“Outside show is a poor substitute for inner worth”-Aesop
We live in a society where outward appearance influences how one is judged. Being in shape, having material trappings, taking exotic trips, all serve to create one’s persona. Those out of step with the latest trend may yearn to conform, but at the end of the day trying to maintain a phony image can lead to financial destruction.
Investing in stocks is similar. Sectors and investment styles come in and out of favor and those who chase returns can quickly become disoriented. Each decade seems to have its theme. The 1970’s had the Nifty Fifty; large cap stocks that rose to very high valuations as investors felt they had to own them at any price. The 1980’s had the real estate boom/bust, and the 1990’s had the dot.com rally in which internet related stocks rose regardless of whether the companies had sales, earnings, or even viable business plans. The financial crisis of 2008 remains fresh in our collective memory and investors remain wary of reliving the turmoil, with many having missed the rally of the last few years.
Ayrshire Capital follows a disciplined investment process that focuses on fundamentals, not fads. We invest in companies with sustainable business models that can ride out the economic cycles. Businesses owned in client portfolios have the attractive traits of free cash flow, strong investment ratios, and management teams that don’t forget about their owners. Shareholder friendly dividend programs, stock repurchases, and accretive acquisitions are prevalent among our holdings.
The economy continues to show signs of gradual improvement. Unemployment has improved to 6.1% from a high of 10% in 2010. Underemployment has declined to 12.1% from a high of 17% during the height of the crisis. Total auto sales are now running at 16.9 million units compared to 9 million in 2009, and capacity utilization is at 79.1%. The Federal Reserve is continuing on its path of tapering the Quantitative Easing programs and it is likely that the Fed will begin to raise interest rates in 2015.
As we begin the second half of the year we are encouraged by the strengthening economy, but we are a little more wary of the overall valuation of the stock market. We don’t think the equity markets are excessively expensive but we do think that corporate earnings and sales growth need to improve to justify further advances. Many bond investors have been pushed to take more risk by owning equities because bond yields are so low. When rates eventually rise some investors may reallocate funds back towards the bond market. Ultimately, this may create an environment where bond yields remain low for an extended period.
While this scenario is not great for yield hungry investors, it is ok for stocks. We believe that many businesses are well positioned to accelerate capital spending in the coming year and this should benefit our industrial company holdings such as Emerson, Danaher, United Technology, and Roper Industries. The stock performance of these companies has lagged the market over the last six months and we believe that as business orders improve so will the performance of these stocks. We expect there to be some rotation in the markets as the leaders are extended, but good companies remain that have not participated in the rally. Both the Russell 2000 index and the Dow Jones index have lagged the S&P 500. We expect this divergence to dissipate.
We look forward to speaking with you in the coming quarter and please don’t hesitate to call if you have any questions. Thank you for entrusting Ayrshire Capital Management with the management of your money.
JM Sam Nevin, Jr.
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