“Nothing in life is to be feared. It is only to be understood.”-Marie Curie
The S&P 500 index changed in value by over 1% on nearly a third of the trading days in the first quarter, twice the frequency with which it experienced moves of this magnitude in all of 2014. In our January letter we wrote that we expected the stock market to be more volatile and that seems to be playing out. Volatility is often considered a gauge of fear, and investor concern has risen as stock multiples are hovering near the high end of historic averages and the Federal Reserve appears intent on normalizing monetary policy. Another harsh winter in New England and the Midwest has taken its toll on the economy, as well. Despite the many moving variables, we believe stocks continue to be the most attractive alternative for long term investors.
The Minutes of the latest Federal Reserve meeting offer an interesting glimpse into the current environment. Fed members observed that while labor conditions continue to improve, the pace of economic activity has weakened. This data has probably been impacted by a labor dispute at West Coast ports as well as an unusually harsh winter for much of the nation. Consumer spending has moderated, which may also be weather related. It’s hard to shop when you can’t get out of your driveway. The core message of the Fed Minutes is that the long, slow recovery the US has been experiencing over the last six years continues. Understanding and setting an investment strategy according to the pace of the recovery can assuage investor angst and keeps longer term objectives in perspective.
A core tenant of our investment discipline is a fundamental belief that the value of a stock is based upon the company’s ability to grow earnings and manage cash flow in shareholder friendly activities. In the most recent quarter companies owned in client portfolios grew earnings by almost 10% while earnings for the broader S&P 500 index expanded significantly slower. Another value creator is returning cash to investors via dividend increases and reduction in shares outstanding. During the last year all but two of the dividend paying stocks on Ayrshire Capital’s holdings list raised payouts, and 73% reduced shares outstanding. Clearly, the management teams of companies owned in client portfolios are exhibiting shareholder friendly policies.
The stock market is currently trading near the higher end of its historic range. We believe the market has been driven to this level because of a dearth of attractive investment alternatives. Bonds remain unappealing with the 10 year treasury yielding 1.9%. Until a more attractive alternative to equities emerges, we believe equities will remain in an upwardly biased trading range. Over time, earnings growth will correct the current stock market valuation, albeit with lower corresponding market appreciation. To elaborate, in order for the market multiple to return to the midpoint of its historic range, company earnings must grow more rapidly that the stock market appreciates. Therefore, while we believe stocks are the most attractive asset class, it is likely that the equity market will appreciate more slowly over the intermediate term. We are seeking out quality companies generating faster earnings growth than the overall market as a way to produce more appealing returns.
During the quarter we eliminated our position in Southern Company. We originally purchased the stock due to its attractive yield compared to bond returns. We decided to sell it in preparation for higher interest rates and the corresponding pressure that would place on the utility’s multiple. We purchased shares of Cerner Corporation, a medical information technology company, and Vantiv Incorporated, a credit/debit card transaction processing company. Both companies are well run and benefitting from secular trends that should enhance results regardless of the economic environment.
Thank you for entrusting Ayrshire Capital Management 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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