All Eyes Still on the Fed – Highlights from Edgemoor’s Fall 2014 Newsletter

In this latest installment of our quarterly report, my colleagues and I share some observations on the third quarter and the turbulent start to the fourth quarter of 2014, offer our outlook for the economy and markets, and discuss three of the securities we are currently buying: Qualcomm (QCOM), Sanofi (SNY), and Southern Company (SO).

Click here to go to the full report on our website.  Following are a few highlights:

- We forecast ongoing support from Fed policies and solid third quarter corporate earnings, which should combine to boost markets through the end of the year.  In the meantime, investors should brace themselves for more volatility similar to what we have seen recently.

- On volatility and pending Fed actions: Markets have been struggling to predict the exact timing of the Fed’s moves, beyond the expected end of bond purchases this month, and nobody knows exactly what the impact will be.  As a result, volatility has picked up.  Based on current market information, it appears that the Fed will not hike rates until late 2015, and we expect the increase to be gradual.  Any signs that rates will rise sooner or more rapidly would no doubt add to volatility.

- Recent data support the Fed’s view that the U.S. economy remains healthy.  Even though growth has been slower than in past recoveries, the current U.S. economic recovery has been an extended one, and the United States should continue leading the world’s major economies.

- The strength of the dollar presents a bit of a conundrum.  The dollar’s appreciation has contributed to falling prices of commodities and reduced the cost of U.S. imports, both trends that boost the purchasing power of U.S. consumers.  However, the stronger dollar makes U.S. exports less attractively priced relative to goods produced abroad, putting pressure on U.S. companies to keep costs, including wages, low to remain competitive.

- Geopolitical issues remain a concern, but we do not think the impact on the global economy and markets will be severe.

- Forecasts call for third quarter corporate earnings increases averaging about 5%, which should alleviate some concerns about economic strength.  We will be watching for confirmation that the companies we own are optimistic about their long-term prospects, as well as for occasions to buy shares of others that express short-term concerns and become available at prices below fair value.

- Though emotionally difficult, pullbacks are healthy for the markets and present us with buying opportunities.  The S&P 500 index is down about 7% from its peak, and we will likely see a larger drop at some point in the near future.  If so, we will take advantage where we can, and we remain optimistic about the long-term prospects for our portfolios.

As always, feel free to contact us if you have any questions or comments.  For more information, visit our website.

Jordan Smyth and the Edgemoor Investment Advisors Team

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Research Roundup

For those who want more detail, here are some links to reports that we found particularly interesting recently:

Fidelity’s Fourth Quarter 2014 Market Update – A comprehensive analysis of market conditions.  Note slide 49, which points out that investors who review their portfolios more frequently tend to have significantly more conservative asset allocations, due to a heightened fear of a potential loss.  Unsaid but implied: this conservative approach is likely to reduce investment returns over the long-term.

A Japan Strategist Roundtable Discussion: What’s Next for Japan? from WisdomTree – Director of Resarch Jeremy Schwartz reflects on his recent visit to Japan and conversations there.  Key quote: “I see Japan as having some of the best prospects for equity markets over the next five to six years heading into the Tokyo Olympics in 2020.”
Capitalizing on Inefficiencies in Mega-Cap Equities from Fidelity – An update to prior research demonstrating the appeal of stocks in the largest companies, which comprise the bulk of our portfolios.
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Bear Market Myths

Click here for a recent story on MarketWatch that attempts to debunk certain myths regarding bear markets.  While the author is a bit too dismissive of some of the concerns roiling global markets currently, we agree with the overall point that fundamentals remain attractive.  In particular, this quote strikes us as on the mark:

True, this could turn into a 10% correction, which would be normal, since we have not had one for three years. But this is not the start of a bear market, and now is more of a time to buy stocks than to sell them.

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Trying to Time the Market is a Losing Proposition

With the stock market near its all-time highs, some investors are wondering whether it makes sense to cash out and wait for a correction, a classic example of market timing.  Mark Hulbert recently penned an excellent article (“Timing this market is guaranteed to make you a loser,” MarketWatch, August 8, 2014) that provides specific examples of the perils of trying to time the stock market.  In particular, he points out that an investor attempting to do so has to be correct twice, on the timing of both the exit and reentry, in order to succeed.

We agree that market timing is likely to hurt, not improve, returns.  The most recent 4% decline provides a great example of the difficulty of trying to predict short-term swings: despite cries from some pundits that the market was in a free fall, it has already recovered half of its losses.  My point is not that the market will only rise from here; we do expect a correction in the stock market beyond the dip over the past few weeks.  However, we don’t know, nor does anyone else know, exactly when a correction will occur.

It is nearly impossible to call the market’s moves over any short-term period.  Better to have a sound strategy for investing over the long haul and stick with it, even when the market is not cooperating in the short term.

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Onward and Upward – Highlights from Edgemoor’s Summer 2014 Newsletter

In this latest installment of our quarterly report, my colleagues and I share some observations on the market’s solid gain in the second quarter of 2014, offer our outlook for the economy and markets, present our thoughts regarding the view among some that the markets are overheated, and discuss three of the securities we are currently buying: Apple (AAPL), Devon Energy (DVN), and Gilead Sciences (GILD).

Click here to go to the full report on our website.  Following are a few highlights:

- After the market’s modest rise in the first quarter, stocks picked up steam in the second quarter.  The S&P 500 index gained 5.2%, the best second-quarter performance since 2009, on improving economic conditions and expectations of continued low interest rates.

- We forecast further, modest gains for the stock market as the economy increases the pace of its recovery and corporate earnings follow.  In this environment, picking specific securities that trade at a discount, as opposed to buying the broad market, can make all the difference.

- We remain wary of bonds given current low yields and expectations of increasing interest rates in 2015, and we continue to favor the total return potential of high yielding equities and other income generating securities.

- Former Fed Chair Ben Bernanke committed the Fed to keeping rates low to boost the economy’s recovery from the financial crisis, and current Chair Janet Yellen is continuing this same strategy.  So far, inflation has remained tame, freeing the Fed to continue its stimulative policies until the economy appears to be strong enough to continue expanding without the Fed’s assistance.

- Economic data seem to confirm the widely held belief that the 2.9% drop in gross domestic product during the first quarter was an anomaly caused by severe winter weather.  The U.S. economy is showing signs of vigor, and we expect continued steady growth.

- The combination of steady economic growth, low interest rates, and low inflation creates a favorable environment for stocks.

- One of the central tenets of our value-oriented approach to investing is that purchasing specific securities at a discount to fair value, based on a detailed analysis of fundamental measures, is the best way to succeed.  Even in today’s market, we are able to find enough stocks available at a discount to fair value to create a diversified portfolio with appreciation potential greater than that of the broad market.

- There will be a correction at some point – we do not know when, but we have not seen a decline of 10% since 2011.  Given the near impossibility of timing a correction perfectly, we think the best strategy is to hold securities that should perform relatively well through any downturn and bounce back when the market recovers.

As always, feel free to contact us if you have any questions or comments.  For more information, visit our website.

Jordan Smyth and the Edgemoor Investment Advisors Team

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