Daily Bullets……For April 17, 2014

·         Banks ramping up lending….In a very encouraging sign for the economy, the Wall Street Journal reports this morning that large U.S. banks increased commercial loans outstanding by a healthy 8.3% in the first quarter, suggesting both borrowers and lenders are becoming more confident about the economy. This is a significant positive for the economy in part because tight credit has been one of factors contributing to the slow economic recovery we’ve experienced. This is another factor that supports our outlook for acceleration in GDP growth this year (no link for this comment).

·         Pension problems….A large hedge fund, Bridgewater, stated on CNBC this morning that 85% of public pensions could fail in 35 years. It is a hypothetical and controversial view. It points up the serious problems with significantly underfunded public pensions, which is not new news. However, we expect the problem could lead to pension reform and potentially reduced secular economic growth. Link: http://www.cnbc.com/id/101575849?__source=yahoo%7Cfinance%7Cheadline%7Cheadline%7Cstory&par=yahoo&doc=101575849%7COutlook%20for%20pensions%20is%20p

·         More positive data points……..Closely watched initial unemployment claims came in a little better than expected, while Philly Fed Business Activity Index increased to its highest level in seven months. This data adds to a recent string of positive data that paints a picture of an improving economy, again in line with our previous expectations. Link: http://money.msn.com/business-news/article.aspx?feed=OBR&Date=20140417&ID=17529893&topic=TOPIC_ECONOMIC_INDICATORS&isub=3

·         Hedge funds struggling……Interesting article out this morning on the continued struggles of hedge funds which, in general, have been badly underperforming. Why? Bifurcated and over-concentrated bets which, when wrong, have disastrous consequences. This is more support of Warren Buffett’s famous bet five years ago that the S&P500 index will beat hedge funds. So far he is correct by a long shot. Diversification works and is important in conservative and responsible wealth management. Link: http://www.cnbc.com/id/101592736?__source=msn|money|headline|headline|story|&par=msn

 

Daily Bullets…..For April 16, 2014

·         China GDP positive for market…….China reported its first quarter GDP rose 7.4% year-over-year compared with expected increase of 7.3%. Market response is positive and provides some relief over concerns of a significant slowing in China’s economy. Because of its enormous size, trends in Chinese economy have an outsized impact on the financial markets. Link: http://money.msn.com/business-news/article.aspx?feed=OBR&date=20140416&id=17500759

·         Earnings beats today……A number of prominent companies, notably in legacy tech, reported better than expected earnings today. We also note several significant dividend increase announcements. Both are providing some lift for the market this morning. Dividend increases are an excellent indicator of company management’s confidence in the outlook for their businesses and cash flows. Link: http://money.msn.com/business-news/article.aspx?feed=OBR&date=20140416&id=17528132

 

·         Industrial production improving……Federal Reserve reports this morning that industrial production rose 0.7% in March, better than expected. This adds to recent positive economic data such as retail sales, and indicates economic growth is accelerating from its weather-induced stall in 1Q, and supports our positive view for improving economy and corporate earnings growth this year….positive for stocks. Link: http://money.msn.com/business-news/article.aspx?feed=OBR&date=20140416&id=17529893

 

·         Groundbreaking for new single-family homes….surged 6% in March, with multi-family declining 3%. Applications for new home purchases also rose significantly. There has been much talk of an emerging slowdown in the housing market but, as has been the case for this entire economic recovery, 1) housing will probably improve in an uneven pattern, and 2) there is a lot of pent up demand due to significant underbuilding in 2008-2013. Link: http://money.msn.com/business-news/article.aspx?feed=OBR&date=20140416&id=17529893

 

·         Yellen comments having positive impact…..Federal Reserve Chief Janet Yellen made comments today that while economy is making progress on job creation there is still a long way to go. The implication is Fed policy will continue to remain accommodative and buttresses investor sentiment regarding Fed policy, which is positive for financial assets, such as stocks. Link: http://money.msn.com/business-news/article.aspx?feed=AP&date=20140416&id=17531322

 

Daily Bullets ………..For April 15, 2014 (Happy Tax Day)

·         Housing sentiment still flat……Homebuilder sentiment moved up slightly in March to 47, still in flattish pattern the past few months. Reason? Tighter credit, tight supply of buildable lots. Pent up demand for housing is increasing based on household formations and deep supply reductions of past several years. Link: http://money.msn.com/business-news/article.aspx?feed=OBR&date=20140415&id=17526384

·         Shiller positive on housing…….Nobel economist and housing guru Robert Shiller said this morning he sees more momentum in housing market than the stock. While mortgage rates have moved up, affordability is still good. He believes it is possible home prices could rise 25% in next 3-4 years. Link: http://finance.yahoo.com/news/more-momentum-housing-stocks-shiller-141805700.html

·         10-20% correction: Stovall…… Sam Stovall, equity strategist for Standard & Poors, believes we could see a 10-20% market correction by the end of June. Why? Statistically speaking the market has not had a true correction (down 10-20%) in 2.5 years, way beyond the historic average of about every 18 months. His call is purely statistical in nature. Market corrections are normal and necessary to cleanse excesses and imbalances in the markets. Link: http://finance.yahoo.com/news/odds-favor-10-20-stock-195801126.html

·         Big banks need more capital: Yellen……Fed Chair Janet Yellen speaking at a bank conference this morning stated big banks rquire more capital to withstand periods of financial stress. One implication of this: perpetuates the “risk averse” mentality among bankers that could act as a drag on loan growth and, therefore, act as a drag on the economy. Link: http://money.msn.com/business-news/article.aspx?feed=AP&date=20140415&id=17525691

·         Obamacare may help bonds…..Bloomberg News has an interesting analysis that supports the view that Obamacare may actually be favorable for bonds because it will reduce the rate of health care inflation. Lower inflation would be favorable for bond prices because interest rates would not rise as fast. The irony is longer term rates could rise even if inflation remains low because of credit demands for funding expanding federal deficits. Link: http://money.msn.com/business-news/article.aspx?feed=BLOOM&date=20140415&id=17526095

·         CPI picks up a bit…..Labor Department report this morning that CPI increased 0.2% in March, up from 0.1% in February. Core CPI was also up 0.2% in February and increased 1.7% for 12 months. This may raise concern that inflation is “accelerating”. We hardly view 1.7% as heated inflation and we believe inflation will remain relatively subdued. Link: http://money.msn.com/business-news/article.aspx?feed=OBR&date=20140415&id=17525585

 

Daily Bullets………..For April 14, 2014

• Good news on retail sales!.... March retail sales up 1.1% were much better than expected. The strength was across the board, driven by strong demand for autos, furniture, clothing, building materials, etc.  The really positive aspect is the breadth and reflection that economy and consumer spending, are performing well, and perhaps better than many expected. This supports our long-held outlook for the economy in 2014, unfolding as we anticipated, which has positive implications for stocks. Article link: http://money.msn.com/business-news/article.aspx?feed=OBR&date=20140414&id=17521612
• Another positive sign for U.S. economy…..Job outlook: Reuters reports this morning that U.S. consumers are growing more confident about the job market as the estimated chance of finding a new job increased to 49.0% up from 46.1% in February. This is another reflection of improving consumer sentiment generally and has positive implications for both economy and consumer spending. Article link: http://money.msn.com/business-news/article.aspx?feed=OBR&Date=20140414&ID=17522768&topic=TOPIC_ECONOMIC_INDICATORS&isub=3
• “It can’t be done with current information at hand”…. Jim Cramer has an interesting article out this morning questioning why certain sectors in the market are behaving the way they have been in this recent market pullback (today notwithstanding). His ultimate conclusion is: you can’t determine from available data (as to why sectors such as machinery have done well if investors are concerned about the economy). Hmmm….. Could it be that fundamental investors, or what we would refer to as “strong hands”,  are looking through the near-term noise and are focused on what continues to be pretty solid economic fundamentals, particularly for the U.S.? We think so. Article link: http://money.msn.com/top-stocks/post--why-is-this-market-so-hated-and-feared
• More easing ahead for ECB? ……We note over the weekend, it was reported that Eurozone banks will only pay back 6 billion (Eurodollar) of their crisis loans, which is below the 8 billion that was expected. The implication is Euro bank liquidity is not improving as rapidly as hoped for. Should this be any big surprise? We think not. It reflects more of the same for Europe: recovery will continue to be slow, ECB policy will remain highly accomodative. Article link: http://money.msn.com/business-news/article.aspx?feed=OBR&Date=20140414&ID=17522672&topic=TOPIC_ECONOMIC_INDICATORS&isub=3
• Lower federal deficits…..CBO this morning is reporting it expects U.S. federal budget deficits to be nearly $300 billion lower than previously expected. CBO now expects federal deficit to reach a low-point of $469 billion, or 2.6% of GDP in 2015, then gradually rise to over $1 trillion in 2024. This has positive implications for interest rates near term, as it indicates that marginal demand for credit by U.S. government should ease somewhat in next year or two. It has negative implications for the longer term as funding of increased Federal deficits could place upward pressure on interest rates and remains a long-term structural problem for the U.S. Fortunately, our economy is large and resilient enough to handle a lot of this future financial “pressure” but it is problematic nonetheless. Article link: http://money.msn.com/business-news/article.aspx?feed=OBR&Date=20140414&ID=17522837&topic=TOPIC_ECONOMIC_INDICATORS&isub=3

 

 

 

Daily Bullets….April 11, 2014

As we review the daily news, we see articles that we believe have particular significance for the financial markets and our investment policy. We highlight some of these for you in this column. Our goal is to post daily on these items, but we know realistically there may be days where it is not feasible. Please let us know if you have comments or questions !

 

·         Yesterday………….Dow down 267 yesterday. Why? Necessary and overdue adjustment to what was becoming a short term overbought condition reflected in speculative froth in pockets of the market such as biotech, social media, and stocks with nose-bleed valuations. Could this be the start of a bondfide “correction” (meaning 10-20% decline)? Possibly. But more likely it’s another in a steady series of periodic downward “adjustments” of 5-8%, of which there have been seven since March 2009 (or about every 6-7 months).  Article link:
http://finance.yahoo.com/blogs/breakout/market-nose-dive--major-indices-shed-recent-gains-200646218.html

·         And Today………….Today, through mid-day, market continuing its moderate pullback based on concerns over an earnings report from JP Morgan, follow through from yesterday’s declilne, and perhaps some concern over today’s PPI number. Article link: http://money.msn.com/business-ews/article.aspx?feed=OBR&date=20140411&id=17500759

 ·         Consumer sentiment improving……….The Thomson Reuters/U- Michigan's preliminary April consumer sentiment index came in at 82.6, the highest since July, and up from March final reading of 80.0. Both current conditions and expectations improved. This is in contrast to mixed retail sales readings we’ve seen lately  but is positive for the overall economy and supports the thesis for moderate but steady economic growth and consumer spending, the “goldilocks” environment favorable for stocks. Article link: http://www.bloomberg.com/news/2014-04-11/wholesale-prices-in-u-s-rise-more-than-forecast-on-services.html

·         U.S. Wholsale prices:   Wholesale prices in the U.S. rose in March. Excluding food and energy, the index increased 1.4% year to year following a 1.1 percent year-to-year gain in February. The 0.5% month-to-month advance in the WPI was the biggest since June. Despite what appears to be some acceleration in WPI, 1.4% continues to be very moderate inflation and well below the Federal Reserve’s target inflation of 2%. For a variety of reasons both cyclical and secular, we continue to see inflation remaining fairly subdued in 2014, which is favorable for financial assets. Article link: http://www.bloomberg.com/news/2014-04-11/wholesale-prices-in-u-s-rise-more-than-forecast-on-services.html

 

 

 

Q2 Investment Strategy Meeting Summary

We held our Q2 investment strategy meeting on March 28. The general investment landscape has not changed significantly since our December meeting. The outlook for U.S. equities remains positive. U.S.  economic and corporate earnings growth both remain healthy in 2014. After a weather-impacted Q1, we expect U.S. real GDP growth to accelerate to 2.5-3% by second half-2104. We see corporate earnings rising 8-10% and we expect inflation to remain subdued. While we expect the Federal Reserve will continue its taper of quantitative easing, we do not expect the process to be overly disruptive for financial markets.

There is some evidence of increased environmental risk reflected in recent pockets of speculative froth (particularly social media) and recent extremes in investor sentiment readings. There has also been considerable discussion recently in the media about the 5-year anniversary of the current bull market. The average bull market since 1945 has been about 4.5 years in duration. We acknowledge this “birthday” has significance, however, we continue to remain positive on underlying fundamentals that should support higher equity prices. Geopolitical factors, particularly Crimea and Ukraine, have also increased environmental risk somewhat. We are watching these developments, but as of now we do not expect a major impact on U.S. equities.

With respect to international investments, we continue to see a mixed picture. We think there is increasing risk of a further slowing in China’s economy that will have repercussions for global economic growth, particularly for emerging market economies. Europe has exited its long recession, however the growth outlook appears anemic and the recovery remains fragile.  For these reasons we continue to overweight U.S. equities in our investment strategy.

We still believe the secular bull market in bonds ended in July 2012 and that bond yields will most likely continue on a gradual upward path.  As we stated in our December commentary, the potential for rising interest rates renders bond investments less attractive. In order to reduce interest rate sensitivity in your portfolios we have focused on reducing durations by maintaining long and intermediate bond exposures at the minimal end of our allocation range.

With respect to changes in our investment models, within our U.S. holdings, we shifted more of our allocations towards value both in large and small cap equity exposure. We reduced weightings in our models to both international equities and REITs, and are now slightly underweight a normal allocation in those areas. Within natural resources, we added exposure to timber and forest products as we believe there is increasing potential for rising timber prices over the next couple of years. There were no significant changes in our fixed income weightings or holdings.

 

Rising Bearish Sentiment Brings Some “Good News”

In wake of stock market sell-off of the past few days, there is increasing evidence that small investors are getting scared. The Associated Press this morning reports that “the number of small investors who say they feel bearish soared this past week” and “some stock funds have been hit with their biggest withdrawals since 2012”. Here is the link to the AP article:

http://money.msn.com/business-news/article.aspx?feed=AP&date=20140201&id=17312155

 

 It may sound illogical but it is actually a good sign. As we’ve noted previously, the stock market has not had more than a 10% correction since mid-2011. This is longer than the statistical norm for time intervals between “corrections” which, since 1945, have occurred on average about every 20 months and average about 13% decline. The fact that small investors are getting nervous and pulling out is positive in that it relieves some of the extreme positive sentiment that is associated with rising markets, particularly a rise like we saw in 2013 (which was up 30%, about 3x the long-term average annual return).

 

We think the underlying fundamentals for U.S. companies remain sound based on improving economic growth and higher earnings in 2014. At about 15x 2014 earnings, valuation is “neutral”, no longer “cheap” but not excessive either. In addition, as we’ve mentioned previously, the financial arbitrage that currently exists between the cost of debt and equity capital is also providing support for equity valuations.

 

This morning’s auto sales and factory order data were lower than expected, partly contributing to today’s sell off, but we note this data bounces around significantly and does not move in a linear fashion. We don’t read much into the softer data. There may also be some investor concern with Janet Yellen taking over as chief honcho at the Federal Reserve, however our expectation is she will maintain a gradualistic approach towards unwinding of the quantitative easing program of the last five years. Concerns over slowing growth in China are legitimate, however, with over $3.5 trillion in monetary reserves, we think China has the financial wherewithal to engineer a “soft landing” for its economy. We continue to believe the best opportunities remain in U.S. stocks, in which we remain overweighted.

 

Our strategy of diversification among multiple asset classes is an important way in which we aim to provide not only asset growth but also reduce portfolio volatility, an important aspect of achieving improved risk-adjusted returns. Corrections and market pullbacks are normal, and in many cases, necessary, as they relieve extended positive sentiment and allow the market to “recuperate” technically. We expect this correction will prove to be another normal mid-cycle correction in an ongoing secular bull market.