In July, the Dow Jones Industrial Average gained 2.8%, the Nasdaq rose 6.6%, and the S&P 500 grew 3.6%. The U.S. economy continues to sputter along in no or low growth mode. Second quarter 2016 GDP registered a paltry 1.2% growth rate, and the first half of the year came in at 1.0% annualized.
Interestingly, the bottom line number masks strength in consumer spending. The real weakness in the economy is in the form of lackluster business spending. Reduced capital investment is the byproduct of a climate full of regulation and an effort to make nearly every industry more stringent to operate in. All is not lost, friends, as there are plenty of segments which are seeing solid demand.
The two most obvious strengths in the economy are in housing and automobiles. Health care service is a consistent need, and right along with it is the pharmaceutical area. Financial services has a variety of different components which are are performing well, including asset management firms, investment banks (strength in merger and acquisitions), and large money service banks.
The big banks have long suffered from rock bottom interest rates and regulatory limits on proprietary trading and higher capital ratios. The energy industry continues to suffer from abundant global supply and weak pricing.
Retail faces the curse of overcapacity, tremendous competition, and the growth of the on line format. Corporate profits have declined for six quarters in a row with a great deal of compression related to energy. Still, across the business landscape, earnings and balance sheets are generally healthy, but the energy area could become more stressed as the year winds down.
There is much concern about the prospects of a new administration and how it will change the United States relationship with our global trading partners. The long standing conditions of low inflation and bond yields, volatile currency and commodity markets, and increased central banking involvement in the capital markets remain firmly in place.
The rest of the year looks pretty similar as the prior months with maybe one interest rate increase before the calendar turns. As for equity markets, valuations are a touch above historical levels and as long as consumer spending holds up, barrings some unforeseen event, probably stay this way.
Global Economic and Financial Markets Outlook- Ex-China and Japan, Asia Holds Strong While the Rest of the World Struggles
In efficient markets, the correlation between different geographical indexes should be small. In times of global distress, the correlation increases as everything is typically sold. Currently, there is plenty of diversity in the year to date performance of different regions around the world.
In Asia, other than Japan and China, many indexes have seen solid returns. For example, Philippines (+14.5%), New Zealand, (+16.2%), India (+7.4%), Indonesia (+13.6%), and Australia (+5.0%) indexes all show nice results. Europe has been very difficult with most of the region in the red, and in some cases, deep in the crimson (Italy -21.3%, Portugal -10.6%, Spain -10%). There are a few good outcomes in Europe with the U.K. (+7.7%), and Russia (+22.5%) noteworthy.
Clearly, the UK vote to leave the European Union was a dramatic event which will have continuing implications for global indexes. Negative interest rates and the continuation of the monetization of fixed income instruments by Japanese and European Central banks also plays a role in capital flows. Selecting investments from different countries across the globe remains a challenge in the midst of rapidly changing economic and political climates.
Mostly defensive industries continue to attract capital in U.S. equity markets. Utilities trade at high multiples and are ahead by 20% year to date. The same holds true for the Telecommunications industry, up nearly 22%. Food products have also been strong, gaining 15%, as has construction, household goods, and furnishings, surging 10% and 15% respectively.
With the U.S. economy puttering along at zero to two percent growth per quarter, finding pockets of strength based on a specific sector seems like throwing darts. Consumer spending remains solid, so taking a chance on beaten down retail, travel, recreation, media, or gaming might be worth investing some time researching.
As investors begin to adopt a more risk on attitude, one might expect defensive sectors to see some outflow. The big question is how long to wait to for the turn from defense to offense, eh?
Warren Buffet has a famous saying he adopted from partner Charlie Munger's advice and wisdom: ”I'd rather buy a great company at a fair price than a fair company at a great price."
In searching for opportunities in the equity markets, there are many decisions which are made based on statistical determinations of the business. They are made as a way to prove the merit of the investment. Many mistakes are made in allocating capital on the basis of purely numerical analysis.
If you have participated in the day to day operations of a business, you are aware there are many factors which contribute to results. It means the business decisions drive the numbers, the numbers do not make the operations.
Ultimately, management policies and processes about how the business is conducted determines the growth and success over the long term. I have been guilty of making investment decisions based on statistical cheapness. Ultimately, they were incorrect and costly from an asset allocation perspective.
Over a long period of time, the value of the great business continues to march higher because of advantages built up over time. It is the analysis of the quality of the enterprise which is far more difficult, and important, than quantitative cheapness.
Don't misunderstand, one has to evaluate the numbers to understand how a business is performing. Yet, it is getting business quality right and recognizing whether it is truly outstanding which should take precedence for long term investors. Thank you for reading the newsletter. If you have any questions or thoughts regarding investing or this edition,
Disclaimer: Y H & C Investments, Yale Bock, and the family of Yale Bock own positions in securities mentioned in the blog post. Investing in stocks can lead to the complete loss of your capital. As always, on any company mentioned here, past performance is not a guarantee of future returns. Investing involves risk of losses on invested capital. One should research any investment and make sure it is suitable with your objectives, risk tolerance, risk profile liquidity considerations, tax situation, and anything else pertinent to your financial situation. Also, the CFA credential in no way implies investment returns will be superior for any charter holder.