The Picture or the Frame

Welcome to 2013. We here at Hotaling Investment Management, LLC wish you and your family a safe and prosperous new year! We will do our best to work with you to obtain these goals.

By most measures, 2012 was quite a good year for investors. Stocks, measured by the S&P 500 generated a total return of 16%. Bonds, measured by Barclay’s US Intermediate Government/Credit, returned 3.89%. This is a broad look at fixed income returns – and the simple takeaway is that most fixed income sectors did alright last year.

The numbers are now in the books. When the calendar ticked over into 2013, good as the returns were, they no longer matter. Now, by convention, we are collectively focused on what our returns will be for the calendar year 2013.

I am not a big believer in forecasts, so I will not produce a top ten list of prognostications for the coming year. You can find some of the more prominent views (Barron’s Roundtable, Byron Wien or Bill Gross) on-line. Most seers, over time, only generate 50/50 results. Their opinions, while interesting, have limited “investability.”

What I can do is point out certain observations, constraints or opportunities as I perceive them. In my opinion, it is often difficult for investors to hone in on the important stuff, and look through the noise. It is not new information or strategies that make the difference, rather it is seeing and acting on what is already apparent.

  1. Volatility is here to stay. Uncertainty is inherent in investment markets and always has been. Without it, there would be no return potential to investors. When the commentator on CNBC says “markets dislike uncertainty” feel free to turn off the television.
  2. Try not to “love” your investments. As Tom Hanks said in A League of Their Own, “there’s no crying in baseball.” Emotions will only cause problems.
  3. Herd thinking. 2012 produced strong equity returns while in fact most investors were moving money from stock funds into bond funds. The overwhelming tendency is to do what everyone else does. Think about becoming a contrarian.
  4. Taxes are going up. The payroll tax, a new Medicare tax and the new Net Investment Income Tax. They will impact nearly everyone, but will not have any noticeable impact on the investment markets. These are separate from the tax increases/deduction limits agreed to by Obama and Congress in avoiding the fiscal cliff.
  1. Earnings Estimates. Stock prices and earnings are reasonably well correlated over time. Current estimates for the S&P 500 are $113.15 (2013) and $125.11 (2014) per share. Any revision to these numbers is a critical factor to watch relating to the direction of stock prices.
  2. Valuation. The market is trading at 12.8x 2013 earnings estimates, below the 10 year average of 14.2x. A 14.2x on $113.15 implies a $1,600 price level for the S&P 500 or an approximate 10% return from today’s level.
  3. Economic Data. There remains a lot of economic wood to chop. Job growth is stubbornly slow, real income growth is low (declining), and income inequality is growing.
  4. Low Interest Rates. The Federal Reserve has stated its intention to keep rates lower, longer, until true economic growth takes hold.
  5. Marginal Inflation. Labor costs are low. Energy (oil and gas) prices are expected to continue to fall. That’s it.
  6. Cost is critical. Do not overpay. The key sentiment when purchasing an asset is caution, not urgency.

While I am optimistic about the coming year, I think a good measure of patience is in order. Sitting still is OK. Few made their investment riches in one or two trades. We will follow the same tried and true investment process and guidelines we have in the past.

One aspect of our investment process we are improving is our transparency. We are implementing a new portfolio accounting and reporting system called Tamarac that I am confident you will find to your liking. You will be able to view the same reports and analyses we view (if you wish). It will also be available through a client “portal”, allowing you to log in any time you like. This will be in place by March.

In the meantime, please feel free to check in if you have any questions. Valerie, Eileen, Justin and I are always available to take care of you.

Bruce Hotaling, CFA

Managing Partner

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