Ups, and Downs

Stocks, measured by the S&P 500, rose a modest 0.85% for the month of April, and are up 1.92% year to date.  Overall, the market returns are showing a positive slope, but the monthly pattern (up one month, down the next) looks like the edge of a bucksaw.  This price action is largely a continuation of the prior 12 months when stocks rose seven months, fell five, for a net 12.98% return.

As April came to a close, stock prices faded off.  If they continue their recent ping pong pattern, they will produce a negative return for May.  Stocks do tend to exhibit seasonal patterns and the months of May and June are generally among the least profitable to own stocks.  To be fair, September and October have a long history of poor results.  Thus, the old adage, “sell in May and go away.” 

As GARP (growth at a reasonable price) investors, we have benefited from the recent characteristics of the market.  At each capitalization level, (large, mid and small), growth stocks are performing better than value stocks.  This means stocks with characteristics such as high revenue and earnings growth, high returns on capital, strong earnings persistence, and high free cash flow are performing better than stocks with high dividend yields, low price to book and price to earnings ratios.

According to FactSet, as of May 1, a respectable 62.5% of all companies reporting had come in above their estimates.  In contrast, only 49.5% of companies reported beating their revenue estimates.  This points to a quarter where corporate America had a lot to overcome.  The drop in oil prices, a long winter with volumes of snow, labor disputes and the resultant logistics snafu at ports along the west coast, and of course, the ultra-strong US dollar.

Some of these headwinds are showing signs of easing.  The dollar has pulled back.  With investors anticipating a rate rise in the US, and with quantitative easing in the Eurozone, interest rate parity theory has been a factor in the US dollar’s rise.  A strong dollar hurts US earnings when companies repatriate foreign profits, and a high dollar makes US goods less competitive. We typically assume currency fluctuations will balance out, and invest in principally U.S. domiciled companies.

In my opinion, many investors are unknowingly over allocated to global markets.  Nearly 30% of the earnings of S&P 500 companies come from international sources.  According to FactSet, sources of revenue for the S&P 500 are 69% North America, 13% Europe, 10% China and 8% the rest of the world.  I prefer to focus on high quality, high growth US based companies, and trust them to decide the best markets around the globe for their products and services.

The drop in oil prices last year was a true shock.  It caused dramatic capital spending cuts across multiple industries that service the energy complex.  Though the price of oil may have stabilized and even inflected upward, signals are mixed: on one hand we are facing record crude inventories, yet well over 1,000 rigs have been mothballed.    I expect the supply and demand to rebalance allowing prices to normalize, though there are far too many random aspects to the oil markets to get overly long energy. 

Bottom up (aggregate of individual earnings estimates) estimates are $119.3 per share for CY 2015 and $134.3 for CY 2016.  The mayhem in the oil patch led to dramatic cuts to earnings estimates which led to downward revisions to the 2015 numbers.  At its recent 2,080 close (May 1) the S&P 500 is trading at 16.8x its forward 12-month earnings per share estimate (rolling 12 months) of $124.23.

In my opinion, these estimates, supported by diminished headwinds, are constructive for stock prices.  I think the expected return from stocks is below the long term return for the asset class.  While I think there are returns to be earned, I think the jagged pattern will continue, and investors will have to be patient to allow stock prices to catch up to expected future earnings.  

As always, we look forward to hearing from you and addressing any concerns you may have.  I would also like to have the opportunity to personally introduce you to Trish, the latest member of our team.  In the meantime, please enjoy the wonderful Spring we are having.


Bruce Hotaling, CFA

Managing Partner

The views and opinions stated herein are those of Bruce Hotaling, are as of this date, and are subject to change without notice. Information contained in this report was received from sources believed to be reliable, but accuracy is not guaranteed. Investments are subject to market risk, including the possibility of loss of principal. Past performance does not guarantee future results. The S&P 500 is an unmanaged index of 500 widely held stocks. Investors cannot invest directly in an index. The PE ratio (price/earnings) is a common measure of relative stock valuation. This note contains forward-looking statements, predictions and forecasts (“forward-looking statements”) concerning our beliefs and opinions in respect of the future. Forward-looking statements necessarily involve risks and uncertainties, and undue reliance should not be placed on them. There can be no assurance that forward-looking statements will prove to be accurate, and actual results and future events could differ materially from those anticipated in such statements.

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