S&P return year to date


Labor Day is here. For some, along with Memorial Day, it bookends the summer, and that’s that.  It represents the end of the heat, and the beginning of another school year.  In fact, the date became a national holiday in 1894 to recognize the incredible achievements of the American worker.  This was around the time the AC motor, the radio, the gasoline engine and a plethora of other economic dial-movers were discovered.  It was a period of dynamic technological change.  Today, robotics, drones, AI and the like are transforming the world and how we work.

Labor (productivity) is important today as one of the two primary components of economic growth along with population growth.  Population growth is on the decline, so the emphasis is on technological innovation to make the U.S. laborer more efficient.  Curiously, the U.S.’s total output, measured by GDP, has been growing at a lackluster rate ever since the Great Recession.  Payroll numbers have been growing steadily for years now and the unemployment rate is at a low 4.9%, but GDP growth has not been able to pick up.

Last year (2015) U.S. GDP measured 2.4% and stock returns, measured by the S&P 500, were 1.4%.  This year, despite equally low-growth, stock prices have been rising.  I suspect there are several things happening here.  One is the market may be anticipating stronger growth and increasing estimates for Q4 2016 and 2017.   With the election coming up, the market seems to be anticipating a change in the use of fiscal policy.  It would appear that ideology aside, policy makers (not the Federal Reserve) realize they are the ones that can make a difference.  Little if anything constructive has been done to spur economic growth since the American Recovery and Reinvestment Act of 2009 – far too long. 

Another change the market may be anticipating has to do with how corporate America allocates its prodigious cash flow.  Traditionally, spending by businesses large and small is oriented around research, innovation, capital investment and expansion.  These are factors that have traditionally propelled the future growth of American industry.  Recently, much of the surplus cash has been oriented toward pleasing investors on Wall Street in the form of higher dividends and stock buybacks.  This may be good for the board room and bonus calculations, but it is not the correct route to sustainable growth.

Last, but not least, the most evident driver of the strong stock market this year (stocks have generated a total return of 7.66% year to date as measured by the S&P 500) is the search for yield.  For multiple reasons, bond yields are as low as they have ever been.  On top of this, demand for yield is off the charts, as our sovereign counterparts, Germany and Japan, are paying negative yields on their debt.  This makes the current 2.1% yield on the S&P 500 look extremely attractive to income investors, and not just U.S. investors – there is evidence of huge demand for U.S. equities from Europe and Asia. 

Stock sectors known for their dividends, such as utilities and telecom, are up 20% year to date.  It’s no surprise that high dividend payers and value oriented stocks such as these continue to outpace growth stocks.  The shift from growth to value, as I have discussed before, began in December 2015 and accelerated into 2016.  I am making a somewhat contrarian bet that a positive inflection in earnings growth in the coming months will allow growth stocks to return to the head of the pack.

 It’s hard to grasp the degree to which the world has changed since 1894.  The role of labor and the importance of technology are as critical as ever, though they bear little resemblance to what they were.  I have to say, the recent dust up between Apple, Ireland and the EU reflects just how critical innovation in the labor force has become.  A recent Fortune list of the largest technology companies around the globe showed that of the top 25, 14 are from the U.S., 8 are from Asia-Pacific (China, Taiwan and South Korea) and only 3 are from the Euro-zone (Germany, Sweden and Finland).  That says a lot.

Please feel free to check in if we have not spoken recently.  The last few months have been smooth sailing, and often times that means there’s a storm somewhere on the horizon, even if we cannot see it yet.

Bruce Hotaling, CFA

Managing Partner

Summer Time

For the last five months, stock prices have more or less surprised investors, continuing to edge higher amid a flow of unsettling news. On top of that, we experienced two points this year that had many reaching for the emergency brake.  First was the harrowing start to the year, which saw stock prices fall 10.27% after only 28 trading days.  Second was the remarkable post Brexit snap that saw stock prices lose 5.4% over two days in late June.  In spite of this, stock prices have soldiered on, with little regard for the often event-driven mentality, and closed out July with the S&P 500 at 2,173, 7.6% above where they started the year.

This year is unusual because all the asset classes we utilize are putting up solid returns.  Stock prices are on the rise because investors expect improved earnings reports.  Fixed income (US corporate and municipal bonds) has done well largely due to a recovery in credit, particularly energy and a tailwind from falling interest rates.  Another reason bonds have rallied is the flight to safety trade – investors have continued to buy bonds hoping to stay out of harm’s way.  REITs are having a strong year due to a stable financial backdrop and their high yields.  And finally, the pipeline MLPs are putting up attractive returns as the price of oil has stabilized and quarterly distributions look to be secure.

Stock prices have been struggling through an “earnings recession.”   Q2 2016 is expected to be the fifth consecutive quarter of year over year declines in earnings.  From 2012-2014 earnings growth was north of 5%.  Then, in 2015 earnings fell 0.8% and are expected to fall another 0.3% in 2016.  The decline was largely a byproduct of the drop in oil prices. Starting in mid-2014, a barrel of oil dropped in price from over $111 to below $40.  This had an immense impact on a vast array of businesses with both direct and indirect exposure to the energy patch.  While motorists saw heaven at the pump, stock investors cringed as returns from stocks, across most sectors, began a protracted sideways move.

Today, with the possibility for improved earnings on the horizon, stocks are priced at a P/E of 17x expected earnings.  Analysts currently forecast bottoms up S&P 500 earnings of 134.4 for 2017.  A valuation in this range is not unreasonable in light of the extremely low interest rates and inflation.  In my opinion, there is an avenue for stocks to return 6-10% over the next 12 months.  Of course, things will need to go well.  The market is expecting an earnings recovery, and stock prices are being bid up in anticipation of this outcome.  Currently, the dividend yield on the S&P 500 is 2.3% – #paidtowait.

Something we are watching closely is the shift in the type of stocks generating returns this year.  Growth stocks have outperformed value stocks for years.  Then, late last year, the market began rewarding value stocks, and this shift has been in effect all year.  When earnings growth is scarce, dividends become more attractive.  The push into value stocks has driven their prices up, currently trading over 115% of their historical P/E.  Although we have tweaked our models to take advantage of this shift, we prefer not to chase expensive stocks. I expect the market to turn its attention back toward growth with improved S&P 500 earnings later this year and into 2017.

Our advisory approach rests on three principal tenets: utilize quality assets where we are confident in a reliable information flow, insure our investors have a high level of transparency and communication, and all assets must be readily salable.  We have adhered to these guideposts for over 20 years.  During times like these, with an absurd political narrative, and heightened incidents of terror, our principals are more important than ever.  When fear rises, it is generally difficult to rein in.  We will watch closely as events unfold, trimming overpriced assets, and remain prepared to raise cash if need be.

I hope you are enjoying the long days and have had a chance to slow things down.  If you would like, please feel free to check in.  It’s a good time to take a few minutes to review your portfolio.  There is a lot of noisy commentary which makes investment decisions more complex.  We are happy to work with you to make sure you are enjoying your summer time to the fullest.


Bruce Hotaling, CFA

Managing Partner


After a less-than-impressive return from stocks in 2015, things have taken a turn for the worse in the early part of 2016. For the month of January, stock prices measured by the S&P 500 fell 4.96%. Of the 20 days stocks traded, they fell in 9 instances, each day by an amount in excess of 1% (3 in excess of 2%). Not a pleasant way to start the year.

Large cap stocks tended to fare better than mid cap, and small caps simply fell apart. There was little differentiation between growth stocks and value stocks. Sector wise, financials and materials had it the worst. Consumer staples and utilities, both considered defensive sectors, actually had positive returns. There was nowhere to hide either. Stocks from every primary global market, including oil, gas and commodities all fell in value. The one bright spot, gold, silver and fixed income (particularly US Treasury bonds) did show positive returns.

So, where do stocks go from here? The answer, at the moment, hinges on oil. Stock prices have begun to trade in lockstep with the price of a barrel of oil. Oil prices did bounce off a 13 year low on January 20th and have rebounded nearly 14% since that date. In classic thinking, lower oil prices were considered a boon to the economy. Lower energy brings down the cost of production, transportation and ultimately puts more money in consumer’s pockets.

Historically there is not a strong correlation between stock prices and oil, until now. So what has changed? One variation from the old paradigm is we import far less oil today. On top of that, there is little clarity with respect to true global demand and talk of a recession. Some analysts feel the direction of the trade-weighted dollar starting in 2014, was the key driver of the price of oil. US monetary policy began to diverge from the rest of the world, oil depreciated as the action took liquidity out of the system.

There may be more fallout from the drop in the price of oil than anyone could have foreseen. Sovereign wealth funds which had been overflowing in accumulated oil profits may well be raising funds to support budget deficits. The world’s sovereign-wealth funds together have assets estimated in the $6-$7 trillion range, (US GDP in 2015 was approximately $18 trillion). More than three quarters of these assets are in funds from emerging market countries, many based in the Middle East and Asia, and naturally the assets easiest to sell are their global stocks and bonds.

The oil patch has developed a knack for talking its own book. For example, T Boone Pickens, in a June 13, 2014 CNBC interview said oil prices could hit $150-$200 a barrel. Today, only 18 months later, several noted global banks are saying prices could drop to as low as $10-$15 a barrel. The unfortunate truth is no one really has any idea where the balance between supply and demand will be struck. Once oil prices stop falling, many other financial assets will follow.

The general economic backdrop is mixed. Talk of a global recession looms, but in the US, the housing and auto sectors continue to perform well and the jobs numbers are strong. 4Q GDP came in at 0.7% with a notable bump from consumer goods and services. While the industrial manufacturing sector slumps consumer confidence remains above its long term averages.

According to FactSet Research, the 2016 bottom-up estimates for the S&P 500 are $123.3 (versus $117.7 in 2015). This is the true foundation for the market, and stocks are trading in a reasonable range of 15.4x forward earnings. Energy remains the primary issue as returns have nearly evaporated dropping from $8.38 in Q1 2015 to $1.36 in Q1 2016, a drop of over 83%. Earnings for materials and industrials have also dropped, in large part due to oil.

In my opinion it’s most prudent to remain prepared to back away from risky assets. We did this back in August 2015 and we may find it prudent to do the same in February 2016. Many of our favored stocks are selling at attractive prices. This does not mean they cannot become even more attractive, if conditions take a turn for the worse. So, for the moment, we are watching cautiously.

Please feel free to reach out if you would like to review with us. In more difficult times such as these, it is important for us to remain in close communication.      

Bruce Hotaling, CFA

Managing Partner


Stocks rebounded in October, returning 8.3% for the month, and lifting the return on the S&P 500 to 2.9% for the year. October has something of a reputation for producing volatile investment returns. This year, August and September were both volatile and down months. It was important that stocks put up a strong showing to avoid sliding into a prolonged decline, or worse. The cautionary evidence in hand was strong, with two consecutive quarters and months with negative returns. Thankfully, October’s stock returns showed some muscle and broke the market’s downtrend.

Several catalysts drove the change in tone. For instance, corporate merger activity (Walgreens and Rite Aid, Ace and Chubb, Heinz and Kraft) leapt to new heights and gave investors an emotional lift. Another catalyst in October was the resurgence of corporate debt issuance. Corporate borrowings increased signaling improved confidence in the economic outlook and the fortunes of corporate America. Finally, and most importantly, earnings reports have been robust and reassured many sitting on the fence.

According to FactSet Research, the blended growth rate for Q3 S&P 500 EPS improved to (2.2%) at the end of last week from (5.2%) at end of last quarter. With the majority of companies reporting, 76% have beat consensus EPS expectations and in the aggregate, companies reporting earnings are 5.9% ahead of expectations. Nine of ten industry sectors have produced positive earnings growth surprises. Earnings have been impressive and the primary driver of the outstanding returns stocks posted in October.

To be clear, the backdrop for stocks is not overly compelling – so I am somewhat wary. At the same time, there is a constructive backdrop often referred to as “climbing the wall of worry.” The macro headwinds are widely discussed in the media. The ones concerning to me are : 1) slower growth across the globe, 2) the strong US $’s impact on US corporate earnings and 3) certain weak economic stats, such as the recent four-straight disappointing monthly non-farm payroll reports.

While stocks do not look cheap at this point, they do look as though they have a reasonable chance of generating their historical rate of return looking ahead 12 months. This cannot be said for some of the other asset classes investors have popularized. I profess “simple is good” and we avoid using asset classes we cannot cash flow forecast, or own directly (without having to use a third party manager or mutual fund). Our decision drivers are based on transparency, quality and liquidity. We utilize a number of different tools to accomplish this including fundamental, technical and quantitative research methods.

In many instances, we had raised cash (sold stocks) taking a more defensive posture as the market became more and more unsettled over the summer. The strength of the market’s rebound in October is reassurance that the market simply needed to blow off some steam, and is not in fact on the precipice of a prolonged downturn. It had not sold off in some time and there is a high likelihood that it needed to “reset” to a certain degree. Now, our focus is to remain well invested, building stock positons at attractive prices. Seasonally, the final two months of the year and first part of the new year tend to be favorable times to own stocks, and we want to take advantage of that tendency.

Difficult as it’s been, stocks remain the prime driver of returns for most investors this year. Growth stocks continue to generate higher returns than value stocks and dividends still do not matter as much as growth. So we will continue down this path. The fears rippling through the REIT market have tempered as have the fears related to the eventual Federal Reserve rate hike. The MLP market, now tied to the price of oil more than ever, will take longer to “normalize”, in my opinion, though the Q32015 reports are making it clear the businesses are maintaining themselves.

If we have not spoken or if you would like to review your portfolio I would be more than happy to get together with you. In the meantime, we are preparing for year end and want to minimize the effects of capital gains in your taxable accounts. Please feel free to call if you would like to discuss further.

Bruce Hotaling, CFA

Managing Partner