Quarterly Economic Update
Volatility returned in a big way in the first quarter of 2015 as the market focused on everything from central-bank actions to Greek elections, a strong dollar, and a steady beat of merger activity. Federal Reserve (Fed) watching was a full-time job. With the U.S. economy initially showing signs of improvement, the central bank started to send signals that it was ready to raise short-term interest rates and create a more normal monetary policy environment after the extraordinary measures put in place during the financial crisis...(click continue reading button below to see full article)
Economy: Slow Going
From where we sit, we would classify most of the current U.S. economic data as OK to good but far from great. A good portion of that has to do with weather and a west coast port slowdown that should now both be behind us. Like last year, weather will be a factor, but we think we will still see 1st quarter GDP come in on the positive side, which is much better than last year’s 1st quarter print of -2.1%.
Also, like last year, we would expect acceleration in the U.S. economy for the remainder of 2015 with a probability that U.S. growth could approach 3.0% for 2015 compared to 2.4% for 2014.
We believe a big driver will be employment. We have had 12 months in a row of non-farm payrolls greater than 200,000. That is the longest streak since we had 20 months in a row in March 1995.
However, that streak was just broken on April 3rd, as March’s jobs report was the worst in over a year with only 126,000 jobs created. The March employment report follows a recent string of disappointing data (such as disappointing capital spending by businesses).
Whether the short-term weakness relates to temporary factors or something more substantial remains to be seen – and no doubt the first Fed interest rate hike may be pushed farther out this year. Still, in the U.S., there are no signs of recession, no inflation and no significant monetary restraint on the horizon. Mortgage applications are perking up from low levels and government spending is playing “catch up” after lagging previous recoveries. The U.S. has managed to continue to grow (and dare we say – prosper) while European and emerging economies (especially those dependent on oil prices) continue to struggle.
Inflation remains the biggest thorn in the side of U.S. economic data, with oil-price declines pushing the January headline CPI (Consumer Price Index) print below zero for the first time since 2009, a period during and immediately after a major recession.
China, which has been focused significantly on deleveraging non-performing loans and reducing the shadow banking concerns, has now shifted to stimulus mode. They have reduced their long-term growth plans from 7.50% to 7.00%, which is more in line with expectations from most rational investors. By cutting their interest rates to battle the appreciation of the U.S. dollar, the People’s Bank of China is clearly looking to promote growth.
There are signs that things are picking up in Europe as lower energy prices, extremely low interest rates, and a weak euro provide tailwinds. The European Central Bank (ECB) has now increased the growth rate for the Eurozone economy from 1.0% to 1.50% for 2015. In addition, the ECB’s commitment to pre-programmed, massive quantitative easing for the next 18 months should keep recession at bay.
2015: An Aging Bull Market
Markets tend to experience what many would classify as madness every month and almost every day. Viewed via a short lens, this madness can be overwhelming but as time passes things tend to normalize. The good news is we don’t think it will be madness that brings this now six-year bull market to an end, but euphoria, or to steal someone else’s words – irrational exuberance – and from where we sit we don’t see signs of either yet.
Our liquidity-driven cyclical bull market is starting to show its age, but is not yet ready to die. Even when the Fed does start raising rates (which historically is preceded by an 8-10% correction in the stock market), the ECB and Bank of Japan will continue to pump money into the global financial system.
Over a long-term basis, the U.S. stock market has been losing strength for the past year. For example, the S&P 500 Index is at about the same level it was five months ago. This, and other predominately large cap indexes, have the dollar to blame (at least, partly). Fifty percent (50%) of the S&P 500 profits come from overseas, and a rising dollar hurts the conversion of revenue from foreign currencies back to dollars.
On the flip side, the dollars’ strength doesn’t have much effect on small and mid-sized companies. In our last newsletter, we mentioned that we were hopeful the weakness that had been exhibited up to that point in small and mid-cap stocks would reverse. That is currently happening, which is helping the breadth of the market (but breadth is still not yet what we would expect in a strong up trending market).
Our underlying 6-12 month view has been consistently constructive for the past few years because there is “nowhere else to go”. However, we are increasingly uneasy about intermediate-term prospects (3-6 months). The most recent stock market correction of over 10% was on October 3, 2011. That is 3 ½ years ago! If ever a correction was due, now is the time. However, we would look upon any correction as a low(er) risk buying opportunity.
In summary, we are maintaining our favorable stock market view while noting that the market has not had a correction of 10% or more since the Autumn of 2011. If a correction were to occur, we would regard it as a health restoring event. The cash that was raised in the portfolios during the quarter (approx. 10-15%) would likely be directed into the stock market. Absent a stock market correction, we would look to position the cash in investments less correlated to the stock market.
What is Successful Investing?
For us, success in investing is exposing our clients to return in a way that doesn't expose them commensurately to risk, and to participate in gains when the market rises to a greater extent than we participate in losses when it falls.
If we contain losses to recoverable levels, we minimize the recovery periods and let positive compounding do its magic as we make all time new highs in client portfolios more often. We are in the business of wealth creation - not just managing money. You would be surprised how many portfolios we see with values well below the high levels of year 2000. This is the antithesis of wealth creation; this is wasting time.
The purpose of Business Cycle analysis, which is the foundation of our Business Cycle Asset Management investment process, is to provide a broad scope picture of the macro-forces that affect the markets. It has little to do with trying to figure out what will happen over the next week, or even next month, but it does help us recognize major changes in the investment environment. At this point, the business cycle is favorable for stock and bonds, but unfavorable for commodities.
The role of evaluating the risk taken for the return given becomes increasingly important in an aging bull market. At Zephyr, this role has always been very natural for us, as we are students of the market and the economy.
The current volatile environment calls us to remain committed to a disciplined investment approach. It is our belief staying invested in the market according to our disciplined Business Cycle Asset Management strategy may add value by enhancing portfolio returns and/or reducing portfolio risk. It has long been said “Don’t Fight the Fed” and we agree, but we also believe you shouldn’t fear the Fed either.
The Fed has altered the pace and flow of this economic cycle – and may continue to do so in the immediate future. Hence, while this is new territory (economically speaking), we are confident our mandates of capital preservation and wealth creation will lead the way forward and continue to benefit you – our clients.
Enjoy the Spring!
The Zephyr Team
"We cannot direct the wind, but we can adjust the sails."
3625 E. Thousand Oaks Blvd., Suite 145, Westlake Village, CA 91362
Phone: (800) 966-3579 (805) 496-6810 Fax: (805) 496-0630 www.zephyrim.com
Securities Offered Through FSC Securities Corporation, A Registered Broker/Dealer, Member FINRA/SIPC. Advisory services offered through Zephyr Investment Management, a Registered Investment Advisor not affiliated with FSC Securities Corporation.
Past performance does not guarantee future results. Indexes cannot be invested in directly, are unmanaged and do not incur management fees, costs or expenses. No investment strategy, such as asset allocation, can guarantee a profit or protect against loss in periods of declining values. Investing involves risk including the potential loss of principal. This newsletter has been prepared by Zephyr Investment Management for presentation to clients and prospective clients. This should not be regarded as investment advice. Views expressed in this newsletter may not reflect the views of FSC Securities Corporation. Sources: BCA Research; Barron’s; Investors Business Daily; Investors on Track, Inc., Bob Brinkers Marketimer, LA Times, Crestmont Research.