“Economists don’t forecast because they know, they forecast because they’re asked”-JK Galbraith
“In like a lion, out like a lamb” is a phrase often used to describe the month of March and the transition from winter to spring. The sudden freeze that has seized the equity markets in early January leaves investors wondering if a thaw will arrive. Although the number of prognosticators issuing bearish outlooks is multiplying, we believe the investment environment provides good opportunities for those willing to look out beyond the next six months. We’ll share some observations behind our thinking in this summary note.
When we crafted our letter to clients at the beginning of 2015, we said that clients should expect a flattish year. After all, equity markets had generated six positive years in a row and valuations had gotten expensive. The equity market did end 2015 flat, but we missed the mark on a couple of key points. We thought that the price of oil would stabilize around $50/barrel after falling 50% in 2014. It didn’t and oil has continued to fall to its current level of $30/barrel as global supply/demand remains unbalanced. In addition, we underestimated the strength of the US dollar and its impact on reported earnings. While the strong dollar was great for Americans traveling abroad, it did wreak havoc in some regions, especially Europe and Latin America. A challenging combination of a stronger dollar and a slowing Chinese manufacturing sector pummeled commodities, hurting related businesses. China’s economy has been in an orchestrated transition toward becoming more consumer oriented. Many investors and economists are uncertain whether the Chinese government will be able to execute the transition and that has put pressure on China to devalue its currency. We believe that China’s consumers will become a greater factor in generating economic growth longer term but we’re also aware the transition is unlikely to be linear.
As we evaluate the outlook for 2016, we recognize there are many variables in play. First, the US consumer remains in good shape. The US unemployment rate has fallen to 5% and data regarding continuing claims and new claims filed are stable. Inflation remains benign and the Federal Reserve has begun to normalize the Fed Funds rate by implementing its first rate increase in December. American consumers haven’t yet shown the disposition to spend their “energy dividend” from lower prices at the pump but the personal savings rate has improved; something we believe is a healthy long term signal given how poorly prepared many Baby Boomers are for retirement. One cautionary signal is the Purchasing Managers Index which has been signaling a decline in the manufacturing sector for two straight months. Upon a closer reading of the data, much of the softness appears to be related to the weak oil & gas sector, and to weakness in commodities. Clearly, stabilization in the oil & gas sector and commodities would be helpful. Exploration & production activity in the energy markets has collapsed and Saudi Arabia continues to pump excess oil into the market in order to protect its market share.
Regarding investment decisions, the fourth quarter was unusually active as we made many changes to client holdings. We trimmed our holding in Apple since we believe the stock is likely to tread water as it works to develop its next series of products to follow the enormous success of the iPhone. We also sold Kinder Morgan and rolled the proceeds into Schlumberger since we think the intermediate term outlook for Schlumberger is more compelling. We established an initial position in Ecolab, a high quality company with a well-established business in water purification and treatment. We took advantage of market volatility to add to positions in Cerner Corporation and Bank of America, and we exited our position in Anthem. Finally, we trimmed our holding in Amazon early in the January since the stock has more than doubled in the 14 months we’ve owned it and we wanted to defer booking the capital gain until the New Year.
Finally, we recognize as we enter 2016 the market is presenting a scenario where the outcome could be binary in the nearer term. Should China collapse into a recession (something we doubt) then the global markets will suffer. However, should China experience a soft landing and the US economy continue its long, slow march forward then we think the New Year will be more constructive. We’ll be paying attention closely and working to “trade up” in quality should market volatility provide the opportunity.
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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