Quarter End Review and Commentary

The view from Orange County California, one of the highest net worth counties in the United States…

When judged by indexes, it has been a grand year for the stock market. Bonds have done their part too. Our Balanced/Value portfolios have generally seen a gain of about 8% year to date. This is below the stock indexes, as is normal for our “Balanced” style during a bull market.  We shine most when the Applesauce hits the fan, so you will see from the figures found at the end of this article that over the past five years, which encompass the Great Recession Bear Market, our clients enjoyed annual returns of over twice the rate experienced by stock index investors. Speaking of Applesauce (and Google) these were principal drivers of stock market indexes in the quarter. If you were not heavily invested in them, you “underperformed”.

The rise in stocks has been by no means universal-selectivity was quite important during the summer.  Certain industrial cyclicals, like United Technologies went nowhere. While the pharmaceutical sector did well, one of our former positions, Teva, continued to struggle.  As mentioned, certain technology companies soared, Apple and Google, while others went basically nowhere: Microsoft, Oracle and Intel, for example, were not too impressive.  Meanwhile, the energy sector was a mixed picture: defying predictions of a return to worldwide recession, Exxon-Mobil our sole multinational, was up over 8% in the quarter. This performance, shared by other energy multinationals, was no doubt influenced by the boycott of Iranian oil exports and the subsequent firmness in oil price, but I suspect this also has to do with an underlying vigor in the US economy. Oil and gas master limited partnership pipelines, however, were less fortunate and mostly oscillated in a trading range. Meanwhile, the one bank we really like, US Bank, continued its steady march upward. (Please note, not all positions mentioned are held in all client accounts – we seek to meet each client’s needs for return and peace of mind with a unique mix of holdings). 

It has been a long time since economists have spoken of the quote “wealth effect” created by a rising stock market. I believe it is time to consider this factor when looking at possible opportunities in the near future. When people feel as though their net worth is declining, they tend to tighten the purse strings.  A stabilizing housing market and a rising stock market do wonders to loosen those cinches. I have learned that quite often, so called “anecdotal” indicators provide valid clues as to the overall state of our economy. Here in Orange County California, collapsing home values caused many middle-class shoppers to feel “poor.” Since we Californians live a good part of our lives on the road, it is noteworthy that Southern California freeways are noticeably more crowded than, say, a year ago.  My unscientific survey of shopping center parking lots indicates that people are back out spending. The volume of sales at online retailers like Amazon continues to expand.

Then there is the value I find in speaking with some of the blue-collar members of a Orange County business building organization that I belong to, here locally, called Le Tip. We had an evening mixer last week and I heard something from the painter, the appliance repair man and the electrician that I have not heard in years: to paraphrase: “I haven’t been this busy in a long time – I can’t keep up with all the work.”  These observable factors here in Southern California may well represent a broader experience throughout the United States. Recent economic reports, on balance positive, seem to confirm this view. So it appears that economic growth, if not a boom, has legs that can carry the real estate and stock markets higher still.  How long will this seeming momentum continue?

President Obama appears to be benefitting from James Carville’s now famous remark to Clinton campaign workers in 1992: “It’s the economy, stupid.” Either through wisdom or paralysis, the President appears to have made a good decision in retaining the economic team he inherited from George W. Bush when he came into office. I said as much as our December 2008 client appreciation luncheon after the last Presidential election, when the President-Elect had signaled his intention in this regard.  It certainly was not a moment to bring on an entirely new team as the country was in the midst of a near economic meltdown and the collapse of Citibank, Morgan Stanley, AIG, Merrill Lynch, Bank of America and perhaps dozens of other banks had been avoided by that same team.  Although some key players have departed, two principal actors, and if you will, Co-Executives in our government, Federal Reserve President Benjamin Bernanke and Treasury Secretary Timothy Geithner, remain in place. Economic activity has moved haltingly forward now for the past 3+ years and the all important  housing market seems to be in recovery, but the pace is much slower than in past recoveries. Further, we seem to be experiencing European style unemployment, where a significant portion of the working population cannot find gainful employment. Conventional wisdom would suggest that the sitting President would be vulnerable in this scenario to a financially savvy replacement, such as Mitt Romney. But the “Wealth Effect” seems to be kicking in, and so, it appears Pres. Obama stands a better than even chance of re-election .   Does he deserve the credit for an economic recovery, however tepid it may be? I will let history make that decision, but my job is to simply deal with reality as it appears. It appears to me that the economy still has legs and it appears to me that there are still opportunities in holding a meaningful position in common stocks, whomever wins November’s election. 

Our clients have enjoyed a good quarter, a good year and have fully participated in the economic recovery so far. This certainly does not mean that I am complacent about client performance, however having managed portfolios through a truly lousy decade, in which our balanced approach has significantly outperformed stock and real estate markets, I am not about to walk away from a successful formula.

Here is a summary of typical client annual rates of return, compared to some popular indexes (all figures are net of fees, are rounded and individual client performance may vary significantly from typical performance):