“And that’s the way it is”– Walter Cronkite
The beginning of the fourth quarter has been greeted by another political mess in Washington in which the only certainty is that this self-inflicted crisis will eventually end. Attempting to explain or even to handicap the outcome of politically motivated actions is fruitless so during this update we’ll focus on the current economic and business fundamentals.
On the economic front, the US economy continues to improve. Weekly initial jobless claims are trending lower and currently stand around 300,000, roughly the same level as before the economic crisis. Continuing jobless claims dipped below 3 million in the latest report, less than half the peak level reached in 2009. Automobile sales in the latest report reached 15.2 million vehicles annualized, up an annualized 1 million in the last year, and up over 5 million since the trough. Housing remains another favorable influence in the domestic recovery. Broader measures, such as consumer confidence and the Leading Economic Indicator Index, continue to trend favorably. Despite these favorable statistics the Federal Reserve Open Market Committee decided at its September meeting to maintain the current quantitative easing (QE) initiatives. The committee cited its mandate for maximizing employment and a benign inflation environment as justification for its decision. We suspect that the Fed’s concern with the potential for political chicanery related to the debt ceiling extension may have tipped the scale toward deferring action.
Focusing on the underlying environment for businesses, companies continue to struggle to generate revenue growth. Sales for companies in the S&P 500 are projected to increase only 2.25% in 2013. Companies owned in your portfolio have generated much better sales growth in the high single digit range on average. Earnings are growing faster than revenues as management teams squeeze greater cost efficiencies and margin expansion from corporate assets. We’ve been encouraged to see businesses deploy excess cash flow in shareholder friendly activities such as share repurchase programs and dividend increases. In the last year, 28 of the 36 stocks on Ayrshire Capital’s holding list increased shareholder dividends by an average of 21% and we expect this to behavior to continue into 2014.
One area where we expected more activity has been in corporate mergers & acquisitions. Despite the record setting Verizon Wireless/Vodafone deal valued at $130 billion, the number of transactions remains below average. Given the low interest rate environment and reasonable valuations of publically traded companies, one must suspect that management teams remain cautious and still bear the scars of the financial crisis. As time passes and the crisis slips further into the collective corporate memory, deal flow will probably accelerate and prop up equity market valuations.
During the quarter we made few changes to client portfolios, allowing holdings to rise along with the strong move in the equity markets. In July we added UnitedHealth Group to client portfolios. We have invested in UnitedHealth Group many times since the early 1990’s and we think UNH is well positioned to capitalize on changes in the delivery of healthcare resulting from the implementation of the Affordable Care Act aka “Obamacare.” In August we sold client positions in Apache Corporation. The company has an excellent portfolio of assets around the world but we were concerned that its assets in Egypt could be compromised given the unrest in the country. Additionally, the underlying price of oil & gas has made earnings comparisons tough over the intermediate term. We have great respect for Apache’s management and look forward to owning it again when the time is right.
Historically October has been a volatile month for stocks and this year appears to offer more of the same. Bonds have rallied lately thanks to the Fed’s decision to defer QE tapering but we believe bond yields will move higher over the coming years. We have lowered client exposure to bonds since 2011 and expect stocks to perform better than bonds over the next decade. We’ll continue working to maintain a steady hand by focusing on fundamentals, strong cash flows, and secular trends. Thank you for entrusting Ayrshire Capital Management LLC with managing your money and please call if you have any questions or comments to share.
JM Sam Nevin, Jr.
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