“Knowledge of what is possible is the beginning of happiness”-George Santayana
Uncertainty breeds anxiety, an emotion with which investors must cope. Understandably, people have been frightened by the fiscal cliff negotiations, Eurozone crisis, and the overall headwinds of deleveraging, now in its fifth year. Despite these challenges, the US economy has continued to trudge forward, growing by 2.2% in the last 12 months, and equity markets have recovered from the lows of 2009. Through it all we have remained focused on company fundamentals, not political rhetoric. We expect 2013 to be similar to the year just completed as fiscal issues are addressed, central banks maintain accommodative policies, and the economy continues to improve slowly.
On the economic front, the recoveries in housing and automobile markets have been important sources of strength. Manufacturing production has been sluggish and businesses have been slow to spend on capital projects. Consumers are active, but the emphasis is on value. Wage growth remains low and unemployment of 7.8% signals further accommodative Fed policies. As noted in the minutes of the December Federal Reserve meeting, the Governors will reconsider the open-ended asset purchase programs only after employment improves further. The eventual normalization of monetary policy will drive yields higher, and for that reason we believe that equities will perform better than bonds over the intermediate term.
On a fundamental basis, stocks are attractively valued at 11.8x projected 2013 earnings. Balance sheets are strong and many corporations are distributing excess cash to shareholders via dividend increases and stock repurchases. During 2012, 80% of the companies held in client accounts raised dividends by an average of 20%, and 60% of the owned positions reduced shares outstanding via stock buyback programs. One potential red flag we’re watching is revenue growth which continues to be challenging, highlighting the need for companies to cut costs to grow earnings. Adding together weak revenue growth, expense cuts, low interest rates, and strong balance sheets, we wouldn’t be surprised to see accelerating M&A activity in 2013.
During the quarter we purchased shares of Johnson & Johnson (JNJ), AmerisourceBergen Corporation (ABC), and Iconix Brand Group (ICON), and added to client positions in Costco Wholesale Corporation (COST). JNJ is a triple-A rated blue chip health care company that stumbled in recent years. Under new senior management, we expect the company to return to its historically steady performance. The stock yields 3.5% and management has a long history of increasing dividends. AmerisourceBergen is a major drug and healthcare product distributor, currently yielding 2%. ABC benefits from the secular trends of an aging population as well as greater utilization of generic pharmaceuticals which ironically provide higher margin opportunity despite a lower retail price. Iconix Brand Group acquires brands and licenses them to retailers and manufacturers. It has recently gained the licensing rights to the “Peanuts” characters (Snoopy, Charlie Brown, etc.), and it has reached an agreement to acquire the international soccer brand “Umbro” from Nike. Finally, we took some profits in Diageo PLC, and Celgene Corporation since both positions had become significantly overweight in client portfolios. Both positions were trimmed while the stocks were selling at historic highs.
In closing, we don’t want to appear as though we think geopolitical risks are de minimis. There are many imaginable scenarios that make us lose sleep at night. However, none are insurmountable and all have the potential to be addressed given the right mix of leadership and determination. Knowing this, we believe the next decade will be a more rewarding period for investors. Of course we’ll adjust our strategy if leadership and determination fail to materialize but, to slightly modify a quotation from Winston Churchill, “You can always count on (politicians) to do the right thing – after they’ve tried everything else.”
As we enter 2013 we’d like to extend our best wishes to you for a happy, healthy, and prosperous New Year. 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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