Dec 312014
 

Welcome to 2015! Is this the year our domestic markets take a breather after a solid 5 year run or does the last gasp of quantitative easing and a nearly 50% reduction in oil prices over the past several months take the market parabolic, a distant echo of 1999? Regardless of what the broad market may do I believe it best to focus on areas of the market that have significant advantages such as pricing and demographics. We’ll take a look at that below but on a side note, the following news recently made headlines; if you are an exchange traded fund investor (fortunately none of my clients are) you are now back to even if you purchased the Nasdaq (QQQ) all the way back in 2000. 15 years! Talk about buy and hold. Though there are many good arguments, I can’t think of a better case for active investment management. I digress. Let’s get back to 2015.

Cyclical market trends are by definition, short term. Secular markets (long term trends) are typically driven by large-scale national and worldwide events which occur in combination. Wars, demographic/population shifts and governmental/political policies (think global quantitative easing) are all events that could drive secular markets. A secular bull market will have bear market periods within it, but it will not reverse the overlying trend of upward asset values.

Most economists agree that U.S. equities were in a secular bull market from about 1980 to 2000, even though the stock market crash of 1987 occurred within the same time period. The losses from that bear market period were quickly recovered, and the market indexes continued to rise over the next 13 years. Secular bull markets—like from 1949 to 1968 and 1982 to 2000—are extended bull markets characterized by above-average annualized returns and generally less-dramatic downside risk. This does not mean this market is immune to corrections, but it shares characteristics of past secular bull markets.

Economic characteristics of past secular bull markets at their outset include secular valuation lows, secular unemployment rate highs, and negative real interest rates. All three characteristics also were in place at the beginning of the current bull market. A regular discussion topic with my clients is that the economy just seems to be grinding along and huge potential problems remain. I agree. There is no shortage of negative issues to focus on but if one only looks at one side of the story, they may be missing some great opportunities. We live in a volatile, risky world and I don’t expect that will change – ever. That being said, we need to focus on opportunities and make sure portfolios are positioned to take advantage of what is going well rather than choosing to sit out paralyzed by the fear of the unknown. Guessing where the market will be at the end of 2015 is a fool’s game. I don’t know, nor does anyone else. However, I think there are some strong themes developing, four of which I’ll outline below. Keep in mind major negative market moves can drag down all areas of the market and that is where our entry opportunity lies. With large allocations to short term fixed income and cash, volatility is our friend allowing us to get irrational / fear prices on investments which we will be very happy we own 5-7 years down the line – as long as we can stomach the volatility along the way.

Financials look fit: Although many investors might not trust banks after the financial crisis, there has been some serious mending of balance sheets in recent years, and the outlook is bright for financial stocks in 2015. For starters, consider that the sector saw 18% earnings growth in the third quarter, according to FactSet, as lending has remained robust. If consumer spending stays strong through the end of 2014 and into the new year, this trend will continue. Plus, the prospect of tighter central bank policy at the Federal Reserve could lead to higher interest rates and higher margins for loans in 2015. Finally a lower regulatory environment and increasing dividends makes this sector look very attractive on a 2-4 year basis. Wells Fargo, Morgan Stanley and a blend of regional banks will be making their way into client portfolios this year after an extended time in the penalty box.

U.S. dollar will stay strong: Troubles elsewhere around the globe have led to a rise in the U.S. dollar vs. other currencies. When you couple this economic picture with the easy-money policies abroad, the prospect of tighter policy at home, and continued Euro problems which won’t be resolved without the restructuring of Euro membership, it’s very difficult to imagine a universe where the greenback loses significant ground in 2015. This is good for the American consumer and can work to keep inflation in check. Because of the strengthening dollar, global fixed income becomes much less attractive. The Templeton Global Bond Fund, a very strong performer over the past decade is likely to be trimmed throughout the year.

Low oil prices could lead to upside surprises: AAA (the American Automobile Association) released their travel and fuel cost data on January 5th and noted the American consumer saved 14 billion in 2014 due to lower fuel costs. According to the report, if the average cost for a gallon of unleaded stays at $1.90 the savings for 2015 will be near 75 billion. Studies of the Economic Stimulus Act of 2008 by Christian Broda showed the $300 checks received by taxpayers increased spending for the typical family by 3.5% (much more than the value of the check) boosting overall nondurable consumption by 2.4% in the second quarter of 2008. If people have it, they will not just spend it, but spend more.

The deleveraging period since 2008, when consumers were focused on paying off debt, is largely over. Though spending is not likely to reach prior lofty levels due to the lingering memory of the debt crisis and a general increase in frugality, consumer spending has been recovering. With consumer free cash flow on the rise, due in part to lower energy prices, consumer spending (accounting for 68% of U.S. GDP) should remain relatively healthy and could accelerate more than income growth. To tap into the potential increase of consumer spending I’ll be looking at Chipotle, Amazon, Kohls, Home Depot, Lowes and Ford.

Boomers are a sure thing: I hate to sound like a broken record, but I’ll repeat the call that I’ve made several times over the last few years: If you want reliable growth, bank on the demographic shift in America caused by the aging baby boomer population.

Specifically, tap into the tailwind of senior housing and healthcare via high-income REIT plays like Health Care Properties, Ventas, or LTC Properties. There has been significant growth in annuity sales as older Americans look for retirement strategies to provide reliable income. We will consider insurance companies such as Lincoln National or AIG. Of course CVS for retail pharma exposure or Gilead for biotech are names very high on my list for some clients.

Those of you who read the commentary each quarter have likely noticed I’ve provided new companies and focused on areas where we haven’t been looking for several years. This is not because I’m overly bullish, believing we are entering a raging bull market, but because as more money begins to circulate efficiently through our economy, investment opportunities in areas ignored for years will present themselves. A game plan is best executed if developed well ahead of time. Though we are not abandoning our overweighting of energy transportation or aerospace and defense, it’s time for us to move into areas beyond those we have focused on the past several years. 2015 will be volatile but through that volatility we will cherry pick some excellent long-term core holdings. Best wishes for 2015 and thank you for allowing us to work for you.

Sincerely,

NewHardingSignature
Michael R. Harding, CFP
President / Portfolio Manager