“I’ll play it first and tell you what it is later”-Miles Davis
After months of political rhetoric, voters will have the opportunity to be heard in early November. Presidential candidates have spent millions of campaign dollars in crucial swing states while providing woefully little information about how either party’s plan would awaken the economy from its four year slumber. The campaign themes seem to be “vote for me, and then I’ll tell you my plan.” Perhaps greater detail will emerge during the debates, but we’re not holding our breath. Rest assured real fiscal reform will include changes in taxes and entitlement programs. In the meantime, central banks around the world continue deploying accommodative monetary policies creating an interest rate environment that favors equities over bonds.
What strikes us most is how little the fundamental investment environment has changed in 2012. The Euro-crisis remains a work-in-progress. While the Greek government is making progress implementing austerity programs, Spain appears set to be next in line to request bank bailout funds from the European Union. On the positive side, steps taken earlier in the year to facilitate closer cooperation among Eurozone member nations have driven sovereign debt yields lower which has given governments additional time to sort out a longer term solution.
The American economy remains anemic with annualized GDP expanding by only 1.3% in the second quarter. In a recent speech Mr. Bernanke said “Our concern is not really a recession. Our concern is that growth will continue but at a pace that’s insufficient to put people back to work.” Last month the Federal Reserve implemented Quantitative Easing III, a new program to purchase $40 billion of mortgage notes monthly until the labor market shows sustained improvement. However, Mr. Bernanke also emphasizes QE III is not a panacea for the economy; fiscal policy actions like putting the federal budget on a sustainable path and reforming the tax code are also necessary.
Companies capable of producing double digit revenue growth are rare (think Apple) yet many management teams are doing an excellent job managing expenses in this uncertain environment. Projected growth in earnings of S&P 500 companies is forecast to expand by 5% in 2013, down from 12% in 2012. Emerson Electric, in its latest monthly update noted that “economic growth around the world continues to decelerate” and management warned that fourth quarter revenue growth will likely be slower. Although stocks as measured by the S&P 500 remain inexpensive on an historic basis, selling at a 13x P/E, revenue growth will probably need to accelerate from current trends in order to drive equities meaningfully higher.
During the quarter we purchased shares of MasterCard Incorporated, US Bancorp, and Southern Company in client portfolios. MasterCard was purchased to capitalize on a secular trend toward electronic payments. US Bancorp is a well-run commercial bank focused on returning the majority of its earnings to shareholders through dividends and share repurchases. Southern Company is a public utility based in Atlanta currently yielding 4.3%, with a steady history of raising its dividend. We consider Southern Company to be a more appealing yield investment than a corporate bond given the current interest rate environment. We sold our remaining investment in JP Morgan Chase, and also eliminated our investment in Staples Incorporated after being disappointed in management’s attempt to revive international sales.
Looking forward, we remain cautious optimists. While many uncertainties exist at home and abroad, we also recognize we are four years into a global deleveraging cycle. Companies generating solid free cash flow run by management teams geared toward shareholder friendly activities remain our focus. Following the November election a small window should open for bipartisan action to address our nation’s fiscal problems. The Federal Reserve has taken herculean steps to aid our economy but now it is up to our elected officials to consider the greater good and take action. Successful reform of the fiscal crisis would be very bullish in the long run.
Thank you for entrusting Ayrshire Capital with the management of your money. We look forward to speaking with you in the coming quarter.
JM Sam Nevin, Jr.
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