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We’ve Come A Long Way

The current bull market began in early 2009 and prices, measured by the S&P 500, have risen an impressive 205% since then.  Other notable bull runs of the recent past include those beginning in 1997 (+106%) and 2002 (+101%).   Both ended with 50% pull-backs in stock prices.  What goes up must come down?  This phrase, or idea, is attributable to Sir Isaac Newton back in the late 1600’s.  Newton was strictly concerned with the more or less predictable forces of gravity.  Apparently, at this point, stock prices seem to be oblivious to gravity and are following their own laws of nature.    

Recently, stocks rallied a sturdy 5.49% in February and consensus was we had recovered from a punk January.  Then March arrived (in like a lion, out like a lion).  Stock prices tipped back downward, falling 1.74% for the month leaving the benchmark S&P 500 up a mere 0.95% for the quarter.  Some investors are pointing a cautionary finger toward valuations, noting the market is moving into bubble territory.  According to FactSet, the 12-month forward P/E ratio is 16.7x, above the 14.1x 10-year average.  Other measures paint a similar picture.  Dividend yield on the S&P 500 is 1.9% (2.0% 10-year average) and the P/CF (price to cash flow) is 11.8x versus (9.7x 10-year average).  I agree some heightened attention is prudent, though I do not think, with the current backdrop, stocks are in a bubble.

Most of the market’s drama-points have carried over from March.  The Federal Reserve is under close scrutiny as to when (not whether) it will raise rates.  There is a contingent calling for higher rates with the thinking the Fed is implementing arbitrary price controls.  Higher rates equate to normal.  In my opinion this is extremely short-sighted.  The economic data is not compelling and the ultra-strong dollar is a deterrent to growth.  While Fed Chairwoman Yellen has said she sees rates beginning to rise this year in a gradual manner, there is ample precedent higher rates will not derail the stock market.  Other significant issues in play are the continued pressure on oil prices (supply / demand imbalance) and generally slower global growth, particularly in the emerging markets.

In my opinion, the greatest risk to the market for stocks in the U.S. continues to be an unexpected global event (black swan) that destabilizes the prospects for future growth.  Russia is the leading antagonist in this play.  As we recently saw in France, a Germanwings co-pilot purposely flew a passenger jet into the ground in an apparent suicide – trouble seems to be capable of springing up nearly anywhere.  The other area of great concern is the oil patch.   While prices at the pump are optically pleasing, there will likely continue to be fall-out, of the second derivative.  Another law, the law of unintended consequences (not a law of physics), may well surprise us.  An extended period of low prices is likely to create pressures (Russia, the Middle East, South America) from reduced oil revenue, and outcomes that we cannot accurately perceive at this point.   Something will have to give.   For example, more than 50% of the Russian government’s reported total revenue is from petroleum exports, and prices have fallen by more than 50%.

Near term, the key to stock price behavior will be earnings.  April brings spring flowers, and Q1 2015 earnings reports.  One thing that has been happening, and will be born out further with the coming earnings announcements, is Wall Street analysts have been lowering their forecasts.  The energy sector alone accounts for nearly half the decline in expected earnings for the quarter.   The earnings from the energy stocks are highly correlated with the price of oil and the energy sector represents 8% of the S&P 500.  According to FactSet Research, estimates for the S&P 500 have fallen from $29.5 (12/31/14) to $27 (3/31/2015).  As the price of stocks year-to-date is only slightly positive, this amounts to an increased multiple on those earnings.  Prices move higher from increases to earnings, the multiple, or both.

Apart from this cautionary note on earnings, stock prices remain in an uptrend and are exhibiting that Goldilocks trait of being not too expensive, and alternately not too cheap.  We are buyers, though we look to patiently buy on the dips.  The most attractive sectors for us are consumer discretionary, health care and technology, and to a lesser extent, financials.  Materials, telecom, utilities and especially energy are not looking attractive, at all.  We also have some concerns with industrial stocks (ie. rails, oil and gas equipment, machinery), and are trying to determine where we want to be in this sector.  While we often speak of the stock market, we view it as a market of stocks and are constantly looking for both value and opportunity.

Most importantly, I am pleased to announce Patricia (Trish) Markell has joined our team as an investment advisor.  She rounds out our capacity to deliver on all fronts of the investment spectrum.  She has a strong background both engaging clients and on the analytical/research front.  I will introduce you to her the first chance we have, and will send you her bio in the meantime so you can read more. 

Finally, as it is April, we are here at the ready.  Please let us know if you have any last minute tax questions.  We are happy to work with you and your accountants to put your tax filing to bed as quietly as can be.  

Bruce Hotaling, CFA

Managing Partner

Disclaimer:
The views and opinions stated herein are those of Bruce Hotaling, are 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 & P500 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.

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