have a substantial weighting in the U.S. Given the current momentum in jobs growth and consumer spending, not to mention the innovative nature of the American economy, there will certainly continue to be outstanding opportunities there—the relatively high valuations not withstanding. However, we will look hard for opportunities outside the U.S., both in Europe and the developing markets.

In addition, on the risk control side it is worth noting that the benefits of international diversification are increasing, as correlations between the U.S. and international markets have begun to widen again after the herd like movements spawned by the financial crisis over the past several years. In fact, correlations between U.S. equities and the rest of the world, which were running at upwards of 80% at times during the crisis, have now reverted to a more normal 50%-60% range.

Finally, though we will continue to focus on equities for long term growth, the inclusion of other asset classes not only provides a diversification benefit, but also a defensive element in an environment where stocks are not cheap. With credit spreads again widening in U.S. fixed income, and commodities looking reasonably inexpensive, we will look opportunistically for uncorrelated defensive positions when available.