Client Letter

2017 Client Letter

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.

Sincerely,
Patrick Mauro, Daniel Mauro, Henry Criz

For the fifth year running, we are pleased to have been named a Five-Star Wealth Manager as described in Chicago Magazine.  3,411 in Chicago area were considered for the Five Star Wealth Manager award.  726, approximately 22 percent of the award candidates were named 2016 Five Star Wealth Managers. A detailed description of the award can be found in the November 2016 issue of Chicago Magazine.  More details are available at Fivestarprofessional.com

 

Privacy notice:

Patrick Mauro Investment Advisor, Inc. (PMIA) is a registered investment advisor registered with and regulated by the Securities Department of the Illinois Secretary of State’s office, Springfield, IL. PMIA must collect certain nonpublic information regarding your financial assets and net worth. We must do this to help you develop a mandate in managing your account. This information and any other information for which you disclose to PMIA for the purposes of granting access to your brokerage account is treated this way: PMIA discloses this information to no one else, that is to no third party. Your information is kept confidential and secure at the corporate office of record, 38 Mockingbird Lane, Oak Brook, IL 60523.

 

Part 2A, Form ADV:

Every client should know that Rule 204-3 under the Investment Advisers Act of 1940 imposes disclosure delivery obligations on investment advisers. Each year, PMIA offers each client through this letter Part 2A of its Form ADV. This disclosure document may be obtained by writing PMIA and requesting a copy be mailed to you.  Supplemental disclosures for Daniel and Henry can be requested as well.

 

 

2016 Client Letter

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 the 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.

We appreciate your business and the continued confidence you have shown in us.  As always, do not hesitate to contact us with any questions or concerns you may have.  We wish you a happy and prosperous 2016.

Sincerely,
Patrick Mauro, Daniel Mauro, Henry Criz

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 page FS 1 of the November 2015 issue of Chicago Magazine.  More details are available at Fivestarprofessional.com

Privacy notice:

Patrick Mauro Investment Advisor, Inc. (PMIA) is a registered investment advisor registered with and regulated by the Securities Department of the Illinois Secretary of State’s office, Springfield, IL. PMIA must collect certain nonpublic information regarding your financial assets and net worth. We must do this to help you develop a mandate in managing your account. This information and any other information for which you disclose to PMIA for the purposes of granting access to your brokerage account is treated this way: PMIA discloses this information to no one else, that is to no third party. Your information is kept confidential and secure at the corporate office of record, 38 Mockingbird Lane, Oak Brook, IL 60523.

Part 2A, Form ADV:

Every client should know that Rule 204-3 under the Investment Advisers Act of 1940 imposes disclosure delivery obligations on investment advisers. Each year, PMIA offers each client through this letter Part 2A of its Form ADV. This disclosure document may be obtained by writing PMIA and requesting a copy be mailed to you.

2015 Client Letter

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 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 throws 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 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 page FS 1 of the November 2014 issue of Chicago Magazine.  More details are available at Fivestarprofessional.com

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

Sincerely,
Patrick Mauro, Daniel Mauro, Henry Criz

Privacy notice:

Patrick Mauro Investment Advisor, Inc. (PMIA) is a registered investment advisor registered with and regulated by the Securities Department of the Illinois Secretary of State’s office, Springfield, IL. PMIA must collect certain nonpublic information regarding your financial assets and net worth. We must do this to help you develop a mandate in managing your account. This information and any other information for which you disclose to PMIA for the purposes of granting access to your brokerage account is treated this way: PMIA discloses this information to no one else, that is to no third party. Your information is kept confidential and secure at the corporate office of record, 38 Mockingbird Lane, Oak Brook, IL 60523.

Part 2A, Form ADV:

Every client should know that Rule 204-3 under the Investment Advisers Act of 1940 imposes disclosure delivery obligations on investment advisers. Each year, PMIA offers each client through this letter Part 2A of its Form ADV. This disclosure document may be obtained by writing PMIA and requesting a copy be mailed to you.