Market Analysis Archive

Annual Client Letter and Outlook

January 2, 2019

Market Data for year end 2018:

S&P 500 Stock Index: 2507, down 6.3%

Ten-year Treasury Note Yield: 2.68%, up .27%

Gold: $1,281 per ounce, down 2.1%

Oil: $45 per barrel, down 24.3%

Global financial markets faced renewed volatility in 2018 as a confluence of macroeconomic factors increased investors’ sense of uncertainty, pressuring returns across almost all major asset classes. Stocks and corporate bonds had their worst annual performance since 2008, while basic commodities such as oil and copper experienced significant declines. Compared to the historic placidity of 2017, US stocks had two major corrections of greater than 10% in 2018.

The factors pressuring markets alluded to above are primarily threefold:

1) Economic and corporate profit growth are decelerating. 2018 began with economies around the globe experiencing a synchronized expansion. In the US, economic growth and corporate profits surged on the back of the Trump/GOP corporate tax cut and increased federal spending. As 2018 came to a close, however, economic growth in the major economies of Europe and Asia was faltering, while US economic and corporate profit growth were projected to decrease substantially as the stimulus from the tax cuts and increased spending began to wear off. US economic growth in 2018 was approximately 3% in 2018, yet is expected to decelerate to 2.5% in 2019, and 2% in 2020. Similarly, corporate profits are seen decelerating from growth of 22% in 2018 to 8% in 2019.

2) Liquidity (money available for lending/investment) in the financial system is being removed. The US Federal Reserve raised its target for the federal funds overnight interest rate a full percentage point in 2018 to over 2.25%. At the same time, it is effectively liquidating the substantial bond portfolio it accumulated during the post-crisis policy of “quantitative easing”, thus increasing the supply of debt on the market while simultaneously withdrawing funds from the banking system. Further compounding the liquidity draining activities of the Federal Reserve, the US Treasury is having to significantly increase its issuance of bills, notes, and bonds to finance the above cited tax cuts and increased spending. This all has the net effect of decreasing the funds available for private lending and investment.

3) Trade tensions are suppressing corporate investment. In 2018, President Trump followed through on his promise to initiate trade wars on US trading partners. He began by putting on an across the board tariff on all aluminum and steel imports and then a 10% tariff on over $200 billion of goods from China. He has also held out the threat of further tariffs on Chinese imports and European automobiles, as well. Given the highly integrated nature of the global industrial supply chain, such threats are substantially disruptive, creating uncertainty for corporate executives, and decreasing corporate investment. Ultimately, decreased trade leads to higher prices and lower economic output, a lose-lose situation for all involved.
Whether or not 2019 turns out to be a better year for financial markets hinges primarily on the actions of the Federal Reserve and the trade agenda of President Trump. As the US economy is already decelerating, the market does not believe further monetary policy tightening is necessary. The Fed said in December that it sees itself raising the overnight interest rate a further half of a percentage point in 2019 and continuing to sell bonds from its portfolio. If they stick with their stated agenda, there is an elevated likelihood of an economic recession and lower share and corporate bond prices. Similarly, if President Trump cannot de-escalate the trade tensions he has injected into the global economy, we would expect corporate investment and global growth to continue to suffer, leading to further decreases in the prices of risk assets such as stocks and corporate bonds. Speaking more broadly, the President’s erratic behavior has become a distinct source of concern for the markets beyond any specific policy item.

We are admittedly agnostic on the points discussed above. The Federal Reserve has a poor track record of managing a decrease in liquidity without causing a recession, while President Trump’s inherent instability makes predictions on the outcome of the trade wars a highly fraught endeavor. In such an environment, we will stick to our strategy of focusing on investments in high quality companies, diversification, value, and patience. Such a strategy held up well in 2018, and we are confident in its continued performance regardless of the macroeconomic environment. For the remainder of the year we expect the US stock market, as represented by the S&P 500 stock index, to trade in a range of 2200 to 2800. It closed 2018 at 2507.

As always, we thank you for the trust and confidence you have placed in us. Please do not hesitate to contact us with any concerns you may have. We wish you a healthy and prosperous 2019.

Market Update

October 28, 2018

On Friday, October 26, the S&P 500 stock index closed at 2659, below the lower bound of our expected trading range for the year of 2700.
In our last market analysis, we expected a more challenging environment for stocks moving into the fourth quarter of 2018 given decelerating economic and profit growth, reduced liquidity, and escalating trade tensions. This has played out as expected but more violently than we anticipated. Having been quickly repriced, the question, as we see it, is whether or not fundamental conditions will worsen and lead to further declines in stocks.

We see four primary risk factors: 1) Federal Reserve monetary policy, 2) Trump Administration trade policy, 3) the health of the Chinese economy, and 4) the Italian budget confrontation with the European Union.

1) Over the last three years, the Federal Reserve has raised the Federal Funds overnight interest rate eight times in quarter percentage point increments from 0.13% to 2.13%, and it has signaled that it intends to raise the rate by a further quarter point in December and three more times in 2019. Given that the economy may be slowing on its own as the sugar high of the Trump/GOP tax cut wears off, this is a dangerous game. If economic data continues to decelerate (quarterly economic growth fell by 0.7% in the third quarter with moderating inflation), and the Fed does not moderate its policy, the risk of recession and further losses in stocks is heightened.

2) If the Trump Administration continues to escalate its trade war on China, global supply chains will face significant disruption leading to higher costs for both consumers and corporations. This will reduce consumptions and investment, further weaken the economy, and pressure share prices. To wit, industrial firms such as 3M and Caterpillar have stated that Administration trade measures are negatively impacting their financial performance.

3) As we have previously discussed, the Chinese economy is built on a fragile, overly indebted financial system. The Chinese authorities recognize this and are attempting to reduce borrowing without causing significant disruption to growth. This is a difficult balancing act, and there is no assurance it can be successfully managed. Trade war is further complicating the situation. As China is the world’s second largest economy, Chinese economic weakness reverberates around the globe, America included.

4) The Italian government, led by a nationalist/populist coalition, wants to increase Italy’s budget deficit beyond European Union guidelines, setting up for a potentially destabilizing showdown between Italy and the EU. Italy is already heavily indebted, and its banking system is among the most fragile in the industrialized world. Instability in the Italian banking system could spread to the rest of Europe and globally.

Whether or not these risk factors individually or in unison lead to a weaker economy and share prices remains to be seen, but we are monitoring them closely. As they have come on the radar screens of investors, volatility has increased, and we would expect that to continue to be the case heading into year end. For the remainder of the year, we see the S&P 500 stock index trading in a range of 2500 to 2900. It closed Friday, October 26 at 2659.

We will continue to execute our strategy of quality, value, diversification, and patience. While we stay abreast of macro-economic developments, our focus stays rooted on the long-term and in individual company dynamics. This has been our policy for the past two decades, and remains so today.

Third Quarter Review/Fourth Quarter Outlook

September 30, 2018

S&P 500 Stock Index: 2914, up 7.2%

Ten-year Treasury Note Yield: 3.06%, up 0.21%

Gold: $1,196 per ounce, down 9.9%

Crude Oil: $74 per barrel, unchanged

The third quarter witnessed the largest quarterly advance in shares since 2013, supported by a strong US economy and better than expected corporate profits. Treasury yields responded similarly to the strong growth by rising 21 basis points (0.21%) as noted above. Given higher interest rates and a perceived benign financial environment, gold continued to decline. Moving forward, we expect moderating performance in stocks, as we believe that economic and profit growth my have peaked, while the Federal Reserve and Treasury continue to tighten market liquidity. Slower growth and reduced liquidity is not an optimal environment for stocks. Furthermore, by our calculations, the stock market, as represented by the S&P 500 stock index, is at its most expensive valuation since June 2007. While valuation is not a reliable indicator of short-term market movements, the current market valuation does imply that returns will be subdued over the longer-term.

In addition to the economy and corporate profits moving past peak growth, and tightening liquidity, there are several risk factors that could curtail continued gains in shares. The new populist government in Italy threatens instability in European markets by offering a budget that will exacerbate its already precarious financial condition. Italy is heavily indebted and has a fragile banking system. The Italian government wants to expand its borrowing to finance tax cuts and increased spending, and observers worry that their financial system will not be able to digest increased Italian government borrowing. European growth has already moderated from earlier in the year, and financial stress emanating from Italy would only worsen the situation. Distress in Europe would negatively impact both American markets and the US economy, as Europe is a large trading partner of the US and has extensive financial linkages.

Speaking of trade, escalating trade tensions driven by the Trump administration will weigh on corporate confidence in the near-term and slow growth over the longer-term by increasing prices and decreasing investment. While the tariffs and counter-tariffs imposed by the US and its trading partners have yet to show up meaningfully in economic and corporate performance, it will have a long-term corrosive effect on both the US economy and markets. China, who is the principal target of US trade actions, is more vulnerable in the near-term to trade hostilities as it is more trade dependent than the US, and its economy was already slowing due to the Chinese government cracking down on domestic lending. As we have noted in earlier market analyses, the Chinese economy has been driven largely by debt fueled investment, which has left its financial system in a dangerously fragile condition. Given that China is the world’s second largest economy and heavily integrated into the global economy, Chinese weakness could reverberate around the globe and, ultimately, onto US shores.

For the remainder of the year, we expect moderating share performance due to the factors cited above. Market volatility has been running at depressed levels since the first quarter of the year, and we would expect it to increase in the tougher fundamental environment for shares we see moving forward. Additionally, the results of the mid-term elections in November could add further volatility, particularly if the Democrats were to capture both houses of Congress. In such an environment, more defensive, value oriented shares should outperform, while the expensive, momentum driven stocks that have led the market higher in recent years will come under pressure. We feel we are well positioned for such an environment. In the coming quarter we expect the stock market, as represented by the S&P 500, to trade in range of 2700 to 3000. It closed the quarter at 2914.

Second Quarter Review/Third Quarter Outlook

July 2, 2018

Market Data for the quarter ending June 29, 2018:

S&P 500 Stock Index:  2718, up 2.9%

Ten-year Treasury Note Yield:  2.85%, up .11%

Gold:  $1,327 per ounce, down 5.4%

Oil:  $74 per barrel, up 13.8%

Stocks saw modest gains in the second quarter of 2018 as investor enthusiasm for large tech stocks, such as Facebook, Amazon, Netflix, and Google (FANG), was able to buoy the market in the face of broader weakness.  Interest rates crept higher driven by tightening monetary conditions, (more on that below), and oil continued to advance on strong demand and supply disruptions. (Venezuela, Libya, and, moving forward, Iran.)  Gold sagged as the dollar strengthened in response to tight money, as well.

We are cautious on the stock market going into the second half of the year.  We see three primary risks.  To begin with, as referenced above, monetary conditions are becoming more restrictive.  The Federal Reserve is raising short-term interest rates, while at the same time it is effectively selling Treasury bonds it acquired under its quantitative easing program (QE).  Additionally, the recent tax cut and an increase in federal spending have flooded the market with new debt to finance the resulting deficit.  The upshot of all this is that there is less money available to invest in stocks, which on balance, means lower valuations.  In addition to immediate market impact, tighter monetary conditions will steadily pressure capital investment and consumption, thus weakening the economy and corporate earnings.  If the Fed moves too aggressively in further raising interest rates, the economy could be tipped into recession, and the stock market would sell off significantly.

Moving on, the first shots of a global trade war and threatened escalation are an additional threat to economic growth and earnings.  While perhaps aiding select domestic industries, such as steel, on balance, tariffs raise prices and reduce growth.  Global supply chains are highly integrated, and tariffs on foreign goods, rather than helping US firms, damage them.  Retaliation from foreign countries adds further complications.  General Motors stated that the administration’s trade policy will result in reduced investment, production, and employment.  It is highly concerning that the administration seems to not understand basic economics.  If the trade war escalates with both China and our erstwhile allies in Europe, Canada, and Mexico, expect weakness in stocks and, ultimately, the economy.

Finally, the trade hostilities cited above have increased risks to the Chinese economy, the world’s second largest.  We have said many times in previous market commentaries that the Chinese economy is built on a mountain of debt.  Belatedly, Chinese authorities have recognized the need to get lending under control or risk a significant crisis.  As the Chinese government has restricted credit growth, their economy has inevitably lost momentum.  A threatened trade war adds additional pressure.  As a result of these developments, Chinese stocks have fallen into a bear market (a 20%+ decline), and its currency, the yuan, has weakened.  Given the importance of China to the global economy, weakness in China reverberates around the globe, ultimately washing upon US shores.  Emerging market stocks have been broadly pressured this year, and that has oftentimes in the past led to weakness in US markets.  This is a development that bears close scrutiny.

Moving into the second half of the year, we do not expect strong gains in stocks.  In addition to the risks cited above, the market has exhibited characteristics of market tops such as heightened corporate indebtedness, mergers and acquisitions activity, and speculation in “can’t lose” glamour stocks such as the FANGs cited above.  It would not surprise us at all if the market were to close 2018 with an outright decline in share prices.  We feel we are well positioned for such an environment as our portfolios are tilted toward more defensive sectors relative to the broad market, and should hold up well in the face of market weakness.  For the remainder of the year, we see the stock market, as represented by the S&P 500 stock index, trading in a range of 2550 to 2900.  It closed the second quarter at 2718.

First Quarter Review/Second Quarter Outlook

April 2, 2018

Market Data for the quarter ending March 29, 2017:

S&P 500 Stock Index:  2641, down 1.2%

Ten-year Treasury Note Yield:  2.74%, up .33%

Gold:  $1,327 per ounce, up 1.4%

Oil:  $65 per barrel, up 8.2%

After advancing strongly in January on the excitement of the corporate tax cut signed into law the previous month, stocks ran into turbulence for the remainder of the first quarter.  The first spasm was triggered by fears of higher inflation driven by stronger than expected January wage growth, the second was due to rumblings of trade war emanating from the White House, and the third was driven by the data scandal at Facebook, which led to heavy selling in high flying technology shares that have dominated the market.  Overall, in spite of the late wave of selling, technology was the only sector to advance in the first quarter.  Other sectors suffered at the hands of higher interest rates, fears of trade disruptions, and the emerging possibility that growth will not be as strong as was anticipated earlier in the quarter.

Our view is that growth will disappoint current expectations, interest rates will remain at historically low levels, and shares of income oriented sectors will outperform, with technology and growth oriented shares lagging.  On economic growth, we do not see the basis of a sustained acceleration as the tax cuts will primarily benefit wealthy shareholders, who are more likely to pocket than spend their windfall.  We are skeptical that the tax cuts will lead to a pickup in investment as claimed by the tax cut’s advocates.  Furthermore, the Federal Reserve is raising overnight interest rates, while the Treasury is flooding the market with short-term bills, further increasing short-term interest rates.  This is not a recipe for stronger growth.  Tellingly, the gap between short-term and long-term interest rates, known as the yield curve, has narrowed to its lowest level since before the financial crisis.  This indicates that growth will likely decelerate over the medium term.

The greatest risk to the market is that the Federal Reserve will be too aggressive in raising overnight interest rates, throwing the economy into recession.  To wit, eight of the eleven postwar tightening cycles resulted in a recession.  Assaults on international trade will only serve to weaken growth and dampen business sentiment, so present a further risk to the market.  As we have discussed previously, the Chinese economy is heavily indebted and thus fragile.  A credit crisis in China would be highly disruptive to the world economy and financial markets.  Finally a war on the Korean peninsula or in the Persian Gulf would likely tip the economy into recession and lead to heavy losses in stocks.  The recent appointment of John Bolton as national security advisor particularly increases the possibility of conflict with Iran given his historic extreme hostility toward the Islamic Republic.

Going forward, we expect continued volatility as the markets grapple with the issues discussed above.  As of now, we are not predicting a recession or bear market, but are paying close attention to the yield curve and the actions of the Federal Reserve.  If the yield curve were to “invert”, i.e. short-term interest rates trade higher than long-term interest rates, the likelihood of a recession and bear market would increase significantly.  For the remainder of the year, we project the US stock market, as represented by the S&P 500 stock index to trade in a range of 2500 to 2900.  It currently stands at 2641.

Annual Client Letter and Outlook

January 2, 2018

Market Data for year end 2017:

S&P 500 Stock Index:  2674, up 19.4%

Ten-year Treasury Note Yield:  2.41%, down .04%

Gold:  $1,309 per ounce, up 13.6%

Oil:  $60 per barrel, up 11.1%

Global stock markets advanced strongly nearly across the board in 2017, as solid economic growth and corporate profits were paired with continuing low inflation and interest rates.  In the United States, stocks had the added impetus of a large corporate tax cut that is seen by analysts as adding up to seven percent to earnings per share for the S&P 500 stock index.  Long-term bond yields continued to hover near historically low levels as inflation remained subdued.  With this benign backdrop, realized and implied volatility in both stocks and bonds reached record low levels.

Moving into 2018, there is reason to expect that the environment will be more difficult for the stock market.  While we are not forecasting significant weakness due to continued strength in the economy, stocks are facing increased headwinds on two fronts:  valuation and liquidity.  On valuation, the stock market is expensive.  Sentiment is widely positive with expectations for earnings and economic growth elevated.  While the momentum coming out of 2017 is formidable, high valuations and sentiment increase the scope for disappointment and losses.  The market’s margin for error, basically, is substantially reduced.

In terms of liquidity, stocks are going to face increased competition for investor funds from bonds.  To date, a significant component of appreciation in the stock market has been driven by global central banks purchasing large numbers of bonds (known as quantitative easing or “QE”), effectively removing them from the market.  With fewer bonds available for purchase by investors, stocks benefited with the consequent reduced competition for investment dollars.  This process is now being thrown into reverse.  The Federal Reserve is unwinding its bond portfolio by effectively selling bonds onto the market, while the European Central Bank has significantly reduced its bond buying program and may continue to taper it over the course of the year.  Furthermore, with the passage of the tax cut in the US, the US Treasury is going to have to issue a greater supply of bonds to make up for the lost revenue.  The bottom line is that to the extent stocks benefited from central bank bond purchase programs, they will likely be negatively impacted by their reduction and reversal.

Further risks to stocks include an increase in wages and inflation, financial instability in China, and war.  On wages and inflation, the US economy is moving into the ninth year of an economic expansion, with unemployment coming in at 4.1%.  Standard economic models would expect to see stronger wage gains and inflation with these conditions than has yet to be realized.  We believe extensive global industrial capacity and additional workers still available to come into the workforce have suppressed wages and inflation, and may continue to do so.  It is a risk, however, that further economic expansion will start to elevate wages and prices, and that would be a negative for stocks through increased costs for labor and capital.

As we have discussed before, Chinese economic growth has been driven increasingly through an ever expanding mountain of debt.  Debt financing is inherently unstable, as was witnessed in the US housing crisis of 2008.  With debt levels elevated, the Chinese economy walks an increasingly narrow tightrope to continue its expansion.  Thus far, Chinese authorities have been able to keep the music playing.  As they are not omniscient, however, there is the possibility for error that would destabilize the Chinese financial system and significantly weaken economic growth.  As China is currently the world’s second largest economy, weakness in China would negatively impact global financial markets.

A large scale war either on the Korean Peninsula or in the Persian Gulf could have significant negative economic implications, possibly leading to global recession.  Such an event would severely impact stocks, likely leading to losses in excess of 20%.  However, as President Trump’s only leg to stand on politically is the strength of the US economy and financial markets, (as he reminds us almost daily), we find it unlikely that he would risk the negative economic and financial impacts of war with North Korea or Iran.  We put the probability of such an event at under ten percent.

On balance, we expect the US stock market to continue its advance into 2018 but at a reduced rate and with greater volatility than 2017.  For 2018, we expect the S&P 500 stock index to trade in a range of 2500 to 2900.  It finished 2017 at 2674.  Thank you again for the confidence and trust you have placed in us.  As always, please do not to hesitate to contact us with any questions or concerns.  We wish you a happy, healthy, and prosperous 2018.

Third Quarter Review/Fourth Quarter Outlook

October 2, 2017

Market Data for the quarter ending September 30, 2017:

S&P 500 Stock Index:  2519, up 4.0%

Ten-year Treasury Note Yield:  2.33%, up .03%

Gold:  $1,285 per ounce, up 3.5%

Oil:  $52 per barrel, up 13.0%

Stocks continued their rally in the third quarter of 2017, as solid earnings, global economic growth, and persistent low interest rates provided a sound underpinning for share prices.  Although there was heated rhetoric regarding the North Korean nuclear weapons program, markets largely shrugged it off as empty bluster.  Bond yields were little changed with continued low inflation balanced against a Federal Reserve that has expressed its intention to continue to tighten monetary policy.  Yields did begin to rise in the final month of the quarter with the market beginning to anticipate growth and deficit stimulating tax cuts.  Oil prices advanced substantially with global demand coming in stronger than forecasted against reduced supply from OPEC and its allies.

Our expectation is that the stock market will continue to advance in the final quarter of 2017 largely due to a continuation of the trends cited above.  Primary risks in the near term to this forecast include a worsening in the North Korean nuclear situation and the US Congress struggling with the passing of tax cut legislation.  Longer-term, an overly aggressive Federal Reserve and fragile Chinese financial system could derail the stock market, as well.

As described in previous market analysis, a war in North Korea would have devastating humanitarian and economic consequences.  Our belief is that a war is too horrible to contemplate, so both sides will refrain from actual hostilities.  There is always the risk of miscalculation, however, so war cannot be completely ruled out.  A shooting war on the Korean Peninsula would risk a global recession and stocks would likely suffer heavy losses.

Domestically, although one would think it would be easy for a Republican controlled Congress with a Republican President to cut taxes, their inability to repeal the Affordable Care Act gives one pause.  In September, stocks did in fact begin to pick up along with bond yields, as markets began to anticipate the passing of tax cut legislation.   Our expectation is that desperately needing a legislative “win”, the Republicans will likely be able to pass tax cuts of a fairly significant magnitude.  However, if the process bogs down, we would expect to see stocks suffer accordingly.

Longer-term, the Federal Reserve could threaten a continued rally in stocks if they are seen as tightening monetary policy too aggressively.  The Fed has already raised their benchmark overnight lending rate by a full percentage point and has indicated that it intends to raise rates a further quarter point in December and three quarters of a point in 2018.  Furthermore, the Fed will begin this month to liquidate its portfolio of long-term bonds acquired during its “quantitative easing” programs (QE).  As QE was intended to stimulate the economy and markets by injecting cash into the financial system, some fear that the Fed reversing its position will smother the economy and markets when executed in conjunction with higher overnight interest rates.  Although the Fed has assured the market that it will cautiously and gradually tighten policy, there is the risk that they misread economic conditions and tip the economy into recession, thus ending the rally in stocks.

Finally, the Chinese economy has become increasingly dependent on debt, an inherently fragile condition.  China has been a prime mover in the global economic upturn we are enjoying, and if their financial situation were to falter, their economy would likely follow with negative repercussions for the rest of us.  Previous bouts of Chinese financial instability have pressured global markets, and we have no doubt they would do so again.  So far, Chinese authorities have been able to keep their economic train on its tracks, but one cannot be too confident that they will be able to do so indefinitely.

Having said all this, our expectation is that the stock market rally will continue in the final months of 2017 absent the realization of the risks cited above.  When the rally does come to an end, we feel we are well positioned, as our portfolios are more heavily weighted toward defensive sectors such as healthcare, consumer staples, and utilities than is the general market.  Our portfolios also generate greater dividend income than the broader market, giving added support in the event of a downturn.  For the remainder of 2017, we see the stock market, as represented by the S&P 500 stock index, to trade in a range of 2400 to 2650.  It currently stands at 2519.  As always, do not hesitate to contact us with questions or concerns.  We thank you for your business and continued confidence.

Second Quarter Review/Third Quarter Outlook

July 3, 2017

Market Data for the quarter ending June 30, 2017:

S&P 500 Stock Index:  2423, up 2.5%

Ten-year Treasury Note Yield:  2.30%, down .09%

Gold:  $1,242 per ounce, down .07%

Oil:  $46 per barrel, down 9.8%

Stocks rallied, and bond yields declined in the second quarter of 2017 as strong earnings growth, solid global economic performance, and modest inflation buoyed financial markets.  Decreased political uncertainty in Europe also played a positive role, as the moderate Emanuel Macron defeated right-wing populist Marine Le Pen in the French presidential election.  Strength in global economies weakened the dollar, boosting corporate profits, while fears of continued oversupply sunk oil prices.  The market saw record setting low volatility in the second quarter with the benign conditions described above, although volatility did pickup in the final week of the quarter with fears of tighter monetary policy increasing gyrations in stocks, bonds, and currencies.  We will elaborate further on this below along with other risks to financial markets.

The above mentioned fears of tighter monetary policy do represent a legitimate threat to stocks and the global economy.  Following the financial crisis of 2008-09, global central banks dramatically increased monetary accommodation by slashing short-term interest rates and buying large quantities of long-term bonds, thus flooding the financial system with money.  This loosening of financial conditions played a vital role in driving stocks higher while supporting economic growth.  However, recent statements from the heads of the US Federal Reserve, European Central Bank, and the Bank of England suggest that this era of easy money may be coming to an end.  The Federal Reserve has already raised the overnight interest rate charged by banks by a full percentage point in the last eighteen months.  We feel a tightening of monetary conditions is premature given persistently weak inflation and a global economy that although firming, is far from overheating.  If central banks misjudge conditions and aggressively remove monetary accommodation, global economies would be at a heightened risk of recession with consequent negative implications for stocks.

As we discussed in our previous market analysis, the Chinese financial system represents a further risk to the global economy and world stock markets.  Simply put, growth in the Chinese economy is increasingly dependent upon debt, which is an inherently unstable condition.  As was the case with the real estate driven financial crisis in the US, if economic momentum is not maintained, a highly indebted financial system can collapse like a house of cards.  Although Chinese authorities have thus far been able to keep the Chinese economy on track, continued success is far from assured.  If the Chinese financial system were to seize up, the implications for global economic growth would be significant as would the impact on world stock markets.  Previous bouts of Chinese financial instability in the summer of 2015 and early 2016 saw sharp declines in global and US stock markets.

The final risk is perhaps the most significant.  The possibility of war on the Korean peninsula due to the situation surrounding North Korea’s development of nuclear weapons and intercontinental ballistic missiles (ICBMs) capable of striking America is very real, although the odds are exceedingly difficult to handicap.  A war with North Korea would be devastating both in terms of the loss in human life and the impact on the world economy and global financial markets.  The sheer magnitude of death and destruction may, hopefully, be enough to dissuade the parties involved to refrain from hostilities.  However, the leadership of North Korea views the development of nuclear armed ICBMs as essential to its long-term survival, while President Trump has shown himself at times to be impulsive and erratic.  This is a highly combustible situation.  If the US is seen as dramatically increasing the aggressiveness of its rhetoric and military capabilities in the region, we would expect significant declines in world and US stock markets.

Absent the realization of the risks detailed above, we expect the US stock market to continue to rally for the remainder of the year.  Global growth and corporate profits have real momentum and should support higher share prices.  We do not desire to seem overly pessimistic in describing the risks to the markets.  They are far from certain.  However, it is important to always be cognizant of risk.  Understanding market drivers is the key to maintaining investment stability and avoiding panic, which is never a sound strategy.  In the face of uncertainty, which in truth is always present, we will continue to execute our own strategy of quality, value, patience, and diversification.  For the remainder of 2017, we expect the market, as represented by The Standard and Poor’s Five-hundred stock index to trade in a range of 2250 to 2550.  It closed the second quarter at 2423.  We thank you for the continued confidence you have placed in us, and as always, please do not hesitate to contact us to discuss questions or concerns.

First Quarter Review/Second Quarter Outlook

April 3, 2017

Market Data for the quarter ending March 31, 2017:

S&P 500 Stock Index:  2363, up 5.5%

Ten-year Treasury Note Yield:  2.39%, down .06%

Gold:  $1,251 per ounce, up 8.6%

Oil:  $51 per barrel, down 5.6%

The stock market advanced solidly in the first quarter of 2017 on a strengthening global economy and hopes that “pro-business” policies from President Donald Trump would boost corporate profits.  The rally in stocks stalled in the final month of the quarter as doubts surfaced about the ability of President Trump to enact his agenda of lower taxes and increased infrastructure spending.  After rising sharply in the fourth quarter of 2016, bond yields stabilized on skepticism that the Trump administration would be able to accelerate economic growth.  Similarly, the US dollar weakened as US growth was no longer seen as outperforming the rest of the global economy, as previously thought.

Several risk factors present themselves in the months ahead.  First and foremost is the market’s perception of Mr. Trump’s aforementioned ability to enact his pro-business agenda beyond slashing environmental regulations.  In their first major legislative test, President Trump and his Republican allies in Congress were unable to “repeal and replace” President Obama’s landmark healthcare reform, the Affordable Care Act.  The Republicans had been running on repeal for seven years, and a major campaign promise of President Trump was to quickly repeal and replace the Affordable Care Act with something “much better”.  Their inability to execute on a fundamental policy objective draws into question their ability to enact “tax reform”, aka tax cuts, in a meaningful and timely fashion.  Furthermore, the final leg of Trump’s economic agenda, infrastructure investment, may be completely out of reach.  If they are seen as struggling to move forward on tax cuts, we expect the stock market to come under renewed pressure.  A further test of the Republican’s ability to function as a governing party is quickly approaching.  The current budget authorization for the Federal government expires on April 29.  It is not a foregone conclusion that a “continuing budget resolution” will be agreed upon to avoid a government shutdown.  Watch this space.

Politics across the Atlantic also threaten the market.  On May 7, France will elect its next president.  The likely finalists are centrist candidate Emmanuel Macron and right-wing populist Marine Le Pen.  Mr. Macron wants to liberalize the French economy and further integrate France with the European Union, while Ms. Le Pen wants to move the French economy toward greater state control and isolate France from the rest of Europe.  Most dangerously, she has threatened, if elected, to remove France from the Eurozone currency block and bring back the French Franc.  Such a move could possibly lead to the complete dissolution of the Eurozone and a financial crisis of global proportions.  The disruption caused by a disintegration of the Eurozone would be immense given the close financial links among the member economies.  If Le Pen wins the election, we would expect an immediate and severe market correction, possibly leading to a full blown bear market if she were to act on removing France from the Euro.  Fortunately, Ms. Le Pen’s chances are seen as not good, although after the Brexit vote and the election of Donald Trump, one cannot be too sure.

Finally, a recurring risk has been and remains the fragility of the Chinese economy.  In the first months of 2016, the market suffered a strong selloff on fears that the Chinese economy was falling toward recession.  Fortunately, Chinese authorities were able to stabilize the economy by heavy use of stimulative measures such as infrastructure investment and loosening the ability of corporations and local governments to obtain credit.  The upshot is that Chinese growth is increasingly built upon an ever increasing mountain of debt.  As we all learned from the real estate bubble and financial crisis, highly indebted systems are inherently unstable and can collapse like a house of cards when momentum in their growth stalls.  China has become the world’s second largest economy, and the financial and economic impacts of a disorderly unwinding of Chinese debt would be significant.  The Chinese authorities have been able to keep the music playing thus far.  If they were to falter, we would expect the American stock market to suffer a significant correction as was experienced early in 2016.

Fortunately, the risks described above are just that, risks, and far from certain.  While they bear close scrutiny and understanding, on a long-term basis, they will ultimately be bumps on the read toward greater portfolio appreciation.  This was the case with the recessions and bear markets following the popping of the internet and real estate bubbles, with stocks having recovered to all-time highs.  As such, we will continue to execute our strategy of quality, value, diversification, and patience.  For the remainder of 2017, we see the US stock market, as represented by the S&P 500 stock index, trading in a range of 2175 to 2500.  It closed the first quarter at 2363.  We appreciate your business and the confidence you have placed in us.  As always, please do not hesitate to contact us with any questions or concerns.


Annual Client Letter and Outlook

January 3, 2017

Market Data for year end 2016:

S&P 500 Stock Index:  2239, up 9.5%

Ten-year Treasury Note Yield:  2.45%, up 0.18%

Gold:  $1,152 per ounce, up 8.7%

Oil:  $54 per barrel, up 45.9%

After global stock markets began 2016 with their worst January on record on fears of weakness in the Chinese economy and an aggressive US Federal Reserve, markets staged a recovery that accelerated into year end.  The Chinese economy stabilized due to stimulus enacted by Chinese authorities, and the Federal Reserve pulled back from its earlier stated expectation of four interest rate increases in 2016, settling on only one.  Along with the moderation in policy by the Federal Reserve, unprecedented action by global central banks drove long-term interest rates to record lows, with the ten-year US Treasury Note yielding just 1.37% in July (currently 2.45%).  Following the election of Donald Trump, the rally in stocks accelerated on hopes of economic stimulus in the US.  Bonds reacted negatively on a renewed fear of inflation and a once again more aggressive Federal Reserve.

Going forward, several risks present themselves.  First and foremost are higher interest rates and a stronger US dollar and their likely economic and financial impact.  On the back of hopes for economic stimulus and resultant higher interest rates, the US dollar appreciated significantly in 2016 against other global currencies.  A stronger dollar suppresses economic growth in the US by making US exports less competitive on global markets, increasing the market share of imported goods, and reducing the value of corporate income earned overseas.  Higher interest rates reduce the capacity of consumers and businesses to borrow, providing a break on economic activity.  Additionally, higher interest rates make stocks less attractive relative to bonds, thus pressuring stock valuations.

A stronger dollar and higher US interest rates also place stress on emerging markets, as their relatively fragile financial systems are strained by the flight of capital from their markets to the US and its promise of higher returns.  Historically, dollar strength has precipitated financial crises in emerging markets, and given their increased share of global economic activity, the threat of such a dollar induced crisis is a significant risk factor for the American economy and markets.  The Chinese financial system is particularly vulnerable because the aforementioned stimulus orchestrated by Chinese authorities was largely built upon debt.  As indebtedness in China had already grown significantly since the financial crisis, many fear that their financial position is highly unstable.

The political and financial situation in Europe is also an area of concern.  The British vote to leave the European Union (Brexit) shows that anti-globalization forces are ascendant in Europe.  France, Germany, and Holland have important elections in 2017, which could negatively impact the stability of the European economy.  France is of particular worry given the strong popularity of Marine Le Pen of the right-wing National Front party and the upcoming presidential election.  Le Pen is campaigning on leaving the European Union and possibly the Euro currency bloc.  If France were to exit the Eurozone, it could unleash a financial crisis of global proportions.  As it stands currently, Le Pen is not expected to win the presidential election, but as Brexit and the election of Donald Trump have demonstrated, there are no certainties in politics.

The potential for erratic and impetuous behavior by President-elect Trump is a further economic and market risk, although difficult to handicap.  A major international and/or constitutional crisis is a very real possibility with serious financial and economic implications.  If he were actually go through on his threats of high tariffs on foreign exports to the US, dollar strength as described above could be exacerbated, in addition to wreaking havoc on global supply chains.  Thus far, markets seem not to be taking these threats seriously, but we believe there is a definite whistling past the graveyard aspect to it.  Given the many contradictory and irrational statements emanating from Trump Tower, it is difficult to divine what President-elect Trump actually intends to do once in office.

Fortunately, on the threat of a stronger dollar and higher interest rates, we are skeptical that the policies, such as they are, that Mr. Trump and his Republican colleagues in Congress are proposing will generate substantially higher economic growth.  Contrary to popular belief, the supply side tax cuts that are likely to be the focus of the Trump administration have historically failed to spur economic activity.  Reductions in corporate taxes typically result in cash returned to shareholders, the paying down of corporate debt, and spending on acquisitions, not on increased hiring and investment.  Cutting taxes on the wealthy has little impact on growth as they are unlikely to spend their windfall given their already substantial ability to purchase whatever they want.  On Mr. Trump’s oft touted infrastructure investment program, based on what we have heard thus far, it is built on further corporate tax benefits and not on an actual direct injection of funds into the economy.  As such, the economic impact will be muted.

The upshot is that we expect dollar strength to moderate and for interest rates to stabilize at historically low levels.  The economy, which has grown slowly but steadily since the Great Recession, will remain relatively unperturbed.  This should provide a steady backdrop for stocks and bonds, offering modest but positive returns.  Market sectors that have rallied significantly since the election of Mr. Trump, such as financial firms and small company stocks, may be vulnerable, but our exposure to them is limited.  Higher yielding stocks, shares in multinational firms, and international stocks should perform well in our forecasted financial environment.

For 2017, we expect the American stock market as represented by the S&P Five-hundred stock index to trade in a range of 2050 to 2400.  It finished 2016 at 2239.  We appreciate your business and the confidence you have placed in us.  As always, please do not hesitate to contact us with questions or concerns.  We hope you have a healthy and prosperous 2017.

Third Quarter Review/Fourth Quarter Outlook

October 3, 2016

Market Data for the quarter ended September, 2016:

S&P 500 Stock Index:  2168, up 3.3%

Ten-year Treasury Note Yield:  1.61%, up 0.12%

Gold:  $1,317 per ounce, down 0.6%

Oil:  $48 per barrel, unchanged

The US stock market rose moderately in the third quarter against a stable economic backdrop and continued low interest rates.  Perhaps most importantly, the Federal Reserve decided against raising overnight interest rates at its September meeting.  The threat of what many see as a premature rise in overnight interest rates was pushed back until December, thus temporarily alleviating a risk factor that had been weighing on markets.

Moving forward, the market is presented with several risk factors.  The election for President has started to concentrate minds in the market.  A Trump presidency would risk throwing the global economy into a recession with his draconian anti-trade policies, to say nothing of the possibility of wider geopolitical instability.  The market is currently discounting a Clinton presidency, but if that were to change, we would expect markets to react negatively, perhaps significantly so.

While the threat of an increase in overnight interest rates has been likely been pushed back until the Federal Reserve’s December meeting, the market may not be prepared to deal with an increase in interest rates at that time absent a pickup in economic and corporate earnings growth.  While the economy has been improving steadily, growth has hardly been robust.  A rise in short-term interest rates could strengthen the dollar, thus suppressing US exports and inflation.  This would have a depressing impact on growth of an economy that is already growing at a subdued rate.

Although recent economic data has been encouraging, the Chinese economy is still carrying a disconcerting load of corporate and municipal debt.  A significant weakening of the Chinese economy could imperil the global economy by negatively impacting its supply chain in emerging markets that make up an increasing share of global economic activity.  As roughly half of S&P 500 corporate revenues are earned overseas, this would deliver a blow to the US stock market and wider economy.

A final risk that gained salience over the course of the quarter was the parlous condition of the European banking system.  European banks are over-indebted, unprofitable, and/or saddled with bad loans.  Germany’s largest lender, Deutsche Bank, has come under speculative attack for its perceived weak financial position.  While the European financial system is seen by many as to be more resilient than prior to the financial crisis of 2008, some doubt the ability of European policymakers to take the proper actions if the situation were to deteriorate.  A failure of a major European bank, such as Deutsche, would have wide ranging consequences throughout the global financial system and could lead to significant losses in stocks.

The stock market can rise further if the risks detailed above do not materialize.  If one or more do, we would expect heightened volatility and lower share prices.  In the face of this, we will continue to execute our strategy of quality, value, diversification, and patience.  If you have any questions or concerns regarding you portfolio, please do not hesitate to contact us.  For the remainder of the year we anticipate the stock market as represented by the S&P 500 to trade in a range of 2050 to 2250.  It closed the third quarter at 2168.

Second Quarter Review/Third Quarter Outlook

June 30, 2016

Market Data for the quarter ended June 30, 2016:

S&P 500 Stock Index:  2099, up 1.9%

Ten-year Treasury Note Yield:  1.49%, down 0.30%

Gold:  $1,325 per ounce, up 7.5%

Oil:  $48 per barrel, up 26.3%

Stocks ended the second quarter of 2016 with a modest increase.  The stock market rallied over the course of the quarter as action by the US Federal Reserve to raise interest rates was once again pushed back farther into the future because of recent weak US employment data.  The market suffered a setback late in the quarter, however, when the British people voted to leave the European Union (EU) by a margin of 52% to 48% in a popular, though technically non-binding, referendum (aka “Brexit”).  In addition to destabilizing world markets, the United Kingdom was thrown into a state of political disarray, with Conservative Party Prime Minister David Cameron submitting his resignation.  The leadership of the opposition Labor party has likewise been thrown into question.  Scotland, whose people voted decisively to remain in the EU, is threatening to leave the UK itself.  Although moderate in size, the UK has traditionally been a pillar of the global economy and world political order, and the current instability has the potential for wider political and economic disruption.  After a violent two day selloff of 5%, stocks regained their footing as worst case scenarios failed to materialize and cooler heads prevailed.

Brexit threatens the world economy on two counts.  First, the global economy was already in a fragile state, and the possibility of market turmoil can only serve to weaken it further.  In terms of the American economy and financial markets, global financial and economic disruption drives up the value of the US dollar, (the value of the British pound plunged to a thirty-one year low), which is widely considered by investors as a safe haven from global instability and economic weakness.  This makes American goods less competitive, thus weakening American production, and reduces the value of earnings American firms earned overseas.  Roughly half the value of sales by firms in the S&P 500 is generated in international markets.

Secondly, on a longer-term basis, a British withdrawal from the EU could be a harbinger for the unraveling of global trade and geopolitical cooperation in the West.  Throughout Western democracies, to include the United States, predominantly right-wing populist movements are on the march, threatening trade wars, a curtailment of immigration, and isolationism.  If realized, these policies would make the world poorer and less capable of dealing with global threats to political and economic stability.  The impact on firms would likely be depressed earnings and heightened uncertainty, making their shares less valuable.  Such a development is far from preordained, but the possibility is very real.  In the US, more specifically, Donald Trump becoming the presumptive Republican nominee represents a serious threat to America and the world.  If he were to be elected President, given his extreme rhetoric, volatile personality, and nearly incoherent policy positions, the stock market would likely decline significantly.  Although it currently seems unlikely that a President Trump will be the outcome of the election, the probability is not trivial.

On a more positive note, the volatility in markets in the aftermath of the Brexit vote has driven down long-term US interest rates and made it less likely the US Federal Reserve will increase its target rate in the near future.  We have previously named higher overnight interest rates as a major risk to the US economy and stock market.  Given modest growth and subdued inflation in the US and world economies, higher overnight interest rates are not appropriate.  They would only serve to weaken economic activity, depress employment, and lower investors’ estimates for corporate profits.  That having been said, the partial recovery of global stock markets to close the quarter does increase the threat posed by the Federal Reserve going forward.

In addition to Brexit and an overly aggressive Federal reserve, we have in previous letters listed the Chinese economy as a major risk to US stock markets.  While its growth has slowed, indebtedness in the Chinese economy has skyrocketed.  Such a combination is toxic and could lead to sharply lower Chinese growth, if not outright recession.  As China has been a major driver of global economic activity throughout the 21st century, Chinese weakness would reverberate around the world.  As detailed above regarding the causes and effects of a stronger US dollar, distress in China would likely lead to global economic instability and drive the dollar higher, thus suppressing US production and lowering the value of earnings by American firms generated overseas.  This is a threat we are monitoring closely.

For the remainder of 2016, we see the US stock market trading in a range of 1950 to 2200. It closed June 30 at 2099. The risks facing the market are not insignificant, but by no means assured.  In this uncertain environment, we will continue to execute our long-term strategy of purchasing high quality securities at attractive prices.  Thank you for the continued confidence you have shown in our management.  If you have any questions or concerns about your portfolio, please do not hesitate to contact us.

First Quarter Review/Second Quarter Outlook

March 31, 2016

Market data for the quarter ended March 31, 2016:

S&P 500 Stock Index:  2060, up 0.8%

Ten-year Treasury Note Yield:  1.79%, down 0.48%

Gold:  $1,233 per ounce, up 16.3%

Oil:  $38 per barrel, up 2.7%

Stocks swung violently in the first quarter of 2016 but ended the quarter nearly unchanged from the end of 2015.  The primary driver of the volatility was the price of oil.  Oil plunged in the first six weeks of the quarter, trading as low as $25 per barrel.  The collapse in the price of oil was seen as an indication of weak global economic growth, perhaps bordering on recession, while also wreaking havoc on the industrial and financial sectors of the economy.  During the boom in the price of oil from 2009 to 2014, the petroleum industry ramped up its borrowing and became a prime driver of demand for industrial equipment.  While lower prices are beneficial to consumers and non-energy related corporations, the resulting disruption in the financial and industrial sectors was seen as having the potential to tip the overall economy into recession.  In mid-February, Saudi Arabia and Russia, the two leading producers of oil, began discussing the possibility of a freeze in the growth of oil production.  This led to a sharp reversal higher in oil prices.  Stocks followed oil upward, as the concerns cited above dissipated.

Going forward, risks remain in the global economy and financial markets.  The Chinese economy is heavily reliant on debt financing, thus rendering it brittle and diminishing its ability to cope with stress.  Since the turn of the 21st century, China invested heavily in industrial capacity, real estate, and physical infrastructure.  This investment was financed largely through debt.  As this investment cycle has run its course, China has been left with an unbalanced economy and substantial industrial overcapacity.  The Chinese government knows that it must turn from an investment and manufacturing driven economy to one more balanced with consumption and services.  This transition is fraught with risks made worse by the massive overhang of debt that was accumulated in the investment boom.  Given the perilous economic position of China, a large depreciation in the Chinese currency, the yuan, is possible.  This could unleash a chain reaction in the currencies of other emerging markets and lead to a broader economic and financial crisis, as money would stampede out of the emerging world economies.  This would have serious consequences for the American stock market, as a significant portion of US corporate revenues are accrued overseas.  Fortunately, recent economic data out of China has turned up, and the yuan, the Chinese currency, has strengthened.  Nevertheless, the situation bears close monitoring.

While the Federal Reserve in its March monetary policy meeting moderated its projection for further increases in overnight interest rates, the risk of an overly aggressive Federal Reserve remains a risk to the economy and financial markets.  The Federal Reserve raised its benchmark overnight interest rate a quarter point (.25%) in December of 2015 for the first time since June of 2006.  Given the financial turmoil in the first six weeks of the year, this was increasingly seen as a mistake.  The Federal Reserve responded at its March meeting by keeping overnight rates in a range of .25 to .50% and lowering its expectation of further quarter point rate increases in 2016 from four to two.  As soon as financial markets stabilized, however, several Federal Reserve Bank presidents began making public statements that the tightening of monetary policy should be accelerated.  Given subpar wage growth and persistently below trend growth in GDP and inflation, we feel this would be a major policy error that could sink the US stock market and economy.  Fortunately, we believe Federal Reserve Board Chairwoman Janet Yellen does not share the opinions of these hawkish bank presidents and will not adopt an inappropriately aggressive policy.

Outside of economics, political risk factors are present.  While we feel it is a distinct long shot, a President Trump could be an economic and financial disaster given his calls for draconian tariffs on foreign imports.  This could result in a global trade war that would plunge an already fragile world economy into recession.  While free trade is not the economic panacea that many claim it to be, Donald Trump’s position is reckless and destabilizing.  There are more constructive methods of dealing with the negative impact of trade on American workers, such as increasing the earned income tax credit and infrastructure investment.  On the other side of the Atlantic, the United Kingdom is voting in June on a referendum to leave the European Union, (commonly referred to as Brexit).  Such a move would weaken the trade and financial systems of America’s largest trading partners and would be a distinct negative for both the global and American economies.  The outcome of the referendum is highly uncertain, with the economic risks being weighed against perceived vulnerabilities to the refugee situation in Europe made worse by the recent terror attacks in Paris and Brussels.

While these risks are substantial, we by no means think they are inevitable.  In the face of them, we will continue to execute our investment strategy of quality, value, diversification and patience.  For the remainder of 2016, we expect the American stock market, as represented by the S&P Five-hundred stock index to trade in a range of 2150 to 1850.  It ended the quarter at 2060.  As always, please feel free to contact us with any questions or concerns.

Market Update

February 11, 2016

On February 11, look the S&P 500 stock index closed below the lower limit of our expected trading range for 2016, viagra sale 1850.  The index closed at 1829.  Fear of global economic weakness bleeding into the American economy in the context of a US Federal Reserve that has begun to withdraw support for the economy, has driven investors to sell risky assets such as stocks, corporate bonds, emerging market assets, and commodities, and buy the US dollar and government bonds.

The Chinese economy is decelerating rapidly, and as a result, the countries that have supplied China with raw materials are coming under economic and financial strain.  Commodity prices have plunged almost across the board, and resource producing and related stocks have been decimated.  European banks are showing significant strain under the weight of negative interest rates.  American industrial production has contracted four months in a row.  With the US dollar strengthening significantly, the foreign earnings of US corporations are under pressure, and declining exports have become a drag on the economy.  US economic growth in the fourth quarter clocked in at an anemic 0.7%.  All of this points to the possibility of a recession in the American economy in 2016.

The one bright spot in the economy has been the labor market, with consistent job growth and a reduction in the unemployment rate to 4.9% as of the end of January.  Additionally, the January employment data also reported that wages and hours worked increased at a healthy clip.  The dramatic decrease in energy prices, most notably gasoline, has given additional support to the American wage earner.  The downside to the relatively robust employment data, however, is that it may encourage the US Federal Reserve to further increase overnight interest rates.  (The first rate increase in overnight interest rates since June 2006 took place in December of last year.)   This is perhaps the greatest risk to the US economy and stock market, as observers outside the Federal Reserve view the American economy as not being able to withstand higher interest rates at this time.

Our view is that while the risks related to China, overseas economies, and commodity markets are well documented and publicized, and are substantially reflected in the price of natural resource companies, the uncertainty of their impact on the strength of the US economy has become the market’s primary area of concern.  As stated above, this is complicated by the Federal Reserve’s stated desire to further increase overnight interest rates in 2016.  While we believe the Fed will exercise discretion and not push the economy toward recession, this is not a certainty, and substantial risks remain.  In our portfolios, valuations are attractive, and we are positive on their long-term prospects.  The near-term prognosis is, as is often the case, much less certain.  For the remainder of 2016, we are watching the 1700 level on the S&P 500.  A close below 1700 would push the stock market into a “bear market” as defined by a 20% decline from a market’s peak.  If the S&P 500 closes below 1700, we will update our analysis.

Annual Client Letter and Outlook

January 4, 2016

Market Data for year end 2015:

S&P 500 Stock Index:  2044, down 0.7%

Ten-year Treasury Note Yield:  2.27%, up 0.10%

Gold:  $1,060 per ounce, down 10.4%

Oil:  $37 per barrel, down 31.5%

The primary themes of financial markets in 2015 were the deceleration of the Chinese economy and the tightening of monetary policy by the US Federal Reserve.  These two dynamics kept stocks under pressure, punished commodities, and pushed long-term bond yields in opposing directions, resulting in little change on the year.

The deceleration of the Chinese economy, with its focus on manufacturing and infrastructure investment, sent shock waves throughout the global economy leading to slower global economic growth.  Emerging markets that relied upon exports of raw materials to China were particularly hard hit.  In the face of US Federal reserve tightening, their currencies depreciated, thus reducing their ability to service debt denominated in US dollars.  This added further strain to their economies.

The tightening of US monetary policy by the Federal Reserve was a focus of the market throughout 2015 culminating in the first increase in US overnight interest rates since June of 2006 on December 16th.  Higher US interest rates threaten to slow the US economy by increasing the borrowing costs of consumers and businesses and increasing the value of the dollar, which reduces the competitiveness of US manufacturing and US corporate profits earned overseas.  A strengthening US dollar also increases the pressure on commodities, which are primarily denominated in dollars.

The net effect on stocks by these dynamics was a steady pressure that left stocks little changed for the year.  Beneath the surface, stocks exposed to the global economy, particularly those in the natural resource sector, declined in value, while those with a domestic focus and seen to be able to grow regardless of a slowing economy performed strongly.  As mentioned above, commodities were ravaged due to weak global demand and chronic overcapacity across the spectrum.  In the case of oil, the Saudi Arabians were determined to squeeze out foreign competitors, most notably the US shale drilling industry, by pumping oil at full blast in spite of significantly lower prices.  Bond yields were torn between higher US overnight interest rates and a sluggish global economy, resulting in little change for the year.

Going forward, we believe the themes of a weakening China and tighter US monetary policy will continue to drive markets.  It is difficult to discern the actual condition of the Chinese economy due to the unreliability of Chinese statistics.  That having been said, the steady depreciation of the Chinese currency, the yuan, points to continued economic weakness.  The Federal Reserve represents a danger in that their projection for the pace of higher overnight interest rates exceeds that of the market.  The market is telling the Federal Reserve that economic growth and inflation are too weak to weather an aggressive increase in overnight interest rates.  If this were to come to pass, the Fed would risk pushing the US economy into a recession, which would likely send stocks lower, perhaps significantly.

A “tail” risk for the market is a disruption to oil production in the Middle East due to geopolitical unrest.  As of this writing, rioters in Iran sacked the Saudi Arabian embassy in Tehran reacting to the execution of a Shia dissident by the Saudis.  (Iranians are Shia Muslims.)  Saudi Arabia responded by cutting off diplomatic relations with Iran.  Iran and Saudi Arabia find themselves in competition throughout the region, from Yemen to Syria.  If war were to break out between the two countries, oil prices would likely skyrocket and the global economy pushed into recession.  This would in all likelihood lead to a bear market in stocks and lower bond yields.

Our base case is that the Federal Reserve does not raise overnight interest rates quickly enough to push the US economy into recession.  If this proves to be the case, we expect commodities and the economically sensitive stocks that were punished in 2015 to trade higher in price as the fear of aggressive monetary tightening is reduced.  Conversely, those “growth” stocks which performed strongly in 2015 may find themselves coming under pressure given what have become near extreme valuations.  We would also project that longer term US interest rates would trend modestly higher.  For 2016, we expect to US stock market as measured by the S&P 500 stock index to trade in a range of 1850 to 2200.  It ended 2015 at 2044.


Market Update

October 22, 2015

On October 22, The S&P 500 stock index closed at 2053, above the top of our forecasted range of 2050 to 1800 for the remainder of 2015.  Risk factors we discussed in our previous market analysis have been heavily discounted by the market.  The economic situation in China seems to have stabilized, decreasing the likelihood of deflation and financial contagion spreading throughout emerging markets.  In regards to the Federal Reserve, a lackluster September jobs report showing disappointing job creation and no wage growth led the market to significantly reduce the likelihood of an increase in overnight interest rates in 2015.  This is a further improvement in the outlook for deflation and general economic stability, as a rate increase would suppress already tepid economic growth.  Finally, the situation in Congress has greater clarity.  Representative Paul Ryan of Wisconsin will likely be elected Speaker of the House of Representatives.  The market has interpreted this as decreasing the likelihood of a damaging showdown over raising the ceiling on the federal debt.

While the market has discounted these risk factors, we believe that they are still present.  Economic activity in China could further deteriorate, the Federal Reserve could raise interest rates before year end, most likely in December, and a clean resolution of the debt ceiling situation is far from assured.  Furthermore, even if a rise in the debt ceiling is successfully negotiated, a big if given the contentiousness of the GOP congressional membership, the Congress is facing a possible government shutdown in December when a previously agreed to budget resolution expires.  If any of these risks are realized, we would expect renewed weakness in stocks.  We cannot handicap the likelihoods of these risk scenarios, but firmly believe they are not insignificant.  For the remainder of the year we forecast a trading range in the S&P 500 stock index of 1950 to 2150.  It closed on October 22 at 2053.  Please feel free to contact us with any questions or concerns.


Third Quarter Review/Fourth Quarter Outlook

September 30, 2015

Market Data for the quarter ended September 30, 2015:

S&P 500 Stock Index:  1920, down 6.9%

Ten-year Treasury Note Yield:  2.06%, down 0.28%

Gold:  $1,115 per ounce, down 5.3%

Oil:  $45 per barrel, down 23.7%

Global and American stocks experienced elevated levels of volatility and downward pressure in the third quarter of 2015.  Economically sensitive shares such as those of industrial, automotive and commodity firms were sold particularly hard.  The driving factors were twofold:  1) The Chinese economy, which has been the largest single driver of global growth over the past decade, has rapidly decelerated, and 2) the U.S. Federal Reserve appears intent on raising overnight interest rates, which would likely weaken the American and global economies.  With the prospect of slower economic growth, long-term interest rates were suppressed along with stocks, while commodity prices deteriorated substantially across the board.

For much of the preceding decade China has been the driver of global economic growth.  It rapidly industrialized to meet the world’s demand for cheap consumer goods and build a modern infrastructure for its own economy.  Recently, however demand for its goods has weakened in the face of subdued growth in the economies of the developed world, e.g. the US, Canada, Australia, Western Europe, and Japan.  Additionally, its rapid building of infrastructure was taken too far, resulting in massive overcapacity and a heavy load of debt.  The net result has been a significant slowdown in the Chinese economy, putting a strain on countries and industries that have helped fuel its growth.

Particularly hard hit have been suppliers to China, such as emerging market economies, energy and mining firms, and the industrial companies that supply miners and oil drillers.  There currently exists a glut of raw materials on the global economy, ranging from oil, to copper, iron ore and fertilizer.  This glut, along with Chinese manufacturing overcapacity, imposes serious deflationary forces on the global economy.  As we have discussed before, deflation, i.e. lower prices for goods and services, although seemingly benign, is dangerous because it weakens consumer demand, pressures corporate profits and wages, and increases the burden of debt.

The threat of deflation brings the monetary policy of the U.S. Federal Reserve into focus.  In response to the financial crisis and recession of 2008-09, the Federal Reserve has maintained overnight interest rates at nearly 0% in order to stimulate the U.S. economy and support financial markets.  While the U.S. economy has moderately improved, and financial markets have substantially recovered, wage growth and inflation have remained weak, with inflation remaining well below the Federal Reserve’s stated target of 2%.  (The latest reading of annual inflation was 0.3%).  Despite the Federal Reserve failing to achieve their inflation target of 2%, they state that they are keen to raise overnight interest rates.  Although they balked at doing so at their most recent meeting citing global financial market volatility, they insist that an increase in overnight interest rates will take place before the end of the current year.  This apparent enthusiasm for raising interest rates is a distinct negative for the U.S. and global economies because it signals that the Federal Reserve is comfortable with inflation levels that dangerously border on deflation.

There is little visibility on how the China and Federal Reserve issues will resolve themselves, and as such, we would expect continued market volatility.  While shares in commodity and industrial companies have been sold down to, and in some cases beyond historically attractive valuations, we anticipate the possibility of further weakness in the near term.  On a longer-term basis, however, we expect financially sound firms to pull through and produce above average returns from today’s deeply depressed levels.

An additional concern in the near term is the possibility of yet another shutdown of the federal government, and, more ominously, the threat of the U.S. defaulting on its debt due to a failure by the Congress to raise the federal debt ceiling.  While the resignation of House Speaker John Boehner at the end of October makes the possibility of an imminent government shutdown less likely, the issue will likely be revisited before 2015 draws to a close along with a potential crisis over the raising of the federal debt ceiling.  Such political drama has always been a negative for stocks, and we so no reason why this iteration will be any different.

For the remainder of the year we see the US stock market, as represented by the S&P 500 stock index, to trade in a range of 2050 to 1800.  The index closed the third quarter at 1920.  As always, we appreciate the confidence you have placed in us and please do not hesitate to contact us with any question or concerns.

Market Analysis Update

August 30, 2015

The week of August 24, 2015 saw global stock markets experience extreme volatility.  The proximate cause was an August 11 devaluation in the Chinese currency, the yuan, and a collapse of the Chinese stock market on August 24.  This led investors to question the strength of the Chinese economy and fear the possibility of a damaging deflation emanating from China.  (Deflation is a reduction in the prices of goods and services.)  Deflation is seen as damaging because it increases the burden of debts, depresses consumer demand, and pressures corporate profits.

Stocks in companies exposed to Chinese and emerging market growth had already been under pressure for months, with industrial and commodity related firms particularly showing strain.  This culminated in American stock market wide rout on Monday, August 24, and Tuesday, August 25.  From levels of deep despair, the market rebounded violently on the following Wednesday and Thursday, ending the week with a modest net gain.

Going forward, we expect relatively elevated levels of volatility but do not believe a stock bear market, commonly defined as a decline of over 20%, is imminent.  Bear markets are typically driven by a recession or financial crisis, neither of which we see as likely in the near to intermediate future.  America’s direct economic exposure to China is limited, (under 1% of GDP in exports), as is that of American financial institutions.  Most of the stocks we utilize in our portfolios are trading at valuations we feel will lead to robust long-term returns.

We see three risk factors to our relatively sanguine forecast.  First would be an accelerated deterioration in the Chinese and global economies.  As suggested above, while America is relatively insulated from foreign trade, there is a point at which global weakness would begin to bite more severely.  Secondly, the Federal Reserve may begin increasing its benchmark overnight interest rate as soon as September 17.  The market is not prepared for this possibility.  Given current low levels of inflation, a Federal Reserve interest rate increase would send the message that the Federal Reserve is willing to accept low inflation dangerously bordering on deflation, which as previously discussed, will pressure economic activity and corporate profits.  Finally, September may witness the threat of another US Federal government shutdown due to congressional gridlock, which has historically led to market turbulence.

For the remainder of the year, we see the US stock market, as represented by the Standard & Poor’s Five-hundred stock index, trading in a range of 1850 to 2150.  It is currently trading at 1989.  Please feel free to contact us with any questions or concerns you may have regarding the market or your portfolio.

Second Quarter Review/Third Quarter Outlook

June 30, 2015

Market Data for the quarter ended June 30, 2015:

S&P 500 Stock Index:  2063, down 0.2%

Ten-year Treasury Note Yield:  2.34%, up 0.41%

Gold:  $1,178 per ounce, down 0.1%

Oil:  $59 per barrel, up 22.9%%

Stocks were little changed in the second quarter of 2015, with concerns over the future of Federal Reserve monetary policy and the debt crisis in Greece weighing on share prices.  The bond market suffered losses on the prospect of the Federal Reserve raising overnight interest rates later in the year.

The debt crisis in Greece is a result of the Greek government and their creditors, the International Monetary Fund, The European Union, and the European Central Bank, being unwilling to compromise on the terms of a continued bailout of Greece’s overly indebted economy.  This is a classic game of chicken, with both sides racing towards a cliff hoping the other side blinks first.  As the situation stands now, the bailout of Greece has expired and Greece has effectively defaulted on a loan from the International Monetary Fund.  Greece has closed its banks and stock market to prevent a collapse of its financial system.  Greeks are only allowed to withdraw approximately $67 per day from ATMs.

The next shoe to drop will be a vote on a referendum on whether or not the Greek people want to accept the terms of a continued bailout from Greece’s creditors.  These terms mandate higher taxes and reduced pension benefits.  As Greece has already suffered a 25% decrease in economic production, the Greek government has claimed that these terms are too onerous.  If the Greek people accept the terms of the bailout, Greece will likely remain in the group of countries using the Euro currency (Eurozone).  If they do not, they will likely fall out of the Eurozone and revert to their own currency, the Drachma.  As this would risk a near total collapse of the Greek economy, we believe that the referendum will pass, and Greece will remain in the Eurozone.

The market implications, in our view, will be a relief rally in world stock markets if the Greek people do in fact accept the terms of the bailout.  If they do not, we expect further weakness in stocks, at least in the near term.  Longer-term, we think the impact on the global financial system will be limited because Greece is a small country, and the European financial system is robust enough to sustain the shock of Greece leaving the Eurozone.  One should keep an eye on the bonds of other Eurozone countries seen as economically vulnerable, principally Portugal, Spain, and Italy.  If the Greek crisis spreads to these other countries, further and more significant distress will likely be in store for the US and global stock markets.  Thus far, the pressure on the bonds of these countries has been quite limited.

Prior to the worsening of the Greek debt crisis, the primary concern for investors had been the future of Federal Reserve monetary policy.  The current expectation is for a quarter percentage point increase in the Federal Funds overnight interest rate in September and a possible follow on increase in December, from its current level of 0 to 0.25%, where it has sat since 2008.  It is widely believed that higher Federal Funds interest rates are a distinct negative for bonds and a possible problem for stocks.  The thinking is that higher short-term interest rates will put pressure on longer-term debt (bonds), which in turn will make stocks less attractive relative to bonds.  This effect has already been seen in the market for income producing stocks, particularly utilities, real estate investment trusts, and master limited partnerships.

For the broader stock market, some believe that higher interest rates would be indicative of stronger economic growth, which would be good for stocks.  Fed Chairwoman Janet Yellen has stressed that the Federal Reserve is “data dependent”, and will only raise rates as the economy improves, and we take her at her word.  Stock bulls point out that in the previous Fed interest rate tightening cycle of 2004 to 2006, stocks enjoyed a solid advance.  Our view is that to the extent that low interest rates have been central to this bull market, higher rates could present more of a challenge for stocks than in prior cycles.  One positive in the stock bull column is that this issue isn’t a secret to anyone, so anxiety around interest rate increases is already at least partially reflected in the price of stocks, particularly in income oriented shares.

An additional area of concern is the possible popping of a stock bubble in China.  Until recently, the mainland Chinese stock market has been in a vertiginous accent, with share prices more than doubling in the past twelve months.  Since peaking in early June, however, prices have fallen more than 20%, the traditional definition of a bear market.  The mainland Chinese stock market had exhibited the classic elements of a speculative bubble:  rapid appreciation, extreme valuation, and widespread, greed-driven popular hysteria.  (As the US stock market has exhibited none of these symptoms, we feel people who claim the US stock market is in a bubble are off base.)  The Chinese economy has already been flagging as of late, and a popping of a speculative bubble will not be helpful to buoying their economy in the current circumstances.  As China is a major trader in the global economy, Chinese economic weakness has wider economic and financial implications.

For the remainder of 2015, we see the S&P 500 stock index trading in a range of 1950 to 2225.  It finished the second quarter at 2063.  If you have any questions or concerns, please do not hesitate to contact us.


First Quarter Review/Second Quarter Outlook

March 31, 2015

Market Data for the quarter ended March 31, 2015

S&P 500 Stock Index:  2068, up 0.4%

Ten-year Treasury Note Yield:  1.93%, down 0.24%

Gold:  $1,184 per ounce, up 0.1%

Oil:  $48 per barrel, down 11.1%

The stock market stalled in the first quarter of 2015, as it struggled to come to grips with the prospect of higher short-term interest rates driven by the US Federal Reserve in the face of mediocre global and domestic economic growth.  The Fed has made no secret that it would like to begin tightening monetary policy after over six years of zero percent overnight interest rates.  Higher interest rates restrict economic growth and make stocks look less attractive relative to interest paying assets, such as bonds and cash.  While employment data has been relatively robust, other domestic economic data, notably retail sales and durable goods production, have been less so, and the global economy remains fragile.  While the surge in supply form US shale drilling is a significant factor, the collapse in the oil price of the last nine months is seen by many as evidence of anemic global demand.  The ten-year Treasury note interest rate declined over the quarter, as well, pointing to weaker growth.

As the Fed looks to tighten policy, the central bank of nearly every other major economy continues to loosen monetary policy, (the Bank of England is the exception).  This has significantly impacted the value of the US dollar versus other global currencies.  Fed Chairman Janet Yellen seems to grasp that as long as US inflation remains well below the Federal Reserve’s target rate of 2%, aggressive tightening of monetary policy is inappropriate.  (As per the Fed’s preferred measure, US inflation has risen 1.4% over the last year.)  However, the mere discussion of tightening has dramatically driven up the value of the US dollar.  This in turn has already weakened the US economy absent an actual interest rate increase itself.  A strong dollar makes US manufactured goods less competitive and reduces the profits of multi-national American corporations.

This dynamic has yet to fully play itself out and will continue to be the primary factor influencing the course of stock prices.  Geopolitically, further risks are presented.  Greece may leave the Eurozone, i.e. drop its use of the Euro currency.  A country leaving the Eurozone is unprecedented, and the ramifications could be highly destabilizing to the global financial system.  An escalation in the crisis in Ukraine could further weaken a struggling European economy, while instability in the Middle East has the potential to disrupt oil production and drive crude prices higher.  In domestic politics, the threat of another debt ceiling standoff is possible at mid-year.  In 2011, such a manufactured crisis led to extreme volatility in stocks.

Taken together, we are cautious regarding the prospects for stocks over the remainder of the year.  After six years of strong gains, share prices are at the upper end of historical valuations.  This fact and given the factors discussed above, a consolidation in the stock market would not be surprising.  That having been said, we feel the potential for a significant downturn is currently remote.  We do not see the financial or economic excesses that typically drive bear markets and recessions.  For the remainder of the year, we see the S&P 500 stock index trading in a range from 1950 to 2250.  The index is currently at 2068.

Annual Client Letter and Outlook

January 2, 2015

Market Data for year end 2014:

S&P 500 Stock Index:  2059, up 11.3%

Ten-year Treasury Note Yield:  2.17%, down 0.87%

Gold:  $1,183 per ounce, down 1.6%

Oil:  $54 per barrel, down 44.9%

In 2014, the US stock market enjoyed another year of double digit returns.  This was driven by two factors:  solid US economic growth and low interest rates.  Solid economic growth supports corporate profits, while low interest rates make stocks more attractive.  Low interest rates, in turn, had two driving factors:  Low inflation and weak global growth.   Low inflation is primarily the result of continued slack in the US economy following the financial crisis, while weak global growth anchors US interest rates relative to those of other leading economies such as Germany and Japan.

In commodities, gold struggled as inflation remained low and the US dollar strengthened.  Stronger US economic growth relative to the rest of the world drove the US dollar to multi-year highs versus global currencies virtually across the board.  Oil suffered a collapse in the second half of the year impelled by increased US production of oil from shale drilling and weak global demand.  Saudi Arabia, the one country capable of altering supply to support prices, chose not to, and the decline in oil prices accelerated.  We feel that low oil prices are a positive for the US and global economies.  While investment and employment in the US oil sector will suffer, America, Europe, Japan, and China are net consumers of oil, and low prices will support consumption and investment.

While this benign environment for stocks can persist, we can identify two primary risks to the stock market going forward.  First, continued above trend US economic growth could eliminate the slack in the economy, pushing inflation and interest rates higher.  This in turn, would pressure corporate profits and make stocks less attractive relative to interest bearing securities.  The US Federal Reserve is widely expected to begin gradually increasing overnight interest rates charged by banks for the first time in nine years starting in mid-2015.  If interest rate increases were to come sooner and progress faster than this expectation, stocks could be negatively impacted.

Secondly, the weakness in global economies could intensify, leading to financial instability and decimating US exports.  Europe is bordering on deflation, Russia is in the throes of a near financial crisis, Japan has fallen back into recession, and Chinese growth is at multi-decade lows.  While the US economy is the most self-sufficient in the world, it is not an island, and ultimately, international economic weakness and instability could negatively impact our own economy.  Furthermore, US corporations receive a large portion of their sales from overseas, so their profits are already coming under pressure.

While these are the primary risks we can identify, actual threats to the US economy and stocks are often impossible to forecast and come out of the blue.  Politics are a potential wildcard.  There is the possibility, albeit unlikely, for a severe selloff stemming from a threatened failure to raise the US Federal debt ceiling, as was the case in the summer of 2011.  We do not feel Republicans regaining the Senate will lead to de-escalation in partisan warfare, as some have suggested.  In Greece, an-anti Euro party may come into power threatening a Greek exit from the currency union, which would open up a Pandora’s Box of uncertainties.  US stock prices are at the upper end of what can be considered reasonable valuations, so are vulnerable to external shocks and adverse economic developments.  For 2015, we see the US stock market, as represented by the S&P 500 stock index, to trade in a range of 1900 to 2300.  It ended 2014 at 2059.

For the fifth year running, we are pleased to have been named a Five-star Wealth Manager as described in Chicago Magazine.   Fewer than 3% of the 11,800 financial services professionals in the Chicago area are chosen.  A detailed description of the award can be found on page FS 1 of the November 2014 issue of Chicago Magazine.  More details are available at

Thank you for your continued confidence.  As always, do not hesitate to contact us with any questions or concerns.


Market Update

November 18, 2014

On November 18, the stock market as represented by the S&P 500 stock index closed at 2052, above our previously stated trading range for the remainder of the year of 2050 to 1825.

After a sharp mid-October sell off in stocks on fears that Europe was about to be engulfed in deflation, and the hysteria surrounding Ebola, shares have rebounded strongly to record highs.  Three factors we believe are at play:

1)  While the US Federal Reserve is pulling back on its stimulus by ending its bond purchase program known as Quantitative Easing, or QE for short, the European Central Bank (ECB) and the Bank of Japan (BOJ) are ramping up their efforts to increase liquidity and stimulate their economies.

2)  The US economy remains in a highly supportive climate for stocks.  Growth is moderate, and inflation is low.  Subdued inflation has been partially facilitated by oil prices hitting multi-year lows due to weak global demand and an abundance of supply.  Low inflation suppresses interest rates, which in combination with economic growth is a potent tonic for stocks.

3)  A strong seasonal factor is at play.  By this we mean that many money managers find themselves trailing the stock market in terms of performance going into year end and cannot afford to miss a further stock market rally.  This compels them to buy stocks, which pushes the market higher, which compels them to buy more stocks, and so on, and so forth.  This self-perpetuating process has the potential to drive stocks higher right into year end.

This having been said, we feel the following risks to the market must be kept in mind:

1)  We believe that Europe remains the weak link in the global economy and could reassert itself into markets if it shows signs of further deterioration.  The continued standoff between the West and Russia in Ukraine adds a further layer of instability to European and global economies.

2)  As we have discussed previously, an accelerating US economy could prove problematic if it stirs fears of a premature, earlier than expected interest rate increase by the Federal Reserve.  The current expectation is that the Fed will begin to raise overnight interest rate in the middle of 2015 at the earliest.  Higher interest rates are widely seen as negative for stocks.

For the remainder of the year, we see the stock market as represented by the S&P 500 stock index trading in a range from 2000 to 2125.  It currently stands at 2052.

Third Quarter Review/Fourth Quarter Outlook

September 30, 2014

2014 Third Quarter Market Statistics (September 30, 2014 vs. June 30, 2014):

Standard & Poor’s Stock Index:  1972 vs. 1960, up 0.6%

Ten-year US Treasury Note yield:  2.51% vs. 2.52%, down 1 basis point

Gold:  $1,209 per ounce vs. $1,322, down 8.5%

Crude Oil:  $91 per barrel vs. $106, down 14.2%


The benchmark S&P 500 stock index advanced modestly in the third quarter as moderate US economic growth, continued low inflation, and low interest rates were set against concerns that the US Federal Reserve would move to more aggressively raise overnight interest rates against the backdrop of a weakening global economy. Bond yields were little changed as low inflation, a weak global economy, and a muted view of long term growth in the US were counterbalanced by talk of the Federal Reserve raising overnight interest rates.  Gold fell, and the dollar strengthened, on the prospect of tighter US monetary policy relative to the rest of the world, while oil fell on softening global demand and increased US supply from shale drilling.

Though the benign condition of moderate growth, low inflation, and low interest rates that has supported stocks over the past several years may persist, there are significant risk factors to be aware of:

1) As we have written previously, a more aggressive Federal Reserve could derail the equity rally.  The market seems to be comfortable with an increase in overnight interest rates taking place in the middle of next year, with rates increasingly gradually thereafter.  If the Fed were to suggest that it is looking to increase rates sooner and faster than current market expectations, the stock market would likely come under pressure.  Additionally, large scale bond purchases by the Federal Reserve, known as quantitative easing or QE, will likely come to an end in October.  We feel QE has been a significant driver of share prices over the past two years, and the stock market may struggle with its removal.

2) Geopolitics and global economics may not be supportive of further gains.  A heavily indebted Chinese economy is struggling to maintain its growth rate, while an already fragile European economy is coming under further strain due to American and European Union sanctions on Russia over the situation in Ukraine.  Additionally, recent pro-democracy protests in Hong Kong demonstrate the potential for political instability in China. The war against the terrorist group ISIL in Iraq and Syria could affect the global economy if fighting were to spread to the oil fields of southern Iraq, although we feel that is unlikely given the heavy support of Iraqi forces by US and allied airpower.

3) The internal dynamics and sentiment of the market appear fragile.  First, in a healthy market, small stocks tend to lead the market higher.  Worryingly, the Russell 2000 index of small stocks has been lagging the large stock S&P 500 index significantly since the beginning of July.  The Russell 2000 actually declined 7.6 % in the third quarter relative to a 0.6% gain for the S&P 500.  Basically, investors are piling into fewer stocks, thus creating potential instability as the market becomes top heavy.  Secondly, the initial public offering (IPO) of the Chinese internet company Alibaba was the largest in world history.  This gives us cause for concern.  The stock sold represents non-voting shares in a Cayman Islands based shell company that does not actually own the assets of Alibaba.  It merely has a contractual right to a portion of Alibaba’s earnings.  We feel that the enormous size and convolution of this deal is a symptomatic of speculative excess, which is historically a negative for future market returns.

Given the risks cited above, we are cautious about the remainder of 2014. As always, we will continue to stick to our strategy of quality, value, diversification, and patience as it has served us well through both strong and challenging markets.  For the remainder of the year, we see the US stock market, as measured by the S&P 500 stock index, to trade in a range of 1825 to 2050 (currently at 1972).  We expect the yield on the ten-year Treasury bond to trade in a range of 2.25% to 2.75% (currently at 2.51%).


Second Quarter Review/Third Quarter Outlook

July 1, 2014

2014 Second Quarter Market Statistics (March 31, 2014 to June 30, 2014):

Standard & Poor’s Stock Index:  1960 vs. 1872, up 4.7%

Ten-year US Treasury Note yield:  2.52% vs. 2.72%, down 20 basis points

Gold:  $1,322 per ounce vs. $1,284, up 3.0%

Crude Oil:  $106 per barrel vs. $101, up 5.0%


US stocks advanced in the second quarter, as solid employment data and continued low interest rates provided a supportive environment for shares.  The yield on the benchmark Treasury note declined (prices increased), as bonds responded to more muted economic data outside of employment.  Gold rallied on the back of lower bond yields, firming inflation data, and turmoil in Iraq.  Oil increased as events in Iraq had the potential to affect world oil supplies.

While the benign climate for US stocks described above could certainly persist, there are risks to be aware of:

1)  As we have noted before, the most significant risk to a continued rally in stocks would be a more hawkish policy stance from the Federal Reserve, which is to say the possibility of higher overnight interest rates sooner than markets expect.  This would be in response to acceleration in economic activity and/or inflation.  Currently, the economy appears too tepid to warrant higher interest rates in the near term.

2)  Recent events in Iraq could affect oil supplies if the Sunni jihadist group ISIS were to reach the southern oil fields of the country.  Higher prices could crimp the global and US economies, and US shares would not go unscathed.  Fortunately, the jihadist advance looks to have stalled north of the capital Baghdad.  Given that the south is unfriendly territory to the jihadists, and the threat of US airstrikes, we believe an advance on the southern oil fields is unlikely.

3)  The Chinese economy is built to a large extent on the shaky foundation of real estate speculation.  While predictions of a Chinese recession have been voiced incorrectly for many years, the precarious nature of their financial system bears watching.  China, as the world’s second largest economy, is an important global economic player.  Chinese economic weakness could negatively impact the global economy and the profitability of American businesses.

4)  Finally, the US political system continues to be dysfunctional.  Normally bipartisan programs such as the Federal highway bill and the Export-Import Bank, are being held hostage by partisan rancor.  With an economy that remains stuck in low gear, and monetary policy that has done all that it can, constructive fiscal policy is an important element in accelerating economic growth.  Unfortunately, the likelihood of such policy is minimal at best.

Going forward, our base case is that the US stock market continues to grind higher.  However, as described above, there are multiple threats to this forecast.  For the remainder of the year, we see the US stock market, as measured by the S&P 500 stock index, to trade in a range of 1825 to 2075 (currently at 1960).  We expect the yield on the ten-year Treasury bond to trade in a range of 2.25% to 3.00% (currently at 2.52%).


First Quarter Review/Second Quarter Outlook

March 31, 2014

First quarter 2014 market data:

S&P 500:  1872, up 1.30%

Ten-year Treasury note yield:  2.72%, down 32 basis points (hundredths of a percent)

Gold:  $1,284 per ounce, up 6.82%

Crude oil:  $101 per barrel, up 3.06%

Compared to the nearly effortless ascent of 2013, the stock market struggled in the first quarter of 2014, while the bond market firmed.  On a fundamental basis, US economic data, particularly on employment, weakened.  This was to some extent due to harsh winter weather in much of the continental United States.  However, there may be more to it than just cold and snow.  Technically, i.e. regarding investor psychology, both the stock and bond markets were overextended at the end of 2013 and needed to correct.  This is to say investors were overly excited by stocks and pessimistic about bonds at year end, and this condition needed to be unwound.

Going into the second quarter, we do not see a significant departure from the market action of the first.  We are skeptical that the US economy has broken out to a higher growth trend than we have seen since the end of the “Great Recession”.  Furthermore, the Fed’s ongoing reduction in its purchase of Treasury bonds and agency mortgaged backed securities (aka quantitative easing/QE) will continue to remove support from the stock market and relieve pressure on bonds, (which goes counter to conventional wisdom.  Most people think that QE has supported bond prices when the reality is that they have fallen since QE began.)  That having been said, we do not see deterioration in the economy either, and therefore do not expect a significantly weaker stock market/stronger bond market.

Paradoxically, we believe the greatest risk to the market is stronger economic data.  In the latest meeting of the Federal Open Market Committee, the Fed upgraded its economic forecast and moved forward the likely date that it would start increasing overnight interest rates.  As a tightening Federal Reserve is seen by many as the great slayer of bull markets, the market may react negatively to any economic data that would suggest sooner rather than later interest rate hikes.  Likely realizing this, newly appointed Fed chairwoman Janet Yellen backpedalled somewhat on the Fed’s hawkish position in a speech given in Chicago on March 31.  In the other direction, economic weakness in China and possible escalation in Ukraine bear watching.  Both could significantly impact the global economy, and US markets would not be unaffected.

For the remainder of the year, we see the stock market, as represented by the Standard & Poor’s Five-hundred stock index, to trade in a range of 1725 to 2000.  It ended the first quarter at 1872.  We forecast the yield on the benchmark Ten-year US Treasury note to trade from 2.5% to 3.5%.  It ended the quarter at 2.72%.

Annual Client Letter and Outlook

January 2, 2014

Stocks advanced powerfully in 2013 driven by an improving US economic outlook and ultra-easy monetary policy by the Federal Reserve.  Most notable was the purchase of $85 billion per month of Treasury and mortgage-backed securities, often referred to as quantitative easing or QE for short.  On the year, the US stock market, as represented by the Standard and Poor’s Five-hundred stock index, rose 29.6%.  It closed at 1848, an all-time high.  High quality bonds had a difficult year as investors became more positive on the US and world economies and moved into riskier assets such as stocks, junk bonds, and higher yielding European debt.  The yield on the benchmark ten-year Treasury note increased 128 basis points (hundredths of a percentage point) to yield 3.04%.  (Yield moves inverse to price.)  Gold suffered heavy losses on the improving outlook, as much feared inflation failed to materialize.  On the year, gold declined 28.2% to $1,202 per ounce.  Crude oil increased 6.5% to $98 per barrel likewise on the improving economy.

For 2014, investor consensus is nearly universal.  Essentially, the trends of 2013 described above will continue, although at a more moderate pace.  The stock market will move steadily higher on an improving economy, while bond prices will continue to grind lower (yields higher) as the Federal Reserve slows its rate of bond purchases, also referred to as “tapering”.  This scenario is plausible, yet not assured.

The biggest risk to the bullish consensus for stocks in 2014 is a more rapid improvement in the unemployment picture than investors and the Federal Reserve anticipate.  If the unemployment rate (currently at 7.0%) were to fall by midyear to below the Fed’s 6.5% threshold to consider raising overnight interest rates, investors would begin to worry about the potential for higher short-term interest rates sooner rather than later.  This could lead to a disorderly selloff in bonds (higher yields), as opposed to the gradual increase in yields that most strategists and analysts are calling for.  A sharp selloff in bonds would likely have a direct, negative impact on stocks.  After having advanced as far as it has virtually uninterrupted, the stock market is vulnerable and could suffer a sizeable correction if this scenario were come to pass.  Higher US bond yields could also wreak havoc in foreign markets, as well.

Turning to further risks, Europe bears watching.  It seems to have stabilized, but European economies are still operating at a depressed, fragile level.  A deterioration in European economies would be bad for the global economy and could pressure US stocks, although it would likely be good for US bonds, which would be seen as a safe haven.  Chinese local governments are heavily indebted and are a serious threat to continued strong growth in the world’s second largest economy.  Weakness in China could spread to other emerging market economies, and US markets would not be unaffected.  Finally, there are political and geopolitical risks such as the need to raise the US debt ceiling this spring, instability in the Middle East, and the standoff in the East China Sea between China and Japan.  All have the ability to significantly impact US markets.

We find the consensus outlook more likely, but the risks cited above are probably more of a threat than investors realize.  We will continue to execute our strategy of investing in high quality income producing securities, such as dividend growing equities and investment grade bonds, reinvesting the income, and compounding returns.  For 2014, we see the S&P 500 trading in a range of 1725 to 2025.  It ended the year at 1848.  We forecast the ten-year Treasury note to trade in a range of 2.50% to 3.75%.  It ended 2013 yielding 3.04%.

For the fourth year running, we are pleased to have been named a Five-star Wealth Manager as described in Chicago Magazine.   Fewer than 3% of the 11,800 financial services professionals in the Chicago area are chosen.  A detailed description of the award can be found on pages FS 1 and FS 2 of the November 2013 issue of Chicago Magazine.  More details are available at


Fourth Quarter Update

November 25, 2013

On November 22, the American stock market, as represented by the S&P 500 stock index, closed above the upper end of our forecasted fourth quarter trading range.  Our upper limit was 1800 on the index.  The market closed at 1805.

The strength in the stock market is twofold.  Fundamentally, we are in a “Goldilocks” economy.  Growth is strong enough to support corporate profits, but not strong enough to induce the Federal Reserve to tighten monetary policy.  To that point, incoming Fed Chairman Janet Yellen said in her recent Senate confirmation hearing that she believed the US economy and job market were operating far below their potential.  This was widely interpreted by the markets as indicating that removing monetary stimulus such as reducing asset purchases, known as quantitative easing or QE for short, was not imminent.  Quantitative easing has been a major factor in driving the stock market higher since it was initiated in the fall of last year because it shrinks the pool of investible assets, therefore driving up the prices of those that remain, such as stocks.

Technically, the market is being driven higher by buying from portfolio managers who have been underinvested in the stock market, or in its more aggressive sectors, and are trailing the performance of the general market.  Every slight dip in the market has been seen as an opportunity to get into the market or reposition into a more aggressive posture.  Fear of losing has been replaced by fear of losing out.  Without a catalyst to change the dynamic, this is a self-perpetuating phenomenon that has the potential to push the market higher throughout the remainder of the year.  An additional factor in expecting higher stock prices for the remainder of the year is that November and December have historically been two of the strongest months of the year for stocks with excess cash being put to work before year end.

As stated above the trend higher in stocks is likely to continue unless a catalyst forces a reappraisal by investors.  A perceived change in US economic conditions is most likely to be such a catalyst, although negative developments overseas could provide a turning point as well.  Most probable, a substantial strengthening in US economic and employment data could be seen as making a tightening of Federal Reserve monetary policy occur sooner rather than later.  Given the importance of easy monetary policy to the rally in stocks, such a change has the potential to turn stocks lower.  For the remainder of the year we forecast the trading range of the S&P 500 to be 1750 to 1900.  It closed November 22 at 1805.

Please feel free to contact us at any time with any questions or comments.  We appreciate your business and continued confidence.


Patrick Mauro, Daniel Mauro, Henry Criz


Third Quarter Review/Fourth Quarter Outlook

October 1, 2013

2013 Third Quarter Market Statistics (June 28, 2013 to September 30, 2013):

Standard & Poor’s Stock Index:  1682 vs. 1569, up 7.2%

Ten-year US Treasury Note yield:  2.62% vs. 2.48%, up 14 basis points

Crude Oil:  $102 per barrel vs. $96, up/down 6.3%

Gold:  $1328 per ounce vs. $1,232, up/down 7.8%


The stock market and Treasury yields advanced in the third quarter based on continued, yet modest, growth in the US economy, led by automobile manufacturing and housing.  For the bulk of the quarter, the market was fixated on whether the Federal Reserve would begin to reduce, or “taper”, its purchase of $85 billion of Treasury bonds and mortgage backed securities per month.  These purchases are often referred to as “quantitative easing” or QE for short.  In the second quarter, the Federal Reserve suggested that it may begin reducing asset purchases as soon as its September meeting.  Initially, this sent stocks lower and Treasury yields higher (bond prices lower).  The Federal Reserve’s purchases were widely seen to be supporting stock and bond prices, so the withdrawal of asset purchases would conversely lead to lower prices.  Over the course of the quarter, however, stocks were able to overcome investors’ concern over the tapering of Fed purchases, while Treasury bonds remained under pressure for fear of tapering leading to higher overnight interest rates sooner rather than later.

On September 18, the Federal Reserve shocked the market by not reducing the pace of its asset purchases.  This initially sent stocks to a record high and sharply reduced bond yields.  Stocks have since pulled back while bond yields have continued to drift lower.  Having not reduced asset purchases after several months of suggesting otherwise, some feel that a lack of clear communication by the Federal Reserve introduces further uncertainty into the system, which is not a positive for asset values.  We do not feel this is the case.  The Federal Reserve’s initial guidance of a September tapering of asset purchases was in our view arbitrary and not based on economic fundamentals.  While growth has continued at a modest pace, unemployment remains stubbornly high, and inflation is well under control.  By choosing not to taper, the Federal Reserve has indicated that its policy will not be driven merely by the calendar but by economic data, which we see as a positive.

With the Fed focusing once again on economic fundamentals, the biggest risk to the market by far is political dysfunction in Washington.  Federal Reserve Chairman Bernanke said himself that one of the reasons the Federal Reserve’s Open Market Committee chose not to reduce asset purchases was likely “fiscal drag” on the economy emanating from Washington.  The dual threat of a government shutdown and a failure to raise the Federal debt ceiling is bad for the stock market, and there is no other way to say it.  While many have said a short-lived government shutdown would do no harm to the economy and therefore not negatively impact stocks, we believe a shutdown would undermine confidence in the political system and be seen to increase the likelihood of a failure to raise the debt ceiling.  Failure to raise the debt ceiling could have catastrophic consequences for financial markets as it would call into question the creditworthiness of the United States.  To wit, in ten trading days prior to the last debt ceiling showdown in the summer of 2011, the stock market declined a whopping 17%.  Given the devastating consequences of a failure to raise the debt ceiling, we are confident that the ceiling will ultimately be raised, but not before it is taken to the eleventh hour, which purportedly will be midnight on October 17.  However, we expect dramatically increased market volatility leading up to an ultimate market and economy saving settlement.

The performance of the stock market in the fourth quarter is heavily dependent upon the outcome of the budget and debt ceiling crises in Washington.  If the situation is dealt with in a timely manner, stocks will likely resume their upward trajectory, while if it is not, the consequences could be severe.  As stated above, we feel the former is much more likely to the tune of a greater than 90% probability.  That having been said, market volatility will be elevated prior to a settlement.  After the budget and debt ceiling crises are put to bed, markets will return to the analyzing the intentions of the Federal Reserve and the forecast for corporate earnings, in the context of continued moderate economic growth that is supportive of stock prices.  For the remainder of the quarter, we see the S&P 500 trading in a range of 1600 to 1800.  It finished the third quarter at 1682.


Second Quarter Review/Third Quarter Outlook

July 1, 2013

2013 Second Quarter Market Statistics (Mar 29, 2013 to June 28, 2103):

Standard & Poor’s Stock Index:  1606 vs. 1569, up 2.36%

Ten-year US Treasury Note yield:  2.48% vs. 1.85%, up .63% (63 basis points)

Crude Oil:  $96 per barrel vs. $92, up 4.35%

Gold:  $1,232 per ounce vs. $1,596, down 22.8%


After climbing in the first half of the second quarter on moderate economic growth and ultra-accommodative monetary policy, stock and bond prices declined during the second half.  In May, the US Federal Reserve began to indicate that it would likely begin tightening monetary policy by reducing Treasury and mortgage bond purchases, often referred to as quantitative easing or QE, later in the year and eliminating them outright by the middle of 2014.  In response, the bond market sold off hard with yields soaring, while dividend/income oriented stocks, such as utilities, master limited partnerships (MLPs), and real estate investment trusts (REITs), declined substantially.  Gold also suffered, as low inflation and higher interest rates make holding non-interest bearing gold less attractive.  The Federal Reserve took investors by surprise in announcing their intention to begin “tapering” bond purchases.  They had previously stated that they would only begin reducing bond purchases once the labor market showed “substantial improvement.”  While the labor market has indeed improved, monthly increases in non-farm payrolls of 175,000 and an unemployment rate of 7.6% indicate an improvement that is far from substantial.  This inconsistency on the part of the Federal Reserve jolted the market and sent stock, bond, and commodity prices lower across the board.

Heading into the second half of the year, the markets face numerous risks.  Premature monetary tightening by the Federal Reserve is perhaps the greatest risk.  The economy, although improving, is not robust.  Inflation is well below the Fed’s long-term goal of 2%.  In such and environment, higher interest rates are a negative for the economy, for corporate profits, and make stocks less valuable relative to bonds.  A mitigating factor that has perhaps been overlooked by the market is that Federal Reserve Chairman Ben Bernanke and other Fed officials have said bond purchase tapering was not certain, and would be dependent on further strengthening in the economy.  To the extent that higher interest rates slow the economy, an actual tightening in monetary policy becomes less likely.

Moving on, the global economy is weak, with emerging market growth slowing, the Chinese banking system in turmoil, and Europe remaining mired in recession.  Weak commodity prices and the bond market carnage unleashed by the Federal Reserve have exposed economic, social, and financial weaknesses in many emerging market economies.  On a related note, economic weakness in China brought on by distress in their banking system will have ripple effects throughout the globe.  A further deterioration in Europe from already depressed conditions is possible at any time.  Any of these scenarios, either alone or in combination, could weigh on US stock markets.


Finally, continued political dysfunction in Washington poses a threat to the US economy and markets.  After having blithely allowed damaging sequester spending cuts to go into effect, battles over raising the statutory Federal debt ceiling and the fiscal year 2014 budget loom.  If sharply contested, these issues could send the stock market markedly lower, as had the prior debt ceiling crisis in 2011.

Providing support to the stock market in the second half of 2013 is underlying momentum in the US economy.  Most significantly, the US housing market has been strengthening with prices moving higher and sales of existing and new homes increasing.  Even with mortgage rates moving higher on the selloff in the bond market, homes remain historically affordable, encouraging further gains in the sector.  A strengthening housing market is supportive to the economy through home financing activity, construction, building material manufacturing, transport, and an increased sense of wealth for homeowners.  Also benefitting from still low absolute levels of interest rates has been the automotive sector.  Pent up demand from the depressed levels of the past five years along with attractive financing has boosted production of cars and trucks.  Automotive manufacturing is a significant driver of economic activity because it touches many sectors of the economy including manufacturing, financing, transportation, and basic materials.  An additional support to the economy and stocks is increased domestic energy production.  This has kept energy costs in check while improving America’s balance of trade.  Imports of oil are falling, while exports of refined product are increasing.  This strengthens economic growth and improves the nation’s finances.

Returning to monetary policy, although the Federal Reserve has indicated that it would like to begin withdrawing monetary stimulus, it is a long way from actually being restrictive in its policy.  As stated before, Federal Reserve Chairman Ben Bernanke made it clear that overnight interest rates would likely remain pinned close to zero well into 2015.  He said the Federal Reserve would not even begin to consider raising overnight interest rates until the unemployment rate reaches 6.5%, possibly even less, or inflation exceeds 2.5%.  Currently, unemployment is 7.6%, and inflation is trending close to 1%.  Such a policy should be supportive of stock and bond prices once the markets are done digesting the possibility of a reduction in bond purchases.

For the remainder of 2013, we see the S&P 500 stock index trading in a range of 1540 to 1740, with stocks finishing the year toward the upper end of the range.  We do not see a further significant deterioration in bond prices given low inflation and modest economic growth.  Higher interest rates have been a primary driver in weakness in gold, so stability in rates could underpin the price of gold, as well.  The price of oil has held up relatively well in the face of weakness in other commodities.  We believe this is primarily a function of the ability of Saudi Arabia to manipulate the price.  $90 to $100 per barrel seems to be a price they are comfortable with.


First Quarter Review/Second Quarter Outlook

April 1, 2013

Stocks advanced strongly in the first quarter of 2013.  The US stock market, as represented by the S&P 500 stock index, rose 10% to 1569 from 1426 at end of 2012. This marked an all-time high for the index.  The previous high of 1565 was recorded on October 9, 2007. The advance was underpinned by a better than expected economic performance, a relatively benign outcome to the “fiscal cliff” expiration of the Bush-era tax cuts, and a general de-escalation of the fiscal conflict in Washington.  The yield on the benchmark ten-year US Treasury note rose 9 basis points (hundredths of a percent) to 1.85% from 1.76% at the end of 2012.  Gold fell 5% to $1,596 per ounce from $1,675 per ounce as its safe haven appeal faded, while oil advanced 5% to $97 per barrel from $92 per barrel.

As outlined above, the stock market rose on the shoulders of a better than expected economy, a relatively favorable outcome to the “fiscal cliff”, and de-escalation of the fiscal conflict in Washington.  Throughout 2012, we felt investors were too negative on the performance of the US economy.  In the first quarter, the strength of the economy became manifest in strong job creation and auto and home sales.  The recovery in housing is particularly significant in that it led us into recession and had been a persistent headwind to recovery.  It is now contributing positively to the economic recovery.  Meanwhile, the “fiscal cliff” at the beginning of the year was resolved with limited damage to investment income.  Taxes on capital gains and dividends rose modestly from 15% to 20%, only for those taxpayers earning more than $400,000 per year individually or $450,000 per year jointly.  Investors had feared worse.  Finally, the conflict between the parties regarding fiscal policy moderated.  While the budget “sequester” was allowed to go into effect, there was not a showdown on the debt ceiling, nor was there a government shutdown.  This was seen as an improvement over the brinksmanship of 2011 and 2012.  The hope is that the relative truce holds throughout 2013 and that politics does not sabotage the markets and economy.

In our view, the market faces three primary risks for the second quarter and the remainder of 2013.  First, the economic and financial situation in Europe remains an ever present danger.  Much of the continent remains mired in recession, while the banking systems of major economies such as Italy and Spain are highly fragile.  This is a combustible mix and can flare at any moment, as the recent crisis in Cyprus illustrates.  Europe is America’s number one trading partner and has many financial links to the USA.  Any severe duress on the continent could have a significant impact on our markets.  Second, having rallied so much off of its low point in November 2012 (a 16% advance), the market may be ahead of itself.  While investors had previously underestimated the performance of the economy, we believe this is no longer the case.  Telling will be the first quarter earnings reports.  Many companies have been guiding their earnings forecasts lower, yet investors to this point have basically ignored them.  Finally, while it seems both sides are standing down to some degree, the fiscal showdown in Washington is doing the economy no favors.  For example, the “sequester” spending cuts were allowed to go into effect, thus lowering economic growth by up to 0.6%, as per the Congressional Budget Office, in the context of an already tepid global economy.  If the political conflict were to re-escalate, the impact on the economy would be even greater, and the market would likely react negatively, as it has previously to political showdowns.

For the remainder of the year, we see the S&P 500 trading in a range from 1450 to 1675.  It closed the quarter at 1569.  Having already discussed the risks, the primary rationale for the higher end of our range is that while corporate earnings are widely seen growing at a modest single digit pace, the price paid per dollar of earnings tends to increase as a bull market matures.  As we are moving into the fifth year of the bull market, such an outcome is a reasonable possibility.

Thank you for trust you have placed in us and your business.  As always, do not hesitate to contact us with any questions or concerns.


Patrick Mauro, Daniel Mauro, Henry Criz


Annual Client Letter and Outlook

January 2, 2013

In the fourth quarter of 2012, the US stock market, as represented by the Standard and Poor’s Five-hundred stock index, fell 1% to 1426 on worries surrounding political dysfunction in  Washington, DC.  For the year, stocks rose 13.4% as the US economy performed better than expected, the European financial crisis stabilized, and the US Federal Reserve continued extraordinary policies to support financial markets.  The yield on the benchmark ten-year Treasury note closed the year at 1.76%, up 12 basis points (hundredths of a percent) on the quarter and down 11 on the year.  The Federal Reserve’s intervention in the Treasury market kept yields relatively stable throughout the year.  The price of gold declined 5.5% for the quarter to $1,675 per ounce, but increased 6.9% for the year.  As with stocks, the inflationary implications of stronger growth and accommodative monetary policy were tempered by the prospect of deflationary fiscal policy coming out of Washington in 2013.  Oil closed unchanged for the quarter at $92 per barrel.  For the year, the price of oil declined 7.1%.  Decreased fears of a potential war with Iran helped guide the price of oil lower.

As mentioned above, three factors supported US stocks in 2012.  To begin with, the US economy performed better than the general Wall Street consensus.  Strength in important sectors of the economy such as jobs, automobile production, and construction and housing has exceeded investor expectations.  Barring a self-inflicted wound by Washington we believe the economic recovery in the United States is both real and self-sustaining.  Turning overseas, the European financial crisis stabilized, at least temporarily, in 2012.  In a July speech, European Central Bank president Mario Draghi said he would do “whatever it takes” to insure the integrity of the Euro currency.  He followed up with a credible plan to stabilize the sovereign debt markets of distressed Eurozone members.  While the Europeans have a long way to go to insure the long-term viability of the Euro currency, the current environment is undeniably an improvement over recent years.  Given its close economic and financial ties to America, a financial calamity in Europe would be very bad for American markets.  Finally, the US Federal Reserve continued its extraordinary efforts to support the economy vis-à-vis the financial markets.  The Fed has committed itself to buying $85 billion of Treasuries and mortgage bonds per month until either the unemployment rate falls to 6.5% or the inflation rate rises to 2.5%.  By removing so many long-term assets from the market on a continuing basis, the Fed is essentially pushing investors into riskier assets such as stocks, corporate bonds, and real estate, hoping that rising asset prices will make people feel wealthier and increase spending.  While there is much partisan debate surrounding the wisdom and efficacy of this policy, we believe it is having its intended effect of supporting stock prices.

Although these factors were supportive to stocks throughout 2012, the market declined in the fourth quarter due to the renewal of partisan warfare surrounding US fiscal policy.  The latest edition was the so called “fiscal cliff” that represented the potential of $600 billion of tax increases and spending cuts in the coming year.  Investors remember the nearly 20% decline in the S&P 500 in the summer of 2011 over the debt ceiling crisis and were weary of a repeat performance.  Although the parties have once again managed to avoid outright policy failure by modestly increasing taxes and delaying spending cuts, the partisan vitriol and brinksmanship do not inspire confidence going forward.  To wit, another damaging showdown on the debt ceiling is likely in the coming months.   That having been said, from a stock market perspective, this agreement minimized the potential impact on investment income.  Taxes on capital gains and dividends will only rise from the current 15% to 20% for individuals making more than $400k and joint filers more than $450k.

Looking forward into 2013, we think stocks can have positive returns unless US politicians derail the American economy through continual fiscal brinksmanship.  Other risks to our forecast would be a return of the European financial crisis and possible conflict with Iran.  In addition to the economic momentum we discussed above, a positive story to watch for regarding the US economy and American business will be the continuing development of domestic “shale” oil and gas production.  This has the potential to substantially increase the economic competiveness of the nation through lower energy prices and a positive impact on our balance of trade.  With the Fed active in the Treasury market, we feel bond yields will remain relatively stable in 2013, although at the current low yields, we continue to believe that long-term bonds are a poor investment.  (We currently invest only in short-term bonds.)  This same accommodative Fed policy should also be supportive to gold.  Oil will remain largely dependent on geopolitical risks emanating from Iran’s nuclear ambitions.  We feel global supply and demand are basically in balance at the current price.  For 2013, we see the S&P 500 stock index trading in a range of 1350 to 1600.  It closed 2012 at 1426.

For the third year running, we are pleased to have been named a Five-star Wealth Manager as described in Chicago Magazine.   Fewer than 3% of the 11,800 financial services professionals in the Chicago area are chosen.  A detailed description of the award can be found on pages FS 1 and FS 2 of the November, 2012 issue of Chicago Magazine.

We appreciate your continued business and the trust you have placed in us. Do not hesitate to contact us with any questions or concerns you may have. We hope you have a happy, healthy, and prosperous new year.


Patrick Mauro, Daniel Mauro, Henry Criz

Third Quarter Review/Fourth Quarter Outlook

October 1, 2012

The US stock market rallied in the third quarter of 2012, following a decline in the second.  US stocks, as represented by the S&P 500 stock index, advanced 5.8% to 1441, in response to strong policy action by the European Central Bank and the US Federal Reserve.  The yield on the benchmark ten-year Treasury note fell modestly to 1.64% from 1.66%, while gold and oil rallied in sympathy with stocks and a potentially more inflationary environment as a result of central bank action.  Gold climbed 10.8% to $1,772 per ounce, and US benchmark West Texas Intermediate oil rose 8.2% to $92 per barrel.

The major driver of markets in the third quarter was strong action by the world’s two largest central banks, the US Federal Reserve and the European Central Bank (ECB).  In response to duress in the markets for Spanish and Italian government bonds that could potentially lead to disintegration of the Euro currency zone, ECB President Mario Draghi said that he would do “whatever it takes” to maintain the integrity of the Euro.  He followed up his words with action, committing the ECB to buy an unlimited amount of a country’s short-term debt if it first agreed to the terms of a bailout with the Euro zone’s political leaders.  Markets responded positively to this action, as it relieved the immediate threat of a further deterioration in the ongoing European financial crisis.  Longer-term, however, it remains to be seen whether or not European politicians can take the steps necessary to put the Euro on a sustainable path, including a more centralized fiscal system and bank supervision.  These are extremely high hurdles politically.  We fully expect more potentially destabilizing developments out of Europe in the future, as recent street protests in Spain and Greece demonstrate.

Following on the heels of the ECB action, the US Federal Reserve announced that it would purchase $40 billion of mortgage bonds per month indefinitely until the US employment significantly improves.  This action is popularly known as QE3.  (QE is short for quantitative easing, which is the technical term for central bank bond buying with freshly printed currency.  This is the third installment from the Fed, ergo QE3.)  While many Wall Street economists and strategists responded skeptically to this action, the stock market itself rallied strongly both in an anticipation of and in response to the Fed’s aggressive new policy.  Gold rose to its highest level since February as investors looked to protect themselves against potential inflationary effects.  Our opinion is that this is constructive policy.  By reducing the amount of investable assets in circulation, the Federal Reserve drives up the value of the remaining assets, most notably stocks and real estate.  When their assets appreciate, consumers feel wealthier and are more likely to spend, thus advancing economic growth and employment.  As far as any inflationary impact goes, we believe it will be muted in the near term given the huge amount of slack in the system with unemployment over 8%, i.e. inflation is typically driven by tight labor markets, which is far from the case today.

Turning to the underlying economy and corporate fundamentals, the US economy continues to grind forward slowly but steadily.  Economic growth is clocking in at around 1.5%, which is too slow to appreciably reduce the unemployment rate.  Globally, the international economy is also struggling.  Emerging markets such as China, India, and Brazil are slowing, while much of Europe is mired in recession.  Given the tepid economic backdrop, the outlook for corporate profits has moderated.  However, in the five years since the global financial crisis began, US companies have reduced operating costs significantly, and profit margins are near all-time highs.  With interest rates at record lows as well, companies can borrow at extremely generous rates, thus minimizing interest expense and strengthening their balance sheets.  As long as the economy can avoid moving back into recession, which we think likely, we do not see a significant deterioration in corporate profits.

We are sanguine on the economic outlook because the aforementioned Federal Reserve action and nascent strength in two pillars of the US economy, housing and autos.  After six years of declines, the US housing market seems to have finally turned around.  Sales are up, prices are up, and construction is up, albeit from very depressed levels.  In addition to making consumers feel better about their personal finances, as we previously discussed, increased housing wealth and construction activity also stimulate the economy directly through employment in the real estate brokerage, construction, and home improvement industries.  The market for automobiles has shown similar strength.  After years of depressed sales due to the financial crisis, hitherto suppressed demand is finally emerging as people are gaining enough confidence to go out and make a major purchase, while at the same time auto loan credit is becoming more widely available.  The automobile industry is significant in that it touches almost every sector of the national economy, from basic materials, to transportation, to electronics, to manufacturing, to financing, to dealerships.  In short, a strong automobile industry can serve as a backstop to the overall economy.

The single biggest threat to our moderately positive outlook is the so called “fiscal cliff” that may be triggered at the end of the year if US politicians cannot come to an agreement to avoid tax hikes and spending cuts equivalent to 4% of GDP.  This would very likely cause a US recession if it were to come to pass.  Because the impact on the American people would be so disastrous, we believe that the crisis will ultimately be averted, but are also confident that there will be significant political drama in getting to a deal.  From a market perspective, we think this political drama will drive a pickup in market volatility following the election, when the fiscal cliff comes firmly into focus.  That having been said, we think the long-term impact will be minimal because we think it is probable that a deal will be cut before any lasting damage is done, i.e. either this year or early next year.  One caveat is the likely expiration of the 2% payroll tax cut.  This will take $1,000 out of the hands of the average American household and negatively impact already fragile consumer demand.  For the remainder of the year our forecast range for the S&P 500 is 1350 to 1525. It closed the third quarter at 1441.

We thank you for your continued confidence and business.  Please feel free to contact us with any questions or concerns.


Patrick Mauro, Daniel Mauro, Henry Criz


Second Quarter Review/Third Quarter Outlook

July 2, 2012

Global stock markets came under renewed pressure in the second quarter of 2012 as the European financial crisis worsened, and world economies from China to the US saw a reduced rate of growth. The US stock market, as represented by the S&P 500 stock index fell 3.3% to 1362. As investors sought safe havens from financial turmoil, the yield on the benchmark ten-year note fell 56 basis points (hundredths of a percentage point) to 1.66%. Gold sold off on subdued fears of inflation, while oil and other industrial commodities declined in the face of slackening global demand. Gold closed the quarter down 3.8% at $1,599 per ounce. US benchmark West Texas Intermediate oil finished the quarter at $85 per barrel, down 17.6%.

The principal concern of global markets is the financial crisis in Europe. Simply put, the large economies of Spain, and most of all Italy, may be unable to borrow enough money to pay off existing debts and continue the operation of their governments. Of the two, Spain is in the weaker condition with banks on the verge of collapse, a large budget deficit, and extreme unemployment. Italy is in better condition on all three counts, but its debt is enormous, the largest in the world behind the US and Japan. If a failure of the Spanish bond market would push existing bailout mechanisms in Europe to the limit, an Italian failure would certainly overwhelm them. The countries that use the Euro currency must decide whether to more fully integrate their political and fiscal systems, or risk having the Euro torn apart by market forces. Such an eventuality would have devastating economic consequences for both Europe itself and for around the globe. The Euro leaders have always done just enough to avoid catastrophe, as they have just recently at the June 29 EU summit, where they began movement toward an integrated Euro banking system. Whether or not they can muster the political will to bring a conclusive end to the crisis remains to be seen, and therein lies the market’s fears.

Meanwhile, the American economy has shown undeniable signs of slowing in the spring quarter. Economic data ranging from unemployment, to consumer confidence, to industrial production have all weakened, pointing to growth less than the 2% needed to reduce unemployment. At such a slow rate, the US is also more vulnerable to external shocks such as those emanating from Europe or the weakening emerging economies of China, Brazil, and India. In the face of such weakness, American authorities have shown a disappointing inability to address the issues at hand. The Federal Reserve in its June meeting acknowledged the deterioration in economic fundamentals, yet decided merely to extend its current policies, deciding to defer on more aggressive action such as another round of “Quantitative Easing,” i.e. buying bonds and mortgages with freshly printed dollars. While the effectiveness of such action is disputable, whatever the case, it almost certainly is more effective than doing nothing, particularly with inflation firmly under control.

More effective at this juncture would be fiscal policy to stimulate economic growth. Yet our elected officials have shown an almost complete inability to work together to do anything beneficial for the economy. Even passing the once routine and bipartisan transportation bill, upon which many construction jobs depend, had become highly contentious, only to be agreed upon at the eleventh hour. It is next to impossible to see any new initiatives to spur economic growth taking place prior to the election. Furthermore, to make matters worse, the “fiscal cliff” of automatic tax increases and spending cuts looms at the end of the year. If unaddressed, these actions would put the US economy back into recession, as they collectively represent a 4% reduction in GDP. There has been no movement on dealing with this issue, and once again, it is difficult to contemplate any progress prior to the fall election. The ineffectiveness of policy makers and the tremendous uncertainty they have interjected into the economy, weigh heavily upon the market.

On a longer-term perspective, the US residential real estate market appears to be finally stabilizing after six years of decline. Price decreases have significantly moderated, while home sales and construction are up. Compared to renting, homeownership looks significantly attractive given record low mortgage rates. This dynamic has brought both individuals and investors back into the market. We have always felt that a recovery in residential real estate is a necessary precursor to a sustained and robust economic recovery. While there is still a large inventory of foreclosed properties overhanging the market, and many Americans remain underwater on the mortgages, we believe the improvements in the residential real estate market are real and are something to be optimistic about.

Forecasting is always difficult, and even more so when the fate of markets and economies lies upon politics and politicians. In such uncertain times, adherence to our four principles of investment: quality, value, diversification, and patience, is the way through the market wilderness. This strategy navigated client portfolios successfully through the 2008-09 subprime crisis, and we have high confidence that it will once again be able to deal profitably with whatever the future may hold. For the remainder of the year, we project that the S&P 500 will trade in a range of 1250 to 1450. As always, please do not hesitate to contact us with any questions or concerns.


Patrick Mauro, Daniel Mauro, Henry Criz

First Quarter Review/Second Quarter Outlook

April 2, 2012

The stock market continued its advance in the first quarter of 2012. The US benchmark S&P Five-hundred stock index rose 11.9% to 1408 as a persistent and broad cross section of economic data pointed to a strengthening economic recovery. Also influenced by the outlook for a stronger economy, the yield on the benchmark ten-year US Treasury note rose 35 basis point to 2.22% from 1.87%. The price of gold rose 6.7% to $1,672 per ounce, while the price of the US benchmark West Texas Intermediate (WTI) crude oil rallied 4.2% to $103.02 per barrel on a tight market and fears over military conflict with Iran. The international benchmark Brent crude oil futures contract increased more substantially, 14%, to $122.88.

While leading stock indexes have advanced strongly, and many have called an all clear on the outlook for economic recovery, a plethora of potential difficulties remain. In Europe, while official actions (such as providing long-term financing for banks and arranging a second Greek bailout) have avoided an immediate catastrophe, European economies remain weak, and their financial system fragile. Emerging markets, particularly China, are also experiencing a bout of economic weakness. While America is a net importer of foreign goods, it is still exposed to the global economic environment through exports, which remain a significant sector of the economy. Furthermore, many important American firms have significant foreign operations, the performance of which can heavily impact share prices.

American politics remain highly partisan and dysfunctional, but with the full year extension of the Administration’s payroll tax cut, a potential bullet was avoided. While the next major legislative hurdle on the horizon is passing a budget or a continuing resolution by the end of September, we find it highly unlikely that either side has the appetite for a budget crisis immediately before a Presidential election. Following the election, a veritable avalanche of major issues will hit, such as the expiration of the Bush and payroll tax cuts, the automatic budget sequester, and an increase in the debt ceiling. We believe these significant issues will take a back seat to the Presidential campaign and election, and are therefore unlikely to appreciably impact markets in the meantime.

The price of US benchmark WTI crude oil increased in the first quarter of 2012, 4.2%, with gasoline prices rising more dramatically. (The price of gasoline is also affected by the supply of oil refining capacity and the availability and source of oil, i.e. West Texas Intermediate versus more expensive Brent.) If prices were to advance further, they could have the potential to threaten the US economy’s recovery and concomitant stock bull market. The elevated prices have three main components. As the global economy continues to recover from the financial crisis, demand for oil and gasoline has increased. At the same time, geopolitical issues such as those in Syria, Yemen, the Sudan, and most of all Iran, have led to a decrease in the supply of oil. As an added complication, the threat of an Israeli air strike on Iran and a wider war in the Persian Gulf has introduced a further risk premium to the price of oil.

The Saudi Arabians, who are well aware of how a spike in oil prices helped spark the financial crisis in the summer of 2008 (that ultimately decimated demand for their oil), have vowed to increase supplies to insure that oil prices do not appreciate further. They have said they are willing to increase their output by up to 25%, and claimed to have made the infrastructure improvements over the past four years necessary to do so. We are agnostic about how this battle of supply and demand plays out, but we are monitoring it closely.

The wild card in all this remains a potential Israeli strike on Iran. An Israeli attack could result in significantly higher oil prices. On this we remain confident that the Israelis will not strike while economic sanctions and diplomacy have not yet run their course. As we have said before, an attack on Iran would push the limit of Israel’s capabilities, and is too high risk of an operation for them to undertake at this time. Ultimately, if Israel concludes that there is no hope for sanctions and diplomacy insuring that Iran does not develop a nuclear weapon, a strike, by Israel and/or America, would be likely. The bottom line, however, is that we believe the possibility of an actual attack is a 2013, or later, issue. That having been said, the mere threat of an attack in the minds of market participants will continue to have a heavy influence on the price of oil.

Given the myriad of potential difficulties facing the stock market, we have a cautious outlook for the remainder of 2012. We are not outright negative because we do believe the growth momentum presented in the economic data is real. Employment is improving, which leads to increased spending, which leads to improved employment, and so forth. Corporations remain financially strong. The stock market may be able to navigate the difficult road ahead, but as always, we strive to remain fully aware of all potential hazards. For the remainder of the year we see the S&P 500 trading in a range of 1275 to 1500. It closed the quarter at 1408.


Patrick Mauro, Daniel Mauro, Henry Criz

Annual Client Letter and Outlook

January 3, 2012

The stock market, as measured by the Standard and Poor’s Five-hundred stock index, rallied strongly in the fourth quarter of 2011, finishing at 1258 with a gain of 11% for the quarter, but unchanged on the year. Stronger than expected US economic data drove the quarter’s rally, while political drama in the US and Europe served as dampers for the year in total. The ten-year US Treasury note finished the year at 1.87% down five basis points (hundredths of a percent) on the quarter and down 144 basis points on the year. Fear of a European financial meltdown drove investors to the perceived safe-haven of US Treasuries. Gold closed the year at $1,567 per ounce, down 3% on the quarter and up 10% on the year. Gold rose strongly as a hedge against a weaker US dollar in the first half of the year, but fell in the second half as investors sought safety from Europe in US dollars. Oil finished the year at $98.83 per barrel, up 25% on the quarter and 10% on the year benefitting from geo-political turmoil in the Middle East and the continuing motorization of Asia.

In the final quarter of 2011, the US economy began to show a quickening pulse rate. Economic data across the spectrum, from employment, to the consumer, to industrial production, to even residential real estate, came in stronger than economists had expected. This was reflected in higher US stock prices. The essential question for 2012 is whether or not this strength can be maintained. After four years of recession and mediocre growth, it is reasonable to expect acceleration in the economy as pent up demand, in automobiles for instance, begins to at long last break out. While job growth has been muted thus far, those with jobs are feeling more secure and are increasingly willing to spend. Residential real estate construction has finally emerged from record low levels, adding strength to the economy from a sector many had left for dead. Finally, US corporations continue to enjoy record levels of profitability. As the economy expands, corporations are in a strong position to increase hiring and investment, with over two trillion dollars of cash on their balance sheets.

Arrayed against an improving economy are several factors. First and foremost is the monetary crisis in Europe. Because the European Central Bank has resisted acting as a lender of last resort to euro zone countries, investors have put pressure on their sovereign debt, pushing up interest rates. For a highly indebted country such as Italy, this is dangerous. It cannot afford to indefinitely rollover its large debt at interest rates approaching 7%. (Comparable US interest rates have been closer to 2%.) If Italy were to default on its debt, it would be a catastrophe for the European financial system that would not spare the American economy. As it already stands, Europe is likely entering a recession, and will act as a drag on our own economic performance, seeing that Europe is our biggest trading partner. Thus far, European authorities have avoided a total collapse, but whether or not they can continue to keep matters from going over the edge remains in doubt.

Closer to home, our political system is seen by many as being critically dysfunctional. Almost every matter of fiscal policy is executed in a stopgap manner accompanied with partisan rancor and brinksmanship. Such an environment is not conducive to confidence and economic growth, as evidenced by the subdued growth in the third quarter that was coincident with the debt ceiling debacle. Fortunately, there is no major legislative matter facing the Congress for the first nine months of the year, apart from a full year extension of the payroll tax holiday, which will no doubt be another bruising battle early in the new year. After the November election, however, which we expect to be of the more vicious variety, major issues such as the Bush tax cuts, mandatory spending cuts stemming from the failure of the “Supercommittee,” and a further expansion of the debt ceiling are back on the agenda. If past behavior is any indicator, these will be highly contentious debates that could once again depress economic growth.

Lastly, geopolitics could play a major role in 2012. While the recent succession in North Korea with the death of Kim Jong Il has dominated international headlines, we believe that the new leader, Kim Jung-eun, is largely a figurehead, and the same generals who were previously in charge are in charge now. We do not see any major change in North Korea’s intermittently belligerent posture toward South Korea. A greater risk, we believe, is presented by a possible American and/or Israeli strike against Iranian nuclear facilities. We do not think this a high probability event, yet the ramifications are potentially serious. Depending on how Iran chose to retaliate, a wider regional conflict could be triggered, and the price of crude oil would skyrocket. A dramatic increase in the price of oil would seriously dent American economic growth, if not push the economy back into recession. Given Israel’s limited ability to conduct a sustained, long-ranged aerial assault on a highly dispersed and fortified Iranian nuclear infrastructure, it is doubtful such a strike would be successful in seriously delaying the development of an Iranian nuclear weapon. That is why we do not see a lone Israeli strike as likely. Likewise, we think an American led strike is unlikely because of the potential for massive destabilization to the region and the global economy. We believe all diplomatic, economic, and covert avenues would have to be exhausted before such action were seriously considered.

This list is by no means exhaustive of the issues factoring into the market in 2012. A possible slowdown in the Chinese economy, continued high levels of indebtedness for the American consumer, and weakness in residential real estate are also issues that bear monitoring. This is a challenging environment for stocks, but the risks are well publicized and may to a large extent be discounted. Retail investors have been shunning stocks in favor of bonds going on four years, and this is a trend that may have run its course. At current interest rates, it is difficult to see a continuation in the total returns that bond investors have become accustomed to. With the likelihood of disappointment high for bond investors, stocks may be given another look after years in the wilderness. For 2012, we see the Standard and Poor’s Five-hundred trading in a range of 1150 to 1400. We believe stocks will have positive returns if the Europeans are able to prevent a full-blown financial collapse. The trend has been that they have always done just enough to avoid a collapse, so we are on balance, while remaining vigilant, confident that such a crisis can be avoided in the future.

For the second year running, we are pleased to have been named a Five-star Wealth Manger by Chicago Magazine. We appreciate your continued business and the trust you have placed in us. Do not hesitate to contact us with any questions or concerns you may have. We hope you have a healthy and prosperous new year.


Patrick Mauro, Daniel Mauro, Henry Criz

Market Update

October 24, 2011

On October 24th, the S&P 500 stock index closed above the upper boundary of our forecast for the remainder of the year. The S&P closed at 1254, while we saw gains for the fourth quarter limited to 1250. The index has gained 11% since the end of the third quarter.

The market strength is attributable to a classic mismatch between expectations and reality. Market sentiment had become extremely negative by the end of the third quarter on both the domestic economy and the European financial crisis. With expectations so low, it was not difficult for even a little bit of positive news on either front to move the market higher. As it turned out, that is exactly what we got. Although no final plan to end the European crisis is yet in place, policymakers on the continent seem to finally be dealing directly with the core elements of the problem. At the same, data on the US economy, while not robust, has come in just strong enough to indicate that fears of a slide back into recession have been exaggerated. The net effect is a stock market that is appreciably higher than where it began at the end of the third quarter.

As strong as the market has been thus far in the fourth quarter, significant economic and political risks remain, and we expect market volatility to remain elevated. The US economy lacks a clear driver of growth, while the politics behind a solution to the European financial crisis are extremely difficult. However, as we wrote in our latest quarterly market analysis, corporate fundamentals such as profitability and liquidity remain strong, and can underpin the stock market even in the face of continued economic and political uncertainty, in both Europe and the US. For the remainder of the year, we project the S&P 500 trading in a new range of 1100 to 1350.

Thank you again for your trust and confidence. Please feel free to contact us at anytime with questions or concerns.


Patrick Mauro, Daniel Mauro, Henry Criz

Third Quarter Review/Fourth Quarter Outlook

October 1, 2011

Global markets were thrown into tumult in the third quarter of 2011, driven by financial crisis in Europe and the debt ceiling crisis here at home. The latter saw the historic downgrading of America’s long-term credit rating by Standard and Poor’s. The stock market, as represented by the S&P 500 index, fell 14.4% to 1131, crude oil fell 18% to $79 per barrel, and the yield on the benchmark ten-year treasury note fell to 1.92% from 3.16% as investors sought a safe haven from the storm. Gold saw massive volatility rising from $1,500 per ounce to $1,892 before settling at $1625. The net gain for the quarter was 8.3%.

The American economy is moving forward at stall speed, and the market fears that a relapse into recession may be imminent. Three issues are weighing on sentiment. First, the financial crisis in Europe has the potential to send the global economy into turmoil if not handled properly by European authorities. The solutions are relatively straightforward, and Europe has the financial capacity to execute them. The real challenge lies in political will, particularly in Germany. Germany, as the largest economy in Europe, is the de facto leader of the Euro zone countries and must take charge in coordinating any policy response to the crisis. Its electorate, however, is strongly against bailing out profligate Greece, the flashpoint of the crisis. In order to maintain the integrity of the Euro, financial support of Greece is necessary. The alternative could potentially lead to a total meltdown of the European financial system. While German leaders may drag their feet on assisting Greece in order to pander to their constituents, in the end, we believe they will do what needs to be done. In the meantime, Europe will continue to be the prime source of pressure on the market.

Secondly, the American federal political system is in a near state of paralysis. Even the most routine measures, such as funding FEMA to deal with hurricane relief, are contested. In such an environment, it is difficult to envision the federal government doing anything significant to assist the economic recovery. After the fallout from the debt ceiling debacle, neither side is in a mood to hand the other anything that can remotely be construed as a political victory. We cannot see an end to this dynamic at least until after the presidential election in November 2012.

Finally, in the absence of effective fiscal policy, the importance of monetary policy is elevated. Unfortunately, the Federal Reserve is seen by many to have reached the limit of its ability to assist the market and economy. Its last policy maneuver, dubbed “Operation Twist,” involved altering the composition of its security portfolio to further drive down long-term interest and mortgage rates. While helpful at the margin, it is not seen as commensurate with the challenges facing the economy. However, we are more sanguine on this count. The Fed still has the ability to restart outright purchases of securities, i.e. quantitative easing or QE, on a large scale, and reduce the amount of interest paid to banks that deposit money at the Federal Reserve, thus incentivizing banks to lend out money in the real economy. We feel such measures would have a positive market and economic impact.

All is not lost, however. As a support to share prices, there are three significant factors. First, the current environment, as weak as it is in the aggregate, is supportive of corporate profitability. The cost of the two largest inputs of production, labor and capital, are quiescent. With the labor market weak, most employees are generally in no position to push for raises, while the Federal Reserve’s aforementioned moves to lower long-term interest rates have dramatically suppressed funding costs. To the extent the economy weakens further, commodity input prices could moderate and support profitability as well. Secondly, corporations have reacted to the financial crisis by streamlining operations significantly, increasing profitability in the face of chronically weak demand. And finally, corporations have very healthy balance sheets, thanks in part to low interest rates and the disciplined financial management mentioned above. S&P 500 companies are carrying two trillion dollars of cash on their balance sheets. This gives them serious financial flexibility in the face of continuing uncertainty.

We have found the turbulence to offer attractive investment opportunities in many of our equity positions. While the macro environment is perilous, we are confident in the underlying strength of the businesses in which are invested, and as such, have taken advantage of the volatility to invest at favorable rates of return. In spite of the volatility, we remain positive on the long-term prospects for gold. As for the S&P 500, for the remainder of the year we see the index trading in a range of 1000 to 1250. Thank you again for your business and continued confidence. Please feel free to contact us with any questions or concerns you may have.


Patrick Mauro, Daniel Mauro, Henry Criz

Market Update

August 8, 2011

The US, along with global stock markets, has witnessed a dramatic decline in share prices over the past two weeks. On Friday, July 22, the Standard and Poor’s Five-hundred stock index stood at 1345. On Friday, August 5, it closed at 1199, 10.9% lower. The decline saw the confluence of three troubling events: the debt ceiling crisis and resolution in Washington DC, the spread of the European financial crisis to Italian and Spanish debt, and a series of disappointing economic data reports on the US economy. Taken together, many investors with recent memories of 2008 were quick to sell stocks and seek the perceived safety of cash, Treasury bonds, and gold.

While we share these concerns, we are not as pessimistic about the long-term prospects of our portfolios. The economy, although exhibiting slow growth, is on firmer footing than in 2008. Companies are much leaner, both operationally and financially, and residential real estate has already come down well off if its peak. The massive layoffs and collapse in home prices of the past recession are simply not in the cards.

The European financial crisis has ebbed and flowed over the past two years. Although it has lacked the acuteness of the Lehman Brothers fiasco of 2008, it has proven persistent in the face of disunited European political and financial officials. Flare ups are met with band-aids and half-measures, which relieve the immediate pressure, only to reemerge a short-time later. We see more of the same in the months and years ahead.

Finally, regarding Washington DC, it is an undeniable negative that our political leaders cannot work together to formulate pro-economic growth policy. The downgrade of the nation’s credit rating by Standard and Poor’s to AA+ from AAA specifically cited political dysfunction in its decision. This dysfunction is more of a long-term issue than an immediate pressure, however, and concern surrounding it will likely come off the boil. Furthermore, if market duress were to continue for a sustained period, we are confident that the Federal Reserve, which is designed to be above politics, would take action. This would likely take the form of a further round of “QE,” the purchasing of long-term assets such as bonds and mortgages, to inject liquidity into financial markets. This is a reliably effective strategy, in our view.

While the memory of 2008 for many investors is losses, our experience was sticking to our strategy and emerging on the other side of the crisis with portfolios exceeding pre-crisis values. We regard the current challenging environment no differently and as of yet see no reason to believe otherwise. Rest assured, however, that we will continue to monitor financial, corporate, political, and economic events closely. Please feel free to contact us if you have any questions or concerns regarding your investments. Thank you for the continued confidence you have placed with us. In light of increased volatility in the market, we are increasing the size of our trading range on the S&P500 to 1050 to 1350 for the remainder of the year.


Patrick Mauro, Daniel Mauro, Henry Criz

Second Quarter Review/Third Quarter Outlook

June 30, 2011

In the second quarter of 2011, the stock market, as represented by the Standard & Poor’s 500 stock index, declined 0.4%% to close at 1321 on June 30, from 1326 at the end of the first quarter. The benchmark ten-year US Treasury note saw its yield decrease 29 basis points, or hundredths of a percentage point, to 3.16%, from 3.45% on March 31, while the price of Gold increased 4.3% to $1500 per ounce from $1438. Crude oil decreased 11.2% to $95 per barrel from $107.

The stock market came under pressure, and Treasuries rallied in the second quarter for three principal reasons. First, and most significantly, both the global and domestic economies appeared to have slowed in the first six months of the year relative to the pace of the fourth quarter of 2010. While economic data had previously surpassed Wall Street’s expectations on a regular basis, in the second quarter this pattern reversed itself. The data consistently came in below forecasts, particularly on employment. As it is said that the market is a game of expectations, this reversal in trend removed support for equities and put a bid into bonds. The economic weakness was attributed primarily to the disruption in global manufacturing caused by the Japanese earthquake and tsunami disasters in March and a sharp increase in the price of oil to $114 per barrel, which has since pulled back to $95. As Japanese production is gearing back up, and oil prices are in retreat, at least for now, many economists predict that growth will reaccelerate in the second half of the year. The trend in the economic data has indeed begun to moderate, and share prices ended the quarter on a firmer note while Treasuries weakened.

Working against this will be a backdrop of tightening fiscal and monetary policy in America and around the globe. In the US, while the 2009 enacted stimulus tapers off, additional stimulus spending is not on the table, with Democrats and Republicans focused on how to cut spending further. The Federal Reserve, meanwhile, has ended its bond purchasing program known as QE2 with no indication that it has any appetite for further action at this time. Taken together, along with the weight of high unemployment, a housing market that continues to struggle, and fiscally retrenching state and local governments, we are not as sanguine that the economy will substantially reaccelerate in the second half of the year. We are by no means calling for another recession, but would not be surprised by subdued real (inflation adjusted) growth in the 2-3% range, either.

A further weight on the stock market, and a support to Treasuries, was the reemergence of the Greek debt crisis. Simply put, Greece has more debt than it could ever hope to repay without some form of relief. The challenge for European governments is to reduce this debt in such a fashion that does not result in a continent wide financial crisis. If serious doubts about the ability or willingness to repay debt spread to Portugal, Ireland, and, most ominously, Spain, events could spiral out of control, leading to a Lehman Brothers-style banking panic in Europe that could bleed into American markets as well. Greece in and of itself is not a large economy, and the European authorities do have the financial wherewithal to resolve this particular crisis. The threat of a larger contagion, however, is very real. As of this writing, a short-term fix seems to be in the works. The real worry is whether or not the Europeans have the political will to coherently develop long-term policy. This remains to be seen.

Lastly, the uncertainty surrounding the US debt ceiling increase is souring market sentiment. Apart from potentially disastrous consequences if America were to voluntarily default on its debt, the whole exercise in partisan posturing and brinksmanship on such a serious matter undermines the market’s confidence in the ability of the United States government to function in a rational and responsible way. We fully expect this issue to be taken at least to the August 2d deadline the Treasury department has identified for a default, if not beyond. There is some dispute as to whether or not this is a hard deadline. The closer the deadline looms, however, the larger the issue this will be for the market. Ultimately, we see a ceiling increase being authorized, but not before the drama is taken up a few notches first.

Over the longer-term, we see an economy and stock market that will expand at a modest pace below what was considered “normal” prior to the 2007 to 2009 financial crisis. The deleveraging of the American consumer and the related weakness in housing will not be unwound quickly. As the consumer is the main driver of economic activity in America, it is difficult for us to envision more aggressive long-term growth than the aforementioned 2-3%. Such a growth rate could produce real (adjusted for inflation) annualized average stock returns in the 3-5% range over the next decade. While far superior to what is currently offered in the bond market, we believe our quality/value oriented approach will return a premium over the generally more expensive and speculatively oriented broad market averages, such as the Dow Jones Industrials, the S&P 500, and the NASDAQ Composite. Our experience through the financial crisis demonstrates that our four pillars of quality, value, diversification, and patience can deliver positive long-term results in even the most treacherous investment environments. In this sense, we remain positive on the potential returns of your portfolio regardless of the many challenges and potholes that line the road ahead. For the remainder of the year, we see the S&P 500 trading in a range from 1225 to 1425. It currently stands at 1321.


Patrick Mauro, Daniel Mauro, Henry Criz

First Quarter Review, Second Quarter Outlook

March 31, 2011

In the first quarter of 2011, the stock market, as represented by the Standard & Poor’s 500 stock index, rallied 5.4% to close at 1326 on March 31 from 1258 at the end of last year. The benchmark ten-year US Treasury note saw its yield increase 14 basis points, or hundredths of a percentage point, to 3.45% from 3.31% on December 31, while the price of Gold increased 1.1% to $1438 per ounce from $1422 at the end of last year. Crude oil increased 35.4% to $107 per barrel from $79. Financial markets were buffeted from multiple directions during the quarter. Earnings and economic data were generally supportive of stocks, while the news out of the Middle East, Japan, and higher oil and commodity prices worried investors.

The market faces four immediate areas of concern moving into the second quarter. Most prominently in the headlines are the triple disasters in Japan. While the tragic events are dramatic from a humanitarian perspective, the long-term impact upon the global economy, let alone the profits of American business, will likely be limited. The impacted area represents only 1-2% of Japanese economic output. The situation in the Middle East is potentially more ominous. If political instability were to spread to the kingdom of Saudi Arabia, the impact on already elevated oil prices would be substantial. Oil priced above $120 per barrel (currently trading at $107 for the US benchmark West Texas Intermediate crude oil futures contract) on a sustained basis would significantly impact both global and domestic economic growth. Closer to home, the budget and debt ceiling battles in Washington could result in a shutdown of the Federal government. Such an outcome could shake confidence in America’s political leadership and negatively impact American markets.

Finally, uncertainty surrounds the expiration in June of the Federal Reserve’s second round of long-term asset purchases known as QE2. (QE is shorthand for quantitative easing.) It has injected approximately $100 billion per month into the markets by purchasing US treasury notes and bonds. If the purchase program is not extended, the loss of liquidity could have an adverse effect on US financial markets. We believe the condition of the labor market by the end of the second quarter will be the primary consideration in determining whether or not the Fed will continue with the program, although the Fed is not beyond being influenced by politics as well. Inflation will be a secondary factor. As of now, the conventional wisdom is that the program will be allowed to expire. We do not believe this has been fully discounted by the market, and could therefore be a source of weakness. While we believe the program will end in June, we do not rule out a QE3 further down the line if markets and the economy were to deteriorate.

Longer-term, three major concerns remain in place. The parlous fiscal condition of many states presents a significant risk to long-term economic growth. To close budget gaps, states will likely resort to austerity measures that will subtract from economic activity. In many cases, this process has already begun. The European sovereign debt crisis also remains. Peripheral countries like Greece, Ireland, and Portugal may ultimately be unable to repay their debts, and if so, the European banking system could be thrown into crisis. As Europe is our largest trading partner, this would have a significant impact on our economy and financial markets. Finally, perhaps the largest long-term risk is the financial health of the United States government. Given current projections, the US national debt will reach historically dangerous levels by the end of the decade. If America’s creditors lose confidence in America’s solvency, the economic and market repercussions would be severe. This is a threat that is still years out by our estimation, but it is a situation that we are monitoring closely.

Three factors predominate on the positive side of the ledger. First, the US economy undeniably has momentum. Tellingly, most economic statistics have consistently beaten the expectations of Wall Street economists. This is a phenomenon that typically has staying power and indicates sustained economic growth. We will become concerned when Wall Street expectations catch up with the actual economic data. In the meantime, the continued outperformance of the economy should support the US stock market. Secondly, the longstanding flow of money out of US equity mutual funds and into bond funds and emerging market equity funds has reversed. This has been a major underpinning to US share prices in the face of the concerns cited above. As with the economic growth story, this is a phenomenon that has legs. It is unlikely to reverse quickly absent a major dislocation in financial markets. Thirdly, and perhaps most importantly, large portions of the stock market are attractively valued. We are not finding it difficult in the current environment to find quality companies trading at discounts to our conservative estimations of fair value. Our experience has shown that the best long-term defense for a portfolio is owning cheap shares in solid enterprises.

For the remainder of 2011, we see the S&P 500 trading in a range of 1200 to 1425. It currently stands at 1326. Given the numerous worries present, we would not be surprised to see a retest of the 1250 level reached during the height of the Japan nuclear scare, in the months ahead. Longer-term, we expect to see the market continuing its advance for the reasons discussed above. Thank you for the trust you have placed with us. As always, feel free to contact us with any concerns you may have.

Patrick Mauro, Daniel Mauro, Henry Criz

Annual Client Letter and Outlook

December 31, 2010

In 2010, the stock market overcame two significant macroeconomic concerns to continue its post-financial crisis rally. The stock market, as represented by the Standard and Poor’s Five-hundred stock index, closed 13% higher at 1258. Fears regarding fallout from European sovereign debt crisis and possible “double dip” recession in the United States held back stocks for much of the year. Climbing the proverbial wall of worry, however, share prices managed to end the year with solid gains. Bond prices rose and yields shrank on the fears cited above and the second round of major bond purchases initiated by the Federal Reserve. The yield on the benchmark ten-year Treasury note closed the year at 3.31%, down from 3.84%, but significantly above the low yield of 2.33% reached in October. Gold continued its multiyear rally with the price increasing 29% to $1419 per ounce. Continued easy fiscal and monetary policies throughout the developed world have been the major driver behind higher prices.

Looking to 2011, the positive case for the stock market is the undeniable momentum in the US economy. After experiencing a mid-year slowdown, growth has accelerated, and with the Federal Reserve and the US Government continuing to pour liquidity into the system with bond purchases and tax cuts, the strengthening looks to continue into the new year. Stronger economic growth should translate into increased spending, investment, corporate profits, and, ultimately, hiring. Such an environment would be supportive to the stock market and make it resilient in the face of external shocks, such as the European financial crisis. Furthermore, on a standalone basis, bond purchases by the Fed, (popularly known as QE2,) can have the effect of moving money into other financial instruments such as stocks or gold, driving up their prices independently of economic conditions. While high unemployment is a long-term drag on the economy, it could stay the Federal Reserve’s hand in discontinuing its bond purchasing program in 2011, which would be a positive for the stock market, but a significant concern if it does not. Finally, after two major bear markets in a decade, many individual investors have been shunning stocks in favor of bonds. Based on recent reports of flows into and out of mutual funds, however, it seems that this trend has begun to reverse and that retail money is now flowing out of bonds and into stocks. This trend will provide further support for stock prices, if it continues.

Weighing against the stock market are several factors. The most immediate is the pronounced enthusiasm of professional investors for stocks. The stock market finished strongly in 2010 in anticipation of the stronger economy discussed above. This pulled potential price appreciation from 2011 into 2010. Along the same line of thinking, based purely on the amount of ground covered by the stock market rally since the crisis low of March 2009, it is only natural for the stock market to decelerate at this point in the cycle. After gains of 23% in 2009 and 13% in 2010, we would expect to see any further appreciation to be more muted. Europe continues to be a major source of potential instability. While European and international authorities have thus far kept the crisis contained, there is no guarantee that they will be able to do so in the future. If the European sovereign debt crisis were to infect the international banking system, the US stock market could come under significant pressure. The US housing market remains under considerable pressure from excessive inventories of homes. As housing is the largest financial asset for many Americans, this could provide a limitation on spending from US consumers. Additionally, the finances of US state and municipal governments also bear watching, with many facing large budget deficits and the removal of Federal financial support with the expiration of the 2009 stimulus law.

We continue to believe that the long-term bond market has begun a secular bear market that started when the benchmark ten-year US Treasury note bottomed at 2.04% in December of 2008. As such, we think yields will continue to move higher with the strengthening US economy. Keeping any increase in long-term yields constrained will be the still relatively modest pace of economic expansion and the gravitational pull of zero percent overnight interest rates that essentially allow banks to borrow for nothing and lend at the long-term rate, booking the spread as profit. Gold will continue to serve as the refuge for those who believe that the extraordinary monetary and fiscal accommodation of the past decade will ultimately end badly when it comes time to settle our debts as a nation. We believe gold’s decade long bull market will extend well in to the next, as American politicians have made no serious attempt, as of yet, to address our massive and ultimately unsustainable trade and fiscal deficits.

For 2011, we expect the S&P500 stock index to trade in a range of 1150 to 1400 and finish in the upper half of that range. It ended 2010 at 1258. We have confidence that our principle strategy of focusing on value, quality, diversification, and patience will continue to deliver maximum long-term value to our clients regardless of short-term market fluctuations. Please feel free to contact us with any questions or comments. We thank you for the confidence you have placed in us, and we wish you a happy and prosperous new year.

Patrick Mauro, Daniel Mauro, Henry Criz

Third Quarter Review, Fourth Quarter Outlook

October 1, 2010

In the third quarter of 2010 the stock market, as represented by the Standard and Poors Five-hundred stock index, advanced 10.67% to 1141 from 1031. Relief that a European financial crisis had been seemingly adverted and data suggesting the United States would not relapse into recession drove gains. The yield on the benchmark ten-year US Treasury note fell to 2.52% from 2.95% as investors came to expect further purchases of government bonds by the Federal Reserve to support the economy. Gold rallied 8.02% to $1307 per ounce from $1210 per ounce as some investors feared that the Federal Reserve’s activities would ultimately lead to much higher inflation.

While the market is little changed for the year, the road to this point from January 1st has certainly seen its share of volatility. Investors have alternatively been seized by expectations of a “V” shaped economic recovery, a European led global financial crisis, relief, fears of a “double dip” US recession, and relief once more. We see this pattern being the template for years to come. Much sound and fury, but in the end, you are left with a US economy growing at a subdued pace due to over indebtedness, underemployment, and uncompetitiveness. “The New Normal,” as some have called it.

There is no easy way out of this condition, particularly given the state of political paralysis in the US. Fiscal policy is likely to be a drag on the economy with the expiration of spending authorized by the American Recovery and Reinvestment Act of 2009 and the low probability of getting any sort of meaningful stimulus measures to take its place, assuming the Republicans taking at least one house of Congress this November, as now seems likely. As an important offset, however, the Federal Reserve has signaled its willingness to purchase increased amounts of long-term US Treasuries if the domestic economy and inflation do not accelerate. This is in effect printing billions, if not trillions of dollars, and injecting them into the financial system. We feel that such “quantitative easing” was central to pulling the economy out of recession in 2009, and we are confident that further such easing in the future will have the desired effect of providing support to the economy and prices.

In such a low growth environment, our strategy to focus on dividend income should continue to outperform. We emphasize companies that both pay and grow a robust dividend. Furthermore, exposure to healthier overseas markets should also be a profitable exercise. We achieve this primarily through investment in multi-national and export oriented American domiciled corporations. Finally, we believe that the economic malaise America finds itself in will ultimately result in a much weaker dollar. Debt cannot continue to grow faster than the economy indefinitely, and the authorities will result to debasing the dollar in order to both increase trade competitiveness and inflate away the debt. Commodities, more specifically gold and oil, have historically performed well in inflationary economic environments such as the 1970s. Gold in particular offers protection against monetary turmoil more broadly, as America is not the only nation resorting to the printing press to boost competitiveness. Once again, stocks in companies exposed to non-dollar international markets should also do well. While this inflationary outcome is likely many years down the road, rest assured that we are positioning your portfolio today to prosper both now and into the future.

For the remainder of 2010, we expect the stock market, as represented by the Standard and Poors Five-hundred, to trade in a range from 1050-1250, with the market closing the year at the upper end of that band. We believe there is room for further gains if the economy continues to expand, albeit slowly, as we expect it to. Many investors, both retail and professional, have shunned the stock market in recent years, and as the financial and economic environment stabilizes, they may be lured back into stocks, particularly when interest rates on fixed income investments offer such little return. This would drive share prices higher. Bond yields still have the potential to move lower if the Federal Reserve increases its purchases of US Treasury notes and bonds, although we continue to believe they will move much higher in the long-term. Gold may consolidate its recent gains, but we feel that the case for higher prices we have advocated for many years continues to be in place. Ultimately, the printing press will have to serve as the primary source of government funding, resulting in a much weaker US dollar and higher commodity prices, particularly gold.

Patrick Mauro, Daniel Mauro, Henry Criz

Second Quarter Review/Third Quarter Outlook

June 30, 2010

After reaching its highest levels since the collapse of Lehman Brothers in the fall of 2008 on April 23, the stock market began its first major correction since bottoming in March of 2009. The stock market, as represented by the S&P 500, declined 11.8% from 1169 to 1031. Treasury bonds rallied, meanwhile, with the yield on the benchmark ten-year note declining to 2.95% from 3.83%. Also in the face of uncertainty, gold rallied 11.5% from 1115 to 1243. The initial catalyst was the fear of a financial meltdown in Europe due to the sovereign debt of nations such as Greece, Portugal, and Spain. After the European sovereign debt situation was at least temporarily stabilized by a trillion dollar rescue package put together by the European Union, the European Central Bank, and the International Monetary Fund, the anxiety of the markets morphed into concern about the sustainability of the American economic recovery. Further souring sentiment has been the fecklessness of both industry and government in dealing with the disaster in the Gulf of Mexico. Overall, the sentiment has been almost exclusively negative for the past two months.

Europe is likely to muddle through its debt woes. Although we cannot dismiss the possibility of the American economy sliding back into recession, we believe America will grind its way forward. While the unemployment rate remains at multi-decade highs, state and local governments struggle to balance budgets, and the residential real estate market flounders in oversupply, American banks are well capitalized, corporate cash is at record levels, and most American businesses are solidly profitable after massively increasing productivity through cost cutting during the recession. The fact that there is little fat left to cut is a good thing, as it means fewer potential job losses going forward. The outlook is by no means rosy, but we do not believe that these are the makings of another leg down for the American economy.

More troubling is the longer-term diagnosis. More needs to be done to accelerate growth. The anemic growth we are witnessing is setting us up for potentially severe economic and financial consequences further down the line. As is well publicized, the American Federal debt is accumulating rapidly, more rapidly than the current growth of the economy. If this trend continues, there will come a point someday where the ability of the American economy to support the national debt will be called into question. If this point is reached, the only solutions are severe and debilitating tax increases and spending cuts, money printing, or outright default.

We feel that the most politically expedient solution would be money printing. The implications would be higher inflation, much higher interest rates, little to no real economic growth and a perpetuation of high levels of unemployment. As the saying goes, we do not want to go there. The best way to avoid that fate would be to redouble our efforts to spur economic growth so that the economy will have the wherewithal in the future to finance its debts. Unfortunately, the political process has moved into a state of paralysis, with the Congress incapable of passing any sort of additional stimulus measures. This is not an arrangement we see changing anytime in the relevant future.

This puts the onus on the Federal Reserve to provide further stimulus to the economy. While short-term interest rates are already effectively at zero, the Fed can reinitiate the purchase of long-term assets to increase the money supply. It had been doing this up until the end of March, and we feel it had been highly supportive to the economic recovery up to that point in time. As conditions have since deteriorated, the fact that they have not continued with the purchase of US Treasury and mortgage bonds represents an effective tightening of policy. This makes little sense, and is one of the reasons the market came under further pressure following the release of the statement from the latest meeting of the Federal Reserve Open Market Committee on June 23. The committee said, in essence, that conditions had worsened but suggested no change in Fed policy as a response. Ultimately, we think the Federal Reserve will act if economic data continue to weaken. We are confident this action will have the desired effect of accelerating growth and supporting financial markets. However, the sooner this action takes place, the less ground it will have to make up, and the more effective it will be.

The implications for financial markets are single digit returns across the board. The stock market is fully valued at current prices; therefore, they will rely almost exclusively on profit growth for further appreciation. Considering that corporate profit margins are already near all time high levels, it is likely that profit growth will be limited to nominal GDP growth of 4% or so. When you add 4% to the current 2% dividend yield of the S&P 500, you are looking at a 6% long-run return. It is worth noting that our portfolios have higher dividend yields than 2%, thus giving you a built in advantage over the general market. Bond yields are already in the low single digits, and what you see is all that you will get. We continue to be bullish on gold as a hedge against the possibility of aggressive inflation and monetary turmoil if economic growth is unable to keep pace with debt accumulation. Due to increased market volatility, we are expanding are forecast for the S&P 500 trading range to 900 to 1200.


Patrick Mauro, Daniel Mauro, Henry Criz

First Quarter Review/Second Quarter Outlook

April 1, 2010

In the first quarter of 2010, the stock market as represented by the S&P 500 stock index advanced 4.8% from 1115 to 1169. The benchmark Ten-year Treasury note fell one basis point to 3.83% from 3.84%. The price of gold rose 2% to $1115 per ounce from $1093.

We believe the latest surge in equity prices stems primarily from two factors: 1) consistently better than expected economic data, and 2) continued exceptional monetary accommodation by the Federal Reserve. While the economic recovery has certainly not been powerful, especially relative to the magnitude of the preceding recession, it has nonetheless been stronger than the almost always backward looking Wall Street consensus has expected. When reality exceeds negative expectations, stock prices tend to rise. At the same time, the Federal Reserve has maintained, and has signaled that it will indefinitely maintain, highly accommodative monetary policy. Overnight interest rates are pegged at essentially zero, and while the Fed has completed a $1.75 trillion bond purchasing program with freshly printed dollars, it stands ready to reinitiate the program as needed to attempt keeping long-term interest rates low. This easy money policy has had the effect of pushing traditional cash savers into the bond market, and bond market investors into the stock market in search of higher returns.

While we feel this trend can continue for several more months, if not well into next year, we believe ultimately that the foundations of this rally are ephemeral. The economy has benefited from a snap back in demand after falling off a cliff in 2008 and early 2009. When this reflex is complete, it is far from clear what type of sustained driver of demand could plausibly take its place. Unemployment will still be historically high, the housing market will still be distressed, consumers will still be heavily indebted, the Federal budget deficit will still be in the neighborhood of $1 trillion per year, America will still be dependent on foreign goods, capital, and oil, and much of the fiscal stimulus from the Federal government will have run its course. Contrary to the hopes of some, after decades of decline, the export/manufacturing sector is not nearly large enough to become the primary source of economic growth anytime soon. Just when investors start to expect more from the economy, it may decelerate and begin to disappoint their expectations. To be clear, we are not looking for a move back into a recession once this recovery stage of economic expansion is complete, but rather a sustained period of subpar growth.

The easy money policy of the Fed has greater sustainability than continued economic strength, but ultimately is unsustainable as well. The Federal Reserve can continue to print dollars and inflate asset values only so long as the foreign creditors we rely on to subsidize our lifestyle are willing to accept dollars as a store of value and means of exchange. If this confidence in the dollar is lost, the Federal Reserve’s ability to suppress long-term interest rates will be overwhelmed and interest rates could move significantly higher across the board at the same time inflation moves to potentially destabilizing levels. Such an outcome would likely lead to an economic dislocation potentially much more severe than that witnessed as a result of the credit crisis of 2007-08. The upshot is that we believe this scenario, if it were to come to pass at all, is still at least five to ten years away. The dollar is the global reserve currency that all countries must hold to engage in international trade. So long as there is no serious competitor, the dollar’s status is secure, and a precipitous decline in its value and that of US Treasury debt is highly unlikely. The recent tumult in the European monetary union regarding Greece serves to reinforce the near-term viability of the dollar as the monetary reserve asset of choice. As such, easy Federal Reserve policy will continue to underpin financial markets, and is the main reason we are not negative on stocks in the near to intermediate term.

Longer-term, we believe the sensible way to prepare for slower growth, higher interest rates, and a weaker dollar is to gravitate portfolios toward higher dividend yielding sectors such as healthcare, consumer goods, and utility stocks, hard assets, such as gold and oil, and shares in multinational corporations and exporters. The thinking behind investing in the defensive equity market sectors is that their non-cyclical nature should serve them well in a struggling economy, and that their higher yields/lower valuations give them a measure of safety when interest rates and dividend yields rise, i.e. if the stock market as a whole were to be revalued from a current dividend yield of 2% now to 4% in the future, would it not make sense to hold stocks that are already yielding 4%? The thesis behind hard assets is more straightforward. If the supply of dollars expands faster than the supply of gold or oil, the price of oil and gold will appreciate in dollars. It is much easier for the Federal Reserve to print a dollar than it is for man to pull a barrel of oil or an ounce of gold out of the ground. Given the Fed’s need to print massive amounts of dollars to suppress interest rates and keep the economy from falling back into recession, we think this will continue to be a profitable trade with the added benefit that it offers an effective hedge on your stock positions. Lastly, multinational firms and exporters that do a large percentage over their business overseas would benefit from both a weaker dollar and exposure to relatively stronger foreign markets. We continue to be negative on long-term debt instruments. At current low yields, they offer very little in the way of potential reward, while presenting tremendous risk if interest rates were to move aggressively higher. We believe blending stocks with cash and short-term debt offers a better long-term investment strategy.

For the remainder of the year, we see the stock market trading in a range of 1050 to 1300 on the S&P 500. The 1300 level represents the pre-Lehman Brothers market from August 2008. We believe this level will offer significant psychological or “technical” resistance for bullish stock traders and investors.

Patrick Mauro, Daniel Mauro, Henry Criz

Third Quarter Review, Fourth Quarter Outlook

October 1, 2009

In the third quarter, the US stock market as represented by the S&P500 stock index gained 15%, closing at 1057 on September 30th from 919 at the end of June. Stocks were driven by several factors, from a belief that the economy was recovering more quickly than many had previously thought, to the fact that cash now offers a negative real return, compelling many to go in the market and speculate. Yields on long-term Treasuries fell (prices rose) for the quarter, with the yield on the benchmark ten-year Treasury note falling to 3.31% from 3.52% at the end of June. The price of gold rose 9% from $927 per ounce to $1,009.

As mentioned above, both fundamental and technical factors were involved in pushing asset prices higher. Fundamentally, the recovery in the economy has surprised many in its strength. This has been a result of both the extraordinary fiscal, monetary, and financial measures undertaken by the government, and the extent to which panic production freezes by companies in the fourth and first quarters of 2008/2009 had to be reversed in order to rebuild severely depleted inventories. Economic strength gives investors confidence, which facilitates the purchase of stocks.

Just as significantly, however, has been the debasement of cash by the Federal Reserve with its zero percent overnight interest rate policy. Given the prospects for future inflation and the open ended nature of the policy, cash has come to be seen by many as a guaranteed loser. This has compelled such investors to move into financial markets in search of returns. This buying, in conjunction with the strengthening of the economy, lures more buyers in, sending asset prices even higher. Ultimately, those investors with outsized cash positions feel the squeeze of underperformance, and capitulate by buying assets without regard to any actual fundamentals.

We believe that this technical effect can be seen by the simultaneous rally in stocks, bonds, and gold. One would think that if the economy were revving up, as the stock market implies, or that inflation is a serious threat, as does gold, Treasuries would retreat from already elevated prices in anticipation of higher future interest rates. The fact that all three markets rallied together argues that the fundamental story was superseded by the need to hold anything other than cash. As is often case, such technical factors influence markets as much as any fundamental considerations. For many, fundamentals are the rationalizations for buy and sell decisions, while the technicals, the buying and selling of others, are the actual motivation. This should never be ignored.

Looking forward, we are cautious on the stock market as a whole. It has had a tremendous move off its March lows (56%), and much of the buying has been driven by technical, momentum based action as described above. While the recession has almost certainly ended in the third quarter, the economy is still undeniably weak, with high unemployment and a fragile real estate market. To add to this, the indebtedness of the nation is at a record level, and it is difficult to see how long-term growth can be robust with this being the case. In the future, Americans must save more and spend less. America must produce more of what it consumes and export more overseas. This is a serious challenge for the country. As a hedge against a botched or disorderly transition, where the nation seeks to get out from under its immense debts primarily by printing money, we remain committed to gold as a core holding. As important as the technicals may be month to month, or even year to year, in the long-run, the fundamentals have the last say.

For the remainder of the year, we see the S&P500 trading in a range from 950 to 1150. In spite of our cautious outlook, we have confidence in our portfolio companies. They have a proven ability to weather economic cycles and consistently deliver cash to shareholders. Although they do not operate in isolation, and would certainly not benefit from a difficult market and economic environment, we are confident they will provide both superior relative returns and positive absolute returns over the long-term.

Patrick Mauro, Daniel Mauro, Henry Criz

Second Quarter Review, Third Quarter Outlook

June 30, 2009

In the second quarter of 2009, the S&P 500 stock index rallied 15% to 919 on June 30th, from 798 on March 31st. Similarly, the benchmark ten-year Treasury yield rose sharply from 2.68% to 3.52% on hopes that a financial and economic catastrophe had been avoided. We would agree with that conclusion. Thanks to the trillions of dollars of support and subsidies granted to the financial sector through the TARP and numerous other Federal programs, along with a $787 billion fiscal stimulus package, an economic collapse has, for the time being, been averted. After the failure of Lehman Brothers in the fall of last year, the government made it clear to all that it would not allow another major financial institution fail, and once investors came to believe this, a major stock and commodity rally ensued. Additionally, economic data began to reflect a deceleration in the rate of economic decline. This data was widely touted by members of the government with the catchphrases of “green shoots” and “glimmers of hope.” The data and rhetoric further fueled the rally.

Needing more than relief and catchphrases to continue its upward tack, the S&P 500 peaked in early June at 946, with no new catalysts to push share prices higher. We believe the reality of a long, hard, low-growth slog to economic recovery may be finally registering with investors, i.e. no collapse, but not much growth to speak of either. The reason for this is that the debt load of the American consumer will take many years to be relieved through savings, debt repayment, and personal bankruptcies in a time of stagnant wages and asset prices. Essentially, consumers are rebuilding their battered balance sheets by spending less than they earn. Previously, the American economy was driven by consumers borrowing against their appreciating homes and retirement accounts to consume goods and services. That game is now over and is unlikely to return anytime soon enough to be relevant. The government must run deficits as far as the eye can see to ensure that the retrenching of the American consumer does not lead to a downward economic spiral.

Ultimately, however, the government must be able to withdraw its debt fueled stimulus from the economy. Ideally, the private sector of the economy will revive sufficiently sometime in the intermediate future to allow the government to begin the process of putting its fiscal house in order. However, if the economy is not able to sustain a recovery, and the government is not able to reduce its deficits, our foreign lenders may withdraw their support for the American dollar and American assets. This could lead to many troubles, the scope of which would make the last two years pale in comparison. At that point, the government would have to either massively raise taxes and cut spending, print greater and greater amounts of money, or default outright on its debt. None of these options is a good one. The good news, however, is that this reckoning will not be met until well into the future, if it comes to pass at all. The big question remains: what will replace the deficit driven “globalization” economic model of the past two decades that brought us to this juncture?

The best way to invest is to focus on companies and assets that would benefit from a declining dollar. This includes multinational corporations, exporters, and gold. To maintain portfolio diversification, we continue to focus on quality value names in other areas of the investment universe as well. Such investments consistently grow their dividend and trade at an attractive price relative to their dividend payout. We believe the closing low of 678 on the S&P 500 in March will hold for at least the next few years, although a retest later in the year remains a real possibility. For the remainder of the year, we see S&P 500 moving in a range from 750 to 1050.

Patrick Mauro, Daniel Mauro, Henry Criz

First Quarter Review, Second Quarter Outlook

March 31, 2009

In the first quarter of 2009, the benchmark S&P 500 stock index fell 11.7% to 798, as the breadth and depth of the economic crisis became apparent to an increased number of investors. On March 10th, however, a powerful rally began that has taken the market up 17.9% from a closing low on the S&P 500 of 676 on March 9th. It is too soon to tell whether or not the March 9th low is in fact the bottom of this bear market. The market has taken massive damage, and it should come as no surprise that it was prone to experiencing a substantial rally at some point, as it has throughout this decline, most recently as this past November and December. What we are looking for is sustained trading above the peak of the last bear market rally, which was 935 on the S&P 500 reached on January 6th of this year. All previous rallies have failed to trade above previous rally highs, and if this rally were able to do so, we would begin to believe that the low was in fact reached on March 9th. The interest rate on the benchmark Ten-year Treasury note rose from 2.24% at the end of 2008 to 2.69% on March 31st, as global deflationary worries subsided. The Federal Reserve began purchasing $300 billion in long-term Treasuries in March, in a bid to keep increases in long-term yields in check. Given their efforts and the overall weak state of the economy, we believe they will succeed in keeping long-term rates low at least for the next several quarters.

Apart from the short-term technical dynamics of the market, we maintain our previously stated belief that the US Government will ultimately succeed in halting the significant economic decline we are experiencing. The exact timing of this is unknowable, but its eventuality is inescapable. To us, the more interesting question is what comes after the recession has ended? What will the economy look like? Who will be the winners and losers? Given what we know now, it is difficult to say. The Obama administration has been sending out mixed signals. In speeches, the President acknowledges that our economy had become overly reliant on borrowing and finance, and that we must move to a more balanced, self-sufficient economy. Yet at the same time, the Treasury, Federal Reserve, and FDIC are steering literally trillions of dollars into the financial sector this year alone, while only budgeting a few hundred billion or so into recapitalizing the industrial base over the next ten years. To wit, the administration has taken a much harder line in dealing with the struggling automotive industry than it has with Wall Street banks. This bears close watching.

At any rate, over the long-term, attempting to rebuild the “globalized,” finance based American economy that existed prior to this recession is destined to fail. This economy was ultimately based on the ability of US consumers to borrow and spend, and this ability has reached an irreversible state of long-term decline with maxed out credit cards, underwater mortgages, and stagnant wages. The globalization/finance based model required ever increasing asset prices for foreigners to lend against in order to sell us their goods and services. Asset prices have collapsed, and this model is broken. The economy of the future must be based on Americans building things besides houses and shopping malls, and then not borrowing heavily against them, as was the case up until 2007. It will take many years for housing prices to recover, home equity to be regenerated, and consumer debt to be paid down. No matter what anybody in business or government tells you, there is no quick fix for this.

To position our clients for this environment, we are focused on investing in companies that manufacture the goods and produce the sorts of services that will be required in a more balanced, self-sufficient American economy. Essentially, we are underweighting the financial, residential construction, and retail oriented sectors that became overgrown during the bubble years. Their heyday is in the past. Our investments should continue to outperform by capturing the share of GDP those three sectors will have to surrender moving forward. For the remainder of the year, our predicted range on the S&P 500 is 600 to 1000.

Patrick Mauro, Daniel Mauro, Henry Criz

March 3, 2009

Standard & Poor’s 500 Stock Index Closes Below 700 at 696

Since the end of 2008, the stock market has declined a precipitous 23% in a little over two months. This decline exceeds what we felt was likely for the year and reflects three factors: 1) A fear that the recession will be much more severe than people had thought previously, both in depth and duration, 2) people are just sick of losing money and want out, and finally 3) a general loss of faith in the American capitalist system where it seems as though the insiders always seem to walk away with fortunes, regardless of what happens, while the shareholders are left holding the bag when things go south.

We do believe the economy is in worse condition than many had previously believed, but in no way feel that a second Great Depression is likely. As we have said previously, the government’s efforts, although inadequate to put a decisive end to the crisis, will keep the eco