Bruce Hotaling

Bruce Hotaling

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The Party’s Over

Stocks, as measured by the S&P 500 rose a surprising 7.87% for the month of January.  This was the best start to the year since 1987, according to the Wall Street Journal.   January’s remarkable stock returns were a generous “bounce” that largely offset the disastrous 9.18% loss that stocks suffered in December to close out last year.  Now, with 4Q18 earnings season underway, we’re faced with the difficult task of assessing stocks, with an eye toward determining which ones will do the most work for us this year. 

On a macro level, the forces that had been driving stock prices have shifted.  After the November 2016 election, stocks went on a manic run; 15 months of positive returns.  Wall Street suddenly had a man in the White House that was going to give it just what it wanted.  From November 2016 through January 2018, stocks returned 31.4%.  Then things changed.  Starting in February 2018 the market stumbled.  Over the ensuing 12 months (through January 2019), stocks fell 1.23%.  During that span of time, stocks fell in four of those months for a total of -22.1%.  These sharp drops in price radically changed the tenor of the market.  They reflect the market’s foreboding of change on the horizon. 

Near term expectations are for more of the same.  There is little prospect of Washington acting in any constructive way with respect to fiscal policy.  More to the point, my hope is Washington will refrain from causing further harm.  The trade war, for instance, is clearly hurting the bottom line of many US corporate and agricultural businesses, based on recent earnings reports.  According to the IMF, the US led trade war with China and the related protectionist tactics may lower global GDP in 2019 by as much as 0.5%.  The threat of another government shutdown looms.  The 35 day shutdown that began late last year damaged the economy and will show up in lower economic growth rates.  FactSet Research’s review of earnings transcripts shows 33% of the companies that   reported to date have made mention of the shutdown.

The elephant in the room, as always, is earnings.  More than any other factor, stock prices reflect forward earnings.  At the moment, 2019 earnings expectations are being revised downward.  While not uncommon, the fear of course, is that continued downward earnings revisions will potentially lead to lower stock prices.  Current FactSet estimates for CY 2019 project earnings growth of 6.3%, but that may be fleeting, and some analysts are quietly suggesting 0% growth for the coming year.  Whether the forecasts hold up or deteriorate further, it will be a huge deceleration from the 19.9% earnings growth in 2018.

Though it’s a stock market, from our perspective, it’s a market of stocks.  In 2018 our style and technique for selecting stocks worked extremely well.  Of course, every year the backdrop and the factors influencing stocks and stock prices changes unpredictably.  We are stock pickers, and we do not subscribe to the suggestion that a low-cost ETF is as good as one can do.  In fact, we strongly believe in the value of thoughtful analysis, tactical buying and selling, and full utilization of the vast technical and analytical tools available to us today.  Our focus remains anchored on the unique potential of each of the stocks we choose to own. 

Finally, the roller-coaster start to the year was so distracting I nearly missed Groundhog Day.  I’m glad to report Punxsutawney Phil did not see his shadow early on February 2nd, which means we ought to expect a shortened winter.  This is good news though there is some concern with the reliability of Phil’s predictions.  In fact, the NOAA says that Phil is right about 40% of the time and does not have any predictive value.  This all leads me to Michael Lewis’ most recent book, The Fifth Risk.  In it he discusses many of the valuable aspects of the federal government, including its immense ability to collect and store various forms of data (economic, weather, census, seismic, soil temperatures, etc.).  With all this information now on the cloud, and vast computing capabilities at our fingertips, one of our most challenging tasks is to thoughtfully begin to ask the right questions to which we want answers. 

Please feel free to reach out if we have not spoken recently.   We are happy to discuss our expectations for the coming year in more detail, or any of your life circumstances that may have changed since we last met. 


Bruce Hotaling, CFA

Managing Partner


For the year 2018, stock prices as measured by the S&P 500 fell 4.4%.  The late-year selling frenzy came as quite a disappointment to many.  Through the end of September 2018, stock prices were up 10.6%.  Then, October brought a wave of selling, and prices fell 6.9%.  After an attempt to stabilize in November, the bottom dropped out in December, and prices fell another 9.2%. 

Since the November 2016 election, stock investors had been quite content.  The market went on a run of 15 straight months with positive returns.  Then trouble began to stir in early 2018 when prices fell in February and March.  Though prices recovered through mid-2018, the year-end disruption led to panicky selling and wiped out cumulative gains for the S&P 500 dating back to October 2017.  Investors are now anxiously wondering what’s to come.

We experienced unnerving volatility in 2008 when stocks fell relentlessly in reaction to the financial crisis and the ensuing recession.  However, the year was bookended by a 5.5% return in 2007 and a whopping 26.5% return in 2009.  Prices recovered quickly benefiting those that remained invested.  The height of the dot-com bubble in 2000 sent prices down 9.1% that year and then a further 11.9% and a painful 22.1% in the two ensuing years.  At present time, there is no evidence of another financial crisis (a one-year market debacle) or a dot-com bust (a multi-year market debacle) but rather a slowing of growth (which is normal for markets in later stages of the business cycle) and continuing political turmoil.

In my view, there are three things to monitor.    First, the backdrop: the trade war with China, the government shutdown, the ongoing Brexit talks, and the realization that political gridlock seems likely to prevail.  Second, the Federal Reserve has been raising interest rates, and the old axiom “don’t fight the Fed” clearly remains alive and well.  Finally, earnings growth crested dramatically last year and is now beginning to decelerate.

Investing can lead to heightened emotions, and I think it’s becoming more difficult for people to confront the random and reckless commentary from Washington.  My sense is that investors are at their limit, feeling that more damage is being done than their prior optimism can counter. 

My take on the Federal Reserve is that it views the US economy as generally healthy, though growth is slowing.  The Fed appears to be shifting away from its more hawkish position and is messaging more flexibility.  Importantly, it has raised rates nine times since near-zero rates three years ago, and that was the responsible thing to do.  It does not appear that current policy, with the Fed Funds rate in the 2.25% range, is overly restrictive.

The earnings outlook for 2019 is tempering.    Earlier in 2018, consensus was for $178 per share or 10% growth for 2019.   According to FactSet Research, analysts now have lowered their earnings estimates for the S&P 500 for the fourth quarter by 3.8%, which has led investors to lower their return assumptions.

Some patience with and confidence in the long-term tendency of the stock market to soldier on is important at this juncture.  I believe that the Federal Reserve will take the correct actions and does not need to be brow beaten.  While the market has re-rated and P/E ratios have fallen 25% from their highs, stocks are much more attractively priced than they were three months ago. 

Stocks are the primary sources of return for most investors.  The numbers bear out, as stocks have generated positive returns 75% of the time over the last 40 years.  When the markets are in flux, we advocate prudent re-balancing between stocks, bonds, and cash.  Since the second bout of volatility kicked up in late September, we have held above-normal levels of cash.  Now, our effort is to put cash to work in quality, stable growth companies selling at reasonable prices.  Our goal is to remain fluid as the market looks to orient itself between high growth and dividend-paying value companies. 

As always, we are available for a call or meeting if you would like to discuss whether some changes to your asset allocation are in order.


Bruce Hotaling, CFA

Managing Partner

Santa is Checking His List

Consider it an early Christmas present.  In the month of November, the S&P 500 rose 1.79% bringing its gains to 5.11% for the year.  The reversal from the prior month was pivotal.  After October’s -6.94% beating, we needed this positive result to avoid having to take an even more cautious stance and raise cash levels.  The stock market has been challenging.

I anticipate that it may take more time for the market to digest the selloff that began in early October. My hope is that we have seen the worst of it, but the 200-day moving average is in a downtrend, and that is not a healthy indicator.  I also expect some earnings revisions to begin to temper investor enthusiasm, possibly spurred by the poorly performing energy stocks and fall-out from the trade war.

There are a handful of disparate circumstances unfolding that may become problematic.  The oil patch is in disarray, and oil prices are in a freefall.  Over the last month, prices have fallen by 25%.  However, according to FactSet Research, the energy sector is expected to report the strongest earnings growth (+24%) for 2018 of the 11 S&P 500 sectors.  That’s an interesting contrast.  Historically, there has been an extremely high correlation between oil prices and earnings estimates from the energy sector. Therefore, oil prices are possibly foreshadowing a notable decline in the earnings forecast from the energy sector.

The housing industry may already be in a recession, with all manner of housing-related data (new home sales, housing starts, buyer traffic) showing signs of weakness.  Housing stocks have done poorly.  The mortgage lending business is now dominated by non-bank lenders, which are responsible for more than 52% of the $1.26 trillion in originations in the first nine months of 2018 (WSJ 11/22/18).  The affordability of certain markets has made buying difficult.  Further, the interest rate increases by the Federal Reserve are causing many potential buyers to take pause.

Corporate debt is another concern. The volume of corporate debt has more than doubled since the financial crisis of a decade ago.  Credit rating agencies (Moody’s and S&P) have been actively downgrading debt issues to low or below investment grade.  The primary concern is the waterfall effect from rising downgrades and defaults.  The recent plight of GE is a poster child for this issue, and this is a problem that could spread like the plague.

While investors have celebrated recent US profits and economic strength, the above-trend growth rates are unsustainable. Growth rates in 2018 (20%+ EPS and 2.8% GDP) are skewed by tax changes, government stimulus, and other non-recurring impacts.  Importantly, a growth reset (5-8% EPS and 2.4% GDP) should be more than sufficient for markets to continue to advance.  In my opinion, 2019 will deliver growth for stock prices, though expectations will need to be tempered.   Dividend yield may become a more important component of the total return than in 2018.  

My thinking is to remain focused on US growth stocks but to pare back some of the higher-growth and higher-priced names.  The style that may be most suitable for a flat or even declining earnings growth environment is referred to as growth at a reasonable price (GARP).  We intend to focus on stocks that have stable growth rates, pay a reasonable dividend, and are not overpriced (on a P/E basis) in relation to both their peers and the market as a whole.

US financial assets have dramatically outperformed the rest of the world in 2018.  Many investors are convinced that investing funds in regions, sectors or asset classes for the sake of diversification is a good thing.  On the contrary, I believe it’s is more important to make investment decisions utilizing reliable information on the companies that we believe have merit and closely monitoring our exposure.

As we close out 2018, we are actively reviewing portfolios to take advantage of tax loss selling.  It has been a challenging year, and we have purposefully taken gains in stocks that have outperformed over the last several years.  We are all available to discuss this with you or to review your portfolio if we have not been in touch recently.  We wish you and your family a wonderful holiday season and best wishes for a prosperous and peaceful new year.

Bruce Hotaling, CFA

Managing Partner

Trick or Treat

October, the month of Halloween and two of the most memorable stock market crashes, can be a scary time.    Fear is often considered the most powerful and uncontrollable human emotion.  When it ignites, the primal human survival instinct takes over and reason and logic go out the window.  This year’s October was no exception, and investor fear levels are clearly on the rise once again.

Stock prices for the month of October fell 6.94%, bringing the year-to-date total return of the S&P 500 down to an unsatisfying 3.01%.  For some context, February (-3.89%) and March (-2.69%) were also difficult months in which to own stocks.  From January 26th to the April 2nd low, stock prices fell over 10%.  The recent drop, from September 20th to the October 29th low, was 9.8%.  Both were uncomfortable drops in price and can be labeled corrections.  Seasoned investors often consider corrections a necessary evil when one chooses to commit financial assets to the stock market for the long run. 

The market’s behavior in October was unusual.  For example, of the 23 trading days in October, 16 saw negative returns.  There were 5 days on which prices rose more than 1%, and 5 days when prices fell more than 1%.  According to Bespoke Research, October 30 marked the end of a 28-day run for the S&P 500 without back-to-back days of positive returns; the preceding occurrence of this phenomenon dates back to World War II.  Stocks have recently struggled mightily and lost ground.  My concern is stock prices themselves are often considered the most telling indicator of future stock prices.

Of course, the stock market is made up of a vast array of companies occupying different sectors of the economy.  Different stocks have characteristics that cause them to respond differently to the same events.  For example, stocks that fared best during October were ones that had the highest dividend yields, the highest level of international revenues, and the poorest Wall Street analysts’ ratings.  Consumer staples and utilities were the only two sectors with positive performance. 

In my opinion, the increased agitation in stock prices may be an early signal of an earnings deceleration. This will likely be coincident with slowing economic growth and possibly even a recession.  For example, expectations are for earnings growth of 10% in 2019.  This is a reduction by 50% of the 20% growth we’ve experienced in 2018.  By mid-2019, investors will fixate on earnings projections for 2020, and those figures will probably be impacted by several factors.   For example, the trade war is causing higher costs for some US companies as a result of higher tariffs, longer lead times, and broken supply chains.  In addition, hints of inflation and indications that wage pressure is building will likely lead the Federal Reserve to continue on its current course of restrictive monetary policy.

Consumer confidence (at the moment) remains extremely high, both historically and in absolute terms.  This is a good thing, at least for now.  The confidence levels reflect the fact that jobs are available and people with jobs are out spending money.   There is still some punch in the proverbial punch bowl, and that could extend what has already been a prolonged economic run.  Given that we live primarily in a service-oriented economy, the historical cycles of older industrial economic cycles do not necessarily work as a barometer.  There may well be more room to run, but according to Bespoke Research, when consumer confidence has peaked historically, we tended to be at the early stages of a recession.

In my opinion, stocks are still the asset class of choice.  The backdrop is the same as when the speed limit on the freeway drops from 75 to 55 and suddenly you feel like you’re crawling along; the freeway still beats the back roads for a long road trip.  We will need to quickly become accustomed to the new rate of economic growth and the new market place and likely pivot to a more value-oriented stock selection approach.  Expected returns from stocks may well be lower going forward than they have been since 2009.  Our work is to choose the best stocks to own as the future characteristics of the market become clearer.  I am happy to discuss this with you in greater detail if we have not spoken recently.  Please feel free to reach out.


Bruce Hotaling, CFA

Managing Partner

Casting About

Stock prices, as measured by the S&P 500, rose 7.7% during the third quarter and are now up 10.5% year-to-date.  These returns are generally in line with historical returns.  Stock prices did jump 21.8% in 2017, but over the last 30 years, stocks have averaged 12.1% annually (1988 – 2017) with a standard deviation of 17.2%.  Based on these figures, the stock market is in “business as usual” mode.  It generally produces returns for which investors, at the end of the day, are rewarded for the risk they undertake. 

That said, investing in the stock market (or staying invested) has always been challenging.  For example, in recent memory, stocks fell 37% in 2008, 22% in 2002, 12% in 2001 and 9% in 2000.  The message is that the average returns of the stock market are available, but to capture them requires a willingness to endure some discomfort and avoiding the impulse to completely disinvest.

Many people are anticipating some type of disruption, as the record bull market grows long in the tooth amidst heightened levels of political turmoil.  Some are casting about for the next sign of trouble.  This could be a peripheral economic indicator or an exogenous shock – something unpredicted that ends up influencing the economy and, ultimately, the financial markets.

Unknown risk factors are difficult to identify and can take control of the markets in a blink.   For example, on October 19, 1987, the Dow Jones Industrial Average fell 22 percent in one day!  It may have been the experimental use of portfolio insurance (program trading), inefficient stock market technology, the huge budget deficit, or who knows what else.  These and other factors led to panic on Wall Street.  That was thirty-one years ago, and while the stock market has evolved enormously since then, we are curiously no better equipped to predict a crash today than we were on Black Monday.  

On a macro level, there are valid concerns such as the national debt and student loans.  The national debt is approximately $21 trillion.  Interest on the debt is rising quickly.  A recent report by the Congressional Budget Office shows that the fastest-growing federal government expense is the interest on our debt.  The expected bill for 2019 is $390 billion, which is 50% more than in 2017.  The report projects the US budget deficit to expand from 3.5% of GDP last year to 9.5% by 2048.   Student loans now rank as the second-largest category of consumer debt (behind mortgages) with a total debt of $1.5 trillion, and 10.7% of the 44 million borrowers are 90 days or more delinquent. (Forbes 6/13/18)

On a more fundamental level, the housing and banking sectors typically do well when the markets are healthy and anticipating growth.  Though the stock market continues to trend higher (20 of the last 22 months), these very two sectors are demonstrating notable weakness.   Weakness in the housing market is evidenced by the CaseShiller Index, which has fallen to its lowest level since March 2010. The malaise in the banking stocks may be due to troubles banks are having securing and paying for deposits – which ultimately impacts their future profitability.

On the contrary, the 2017 Tax Cuts and Jobs Act has clearly spurred a robust inflection in corporate earnings, and this is moving stock prices.  Currently, the aggregate CY 2019 earnings estimates for the S&P 500 are $178.  Using an 18x (trailing PE ratio) multiple on $178 in earnings, would put the S&P 500 at $3,200 at the end of 2019.  Investors using these figures (based on the current quarter-end price of $2,914) expect a 10% return from stocks in the coming year, which is on par with historical averages.

In my opinion, the stock market (from a fundamental perspective) is not cheap, but it is certainly not overpriced, either.  According to FactSet Research, the current forward P/E ratio is 16.8x (based on the above earnings forecasts) versus a 5-year average of 16.3x.  The risk is a deceleration in earnings and/or a compressed multiple.  These are not new worries – they simply feel magnified by the remarkably emotional and politicized haze through which we now view and filter news.  Unable to attach market significance to odd behavior and mistruth, we will rely upon fundamental and technical factors and hold a steady course for now.  I am happy to discuss this with you in greater detail if we have not spoken recently.  Please feel free to reach out.


Bruce Hotaling, CFA

Managing Partner

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