Third Quarter 2019
Its been up and down this year; a veritable rollercoaster. And just like one, it has a lot of thrills but goes nowhere. The start was a great recovery from the fourth-quarter sell-off until May, then decline. Another recovery through June and July and then down in August. Finally, another recovery in September. All the while, the broad market is still trading within the trading range established since early 2018.
There have been sector rotations as some groups have come in and out of fashion. Also, there has been more than one attempt for investors to shift from growth stocks to value. Much of this is happening because investors are so uncertain about the future. Is a recession coming or not? Will the tech industry come under more and more regulation; will some of them be broken-up? Will there be an end to the trade war with China; and on and on?
One thing is certainly happening, investors are becoming more demanding and seeking good business fundamentals. The day when business models were based more upon hope than profitability may be gone. The pinnacle of such thinking may be WeWork, a shared workspace real estate company. This loss-making company with little prospect of earnings was rejected by investors when it tried to go public. (The Talk With Us section of this newsletter has a broader discussion of public offerings.)
If the rollercoaster ride in stocks was exciting, then the bond market was a thrill-ride squared. Who would have predicted the collapse in Treasury Bond yields over the summer months? If two percent for a 10-year Treasury Bond seemed extremely low, how about a collapse to under 1.4%? Many explanations have been postulated as to why this has occurred, we examine them in our Forecast section.
International markets have been just as volatile as ours. Many of the same investor concerns are driving prices there; trade war, economic slowing, interest rates. This may just prove the adage that when the U.S. economy sneezes, others catch cold. To see what we expect, read the Forecast section.
Talk with Us
IPO, Initial Public Offerings; these are in the news a lot lately. Historically, this is the way a growing company could find a broader group of investors to help fund future growth. The company may have been started with private capital from a founder or a small group of entrepreneurial investors.
Sometimes, it is not just new companies, but more mature ones that seek to broaden ownership and gain access to funding for future opportunities. Ford Motor Company went public 53 years after its founding. The Ford family felt it needed more capital to compete with General Motors. The younger Ford members also may have wanted liquidity so that some of their holding could be used for other purposes.
In recent years, many start-up companies are funded by professional investors that specialize in this type of investment. These are often organized as venture capital firms or private equity partnerships. As a consequence, many new companies have access to significant capital early in their growth cycle. This capital also allows them to stay private for much longer. They may grow quite large before ever considering a public listing.
One criticism of companies that come public much later is that so much of their potential growth has already been realized. Public investors are then merely providing a way for the private investors to realize their gain but may not have much growth potential themselves; not a good deal.
A company that seeks to go public must meet a number of requirements. They must register with the Securities and Exchange Commission and provide a comprehensive statement describing the investment; a prospectus. In the prospectus they must show their financials, describe their business in detail as well as divulge various risk factors. They must also meet various listing requirements of the exchange on which they are to be listed.
Recently, some companies have gone public that are not profitable. Obviously, to attract interest from investors, there must be the prospect that further growth will lead to earnings and thus greater value. That may or may not happen, so these are quite risky investments.
After a long period of good market performance and good economic times, some investors may get too optimistic about future possibilities. That is often when risky new offerings find new investors. That seems to have happened this year. Not only may they be extremely risky, they may also be priced much higher than sober analysis would suggest. This may be good for the sellers but not for the buyers.
WeWork recently attempted to come public. It may be the classic example of overvaluation and hope over realism. Potential investors finally wised-up and refused to invest. However, this is after several other over-priced and over-hyped companies did come public; so sad, too bad. “Buyer beware” is the operative warning to investors. Riverplace Capital rarely invests in new offerings. We need to see solid fundamentals priced well. If you are considering an IPO investment, Talk with Us.
The U.S. economy is strong and still expanding. Even so, there are sectors that are doing very well and others that are struggling. Broad swaths of the farm sector are having a tough time. The trade war with China has cut off this market for several products that we have exported to them in the past. At the same time, many other sectors are doing quite well. Some of these are closely associated with the business cycle; materials, industrials, technology, consumer discretionary.
Business cycle sensitive stocks doing well portends good tidings for the economy at large. We expect a continuation of the already 10-year long expansion. The holidays will soon be upon us and we predict another good season. Employment is strong, workers are getting wage gains, and energy prices remain subdued. Our Federal Government is putting a lot of stimulus into our system and interest rates are low; all positives.
With a good economy, low interest rates, and the emerging stock market leadership of cyclical sectors, it is hard to be negative equities. Certainly, surprising events can affect near-term trading. Recently, value stocks have shown relative strength versus growth ones. It may be that because growth has led for so long, valuations are now so rich that there is little future opportunity. In contrast, whole value sectors have been largely ignored. Many value companies have been doing quite well and offer growth too.
The money flows we track show more and more funds moving into these value sectors; a good sign for price appreciation. Price eventually does matter. When buying good value, good things can happen. When paying too much, bad things may happen.
Led by Europe, interest rates almost collapsed in the past quarter. European economic activity has been declining and so have interest rates. The European Central Bank signaled that more monetary stimulus was in order. This pattern has been replicated in Japan, China, and elsewhere. The world’s financial system is again being flooded with liquidity. More money looking for a return when demand for it is not growing means lower rates.
Money now flows internationally. It is quite easy to move money around the world. Even though low, interest rates here are higher than those of many other developed countries. So, money flowed here, and our rates came down. This has been happening for some time, keeping our rates lower than they might be based upon our own economic strength.
Not taken much note of, inflation has been creeping higher. The current inflation rate is now higher than the interest rate on the 10-year Treasury Bond. Sooner or later, bond investors will demand higher returns. However, as long as there is so much worldwide liquidity, this poor bargain may persist.
We are slowly incorporating more value style companies in our portfolios. We have always tried to find good value, even in what are typically growth sectors. We call it “growth at a reasonable price.” However, we are not making a major shift. With more uncertainty than usual, we like having a well-diversified approach.
Business fundamentals are still good, our companies are doing well. Money is still flowing into stocks. Interest rates are low; it is hard not to be positive. Our policy has been to stay invested during this choppy and uncertain period.
There is nothing creative to be done here; commit only to the highest quality and keep maturities reasonably short. We continue to ladder our bond holdings over a relatively short maturity horizon. As some bonds mature, we simply invest the new funds within the 3-5-year maturity range we use as our current guideline. Where appropriate, with interest rates so low, we prefer high dividend paying stocks for income needs. This strategy has performed well providing not only better income, but also appreciation.
Wealth Management (Asset Allocation)
Our asset allocation strategy is for those accounts that seek a broad exposure to geographic regions as well investment styles. This strategy includes investments in international, and emerging markets. It also includes both growth and value styles along with small, medium, and large companies. We tweak the weightings of these components, from time to time, to adjust for opportunity and risk. We have not made any recent changes.
as of 9/30/2019
|Large Cap Stocks (S&P 500)||18.7%|
|Dow Jones Industrial Average||15.4%|
|Mid Cap Stocks (S&P 400)||16.4%|
|Small Cap Stocks (Russell 2000)||13.0%|
|Barclay Aggregated Credit Index||13.1%|
“The most important quality for an investor is temperament, not intellect. You need a temperament that neither derives great pleasure from being with the crowd or against the crowd.”
— Warren Buffett