“The best way out is always through”
-Robert Frost
The unexpected has become the norm. The stock market followed up a flattish year in 2015 with a 10% decline by early February, only to recover and end the quarter flat. For those not nauseated by the market volatility, one only had to watch the candidates for President spar with one another to feel queasy. Is that the best our country has to offer? Irresponsible comments by market forecasters and Presidential candidates are being tossed around freely; capturing headlines and attention, yet when the statements are discredited there is no accountability. Wouldn’t we all like to be in that position! Investing money for others inherently provides accountability and success is revealed over time and through different market cycles.
The year began with mixed economic data, particularly related to industrial production in the USA and in China. Domestically, much of the weakness was based in businesses serving the energy industry. Clearly, the price of oil declining from over $110/barrel to $30/barrel in less than two years has had a profound effect on energy production. Overseas, China has been reporting softer industrial data as the central government works to stimulate spending among its emerging middle class, and lessen reliance on export driven growth. We are monitoring this transition as it is an important evolution toward becoming a more mature economic power. Additionally, the world is still burdened with excess capacity. While this will be absorbed over time, it contributes to a lethargic trajectory of economic progress. In the US, the Personal Savings Rate has risen to 5% from its low of 2% prior to the financial crisis. Consumer expenditures are expanding at a reasonable pace of 2.4%, but it is not near the levels of the 1980’s or 1990’s. The data suggests that Americans are working to strengthen personal balance sheets, something we consider healthy as more Baby Boomers are nearing retirement. Yet each creates headwinds for GDP growth as overconsumption in earlier years adjusts back toward a sustainable level.
In the coming days businesses will begin to report first quarter results. According to FactSet, the total earnings of companies in the S&P 500 is forecast to decline 9.1% in the quarter, most of this reflecting the 103% expected decline in energy company results. If one excludes energy sector related results from the upcoming earnings, the picture affirms a continuation of a moderately improving economy; nothing overly exciting but by no means dire. Looking forward to the second half of 2016 and into 2017, we would expect that reported results will begin to look better as the foreign exchange pressures temper at the same time tough comparisons in the energy sector are lapped. We are seeking businesses capable of generating real unit growth in their businesses, and we will be more wary of companies that have relied mainly on cost cutting measures to boost margins. Corporate operating margins are near the high end of historic measures so further improvement will likely be challenging.
Finally, on the topic of interest rates, the 10 year treasury is yielding 1.75%, lower than where it began the year. The Federal Reserve and Central Bankers around the world reacted to the early 2016 market swoon by backpedaling on monetary tightening and the likelihood that rates will remain lower for longer has increased. Larry Fink, the Chairman of Blackrock, wrote in his annual letter to shareholders that the extended low interest rate environment is having a detrimental impact on people saving for retirement. Specifically, he argued that in the current low interest rate environment people need to save three times the amount of money in order to generate the same income as twenty years ago. Savers are also reaching for yield which forces them into lower quality and less liquid investments, both of which elevate risk. We believe that it is important for central banks around the world to begin to normalize rates. Monetary policy has been used in lieu of legislative action and government reform in many nations. It is asking too much of central bankers to use monetary policy to fix structural problems in governmental programs.
During the quarter we made a few changes to client holdings. We sold our position in Johnson Controls because the company’s transition from being a conglomerate was dragging on too long. We sold our holding in Novartis as its new drug development efforts may fail to replace the revenue lost as mature drugs go off patent. We purchased a position in Nike as we believe it possesses an aspirational brand that will gain in appeal globally. We will continue our hunt for quality companies generating free cash flow run by management teams with a record of deploying money in shareholder friendly ways. This year has started out as a grind, but we expect better days are ahead and that good investment opportunities will arise.
As always, thank you for entrusting Ayrshire Capital with the management of your money. We look forward to speaking with you in the coming quarter.
Sincerely,
JM Sam Nevin, Jr.
Managing Partner
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