Rising Waters

In this latest installment of our quarterly report, my colleagues and I share some observations on the third quarter of 2017 and offer our outlook for the economy and markets.  Click here to go to the full report on our website.  Following are a few highlights:

  • The S&P 500 index returned 4.5% in the third quarter and even climbed in September, a month that usually brings declines.  U.S. market volatility has been subdued for almost the entire year and during the third quarter was the lowest since 1968.
  • S&P 500 index companies reported that earnings increased about 10% in the second quarter, following a 15% rise in the first, as the economy steadily expanded.  GDP growth was 3.1% for the second quarter, up from 1.2% in the first.  The U.S. economy has added an average of 176,000 jobs per month in 2017 and unemployment remains low at 4.2%.
  • We are currently optimistic that the combination of low interest rates and inflation, steady economic growth around the world, and solid earnings will continue to support stock prices.  Passage of a bill reducing U.S. corporate income taxes could provide an additional boost to earnings and stocks.
  • Current expectations are for one more Fed rate increase of 0.25% this year, most likely in December. Low inflation due to a combination of technological improvements, globalization, and demographics gives the Fed reason to move slowly with rates.  We believe the markets will most likely take any slight increase in stride, as with other recent Fed moves.
  • Global economies are expanding together for the first time since the Great Recession, and we expect this trend to continue.
  • Balanced against these positive trends and opportunities, valuations are high relative to historical levels, threats lurk in many places, and a market reversal at some time in the future is inevitable.  However, the timing of any pullback is unpredictable, and the catalyst may be an event that few could foresee now.

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

Gay Truscott and the Edgemoor Investment Advisors Team

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Cybersecurity and Your Credit

Cybersecurity is a major concern, and recent data breaches heighten the importance of protecting one’s privacy and data security.  Following is a summary of the latest data breach at Equifax and our recommendations to reduce the risk that someone can obtain and use your personal identity and data.

Equifax Incident

On Thursday, September 7th, the credit reporting agency Equifax announced it had been the target of a cybersecurity breach that could potentially impact 143 million Americans. Criminals accessed files that included the names, Social Security numbers, birth dates, addresses, and even some driver’s license numbers of Equifax customers.  A more detailed summary can be found here: https://www.equifaxsecurity2017.com

Equifax is giving all consumers the ability to check whether they have been impacted by this breach and the option to enroll in its credit monitoring service, TrustedID Premier, for free for one year regardless of whether you were impacted by the breach. TrustedID Premier includes:

  • Copies of your Equifax Credit Report
  • Credit file monitoring at all three major credit bureaus
  • The ability to lock your Equifax Credit Report
  • Social Security number monitoring
  • Identity theft insurance

To check whether you have been impacted and enroll in TrustedID Premier, simply follow these steps:

  1. Visit https://www.equifaxsecurity2017.com/enroll/ and click the red button “Begin Enrollment” on the left side.
  2. Type in your last name and the last 6 digits of your Social Security number.
  3. The next screen indicates whether Equifax believes your information may have been impacted; click “Enroll” if you wish to sign up for TrustedID Premier for free.
  4. The next screen may show you your enrollment date for TrustedID Premier. If so, return to https://www.equifaxsecurity2017.com/enroll/ on or after this enrollment date and click the red button “Continue Enrollment” on the right side of the page; otherwise, go directly to the next step.
  5. Follow the instructions as prompted, providing any additional information requested and a valid email address to finish enrollment.
  6. You will receive an email within a few days with a link to activate TrustedID Premier.

Freezing Your Credit and Other Tips for Protecting Your Identity

In the wake of this breach, The New York Times has also provided tips for protecting one’s information online in a variety of articles.  Helpful tips include:

  • Lock your credit reports at the three major credit reporting agencies (Equifax, Experian, and TransUnion), either through a security freeze or another option provided by the agencies. This service locks your credit files and prevents the opening of new credit card accounts or loans unless you temporarily open your files to apply for new credit. Please be aware that you may be charged a fee for this service depending on the credit agency and the specific service requested. Fees tend to be one-time charges in the range of $5-$20.
  • Review your credit report at least annually by obtaining it for free from this site: www.annualcreditreport.com. Be sure to use this official site and not others with similar names that companies use to try to sell you services.
  • Change all passwords for websites that store any of your personal information, especially those related to your finances or health.  Do not use the same password for multiple websites.

We at Edgemoor recommend all our clients take the above steps and begin monitoring any online accounts with personal identifying information for suspicious activity. We also urge everyone to be cautious regarding any suspicious requests received online, whether through a website or e-mail.

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Waiting for Action

In this latest installment of our quarterly report, my colleagues and I share some observations on the first half of 2017 and offer our outlook for the economy and markets.  Click here to go to the full report on our website.  Following are a few highlights:

  • Following a solid first quarter, the S&P 500 index added to gains and has now returned 9.3%, including dividends, through June 30th.  Despite ongoing threats of rising interest rates, bonds also provided positive returns, 2.3% as measured by the Bloomberg Barclays U.S. Aggregate Bond Index.
  • Corporate earnings rose 15% in the first quarter, and the U.S. economy continued to expand enough to lead the Fed to boost the federal funds rate by 0.25% in June, following a similar increase in March.
  • The Fed’s deliberations, statements, and actions remain critical to the economy and markets.  Even if the Fed does not act on rates again this year, we believe it will probably begin to shrink its inventory of Treasurys and federal government agency bonds as another way to unwind the massive stimulus it has provided to the economy since the financial crisis.
  • While there remains much work to be done on policy reforms and infrastructure spending promised by the new administration, we expect some version of tax reform from Congress later this year, though it may be difficult to enact anything that takes effect before 2018.  Major infrastructure spending will probably not come until 2018 at the earliest.
  • There are reasons to be cautious about the markets, starting with the observations that stocks are trading at high multiples of earnings and the stock market is overdue for a correction.  However, the economy is slowly expanding, interest rates are still low, and inflation is currently tame.
  • We are waiting for opportunities to buy bonds as rates rise, but bonds’ current low yields make them vulnerable to sharp price swings on small movements in interest rates.
  • We believe markets will continue to trade near their current highs as we await further action from the administration and Congress.

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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The Value of Berkshire Hathaway

I attended my twelfth Berkshire Hathaway Annual Meeting this past weekend and found it to be as worthwhile as ever.  Chairman/CEO Warren Buffett, age 86, and Vice Chairman Charlie Munger, age 93, are still at the top of their game.  Their appreciative audience seemed to me larger than ever with approximately 40,000 stockholders in Omaha, NE for the meeting and related Berkshire Hathaway events.

Once again for five hours they responded to questions from financial journalists, research analysts and stockholders, many of which dealt with how the intrinsic value of Berkshire Hathaway is not reflected in its balance sheet and income statement.  Here are some of the stunning highlights:

  • Berkshire Hathaway’s security holdings of public companies now have unrealized gains of $90 billion not recorded in net earnings.
  • Berkshire Hathaway’s float, accumulated insurance premiums reserved for future claims, now exceeds $100 billion for the first time.  Carried as a liability on the balance sheet, Buffett regards these reserves as a revolving fund since premiums received for new insurance policies likely replenish insurance claims going forward.  Moreover, Berkshire Hathaway’s insurance operations, which have operated at an underwriting profit for the past fourteen years, are currently expected to continue that performance with the result that the investment earnings on its $100 billion float would fall to the bottom line.
  • Berkshire Hathaway has $15 billion of intangible assets, representing the cost of acquired businesses exceeding their book value, which must be amortized as expenses over many years.  In 2016, the amortization of intangible expense for Berkshire Hathaway was $1.5 billion.  Buffett believes this expense is unwarranted because the acquired companies would not have incurred such an enormous intangible expense had they remained independent.  It is only because of Berkshire Hathaway’s ownership that the intangible expense must be deducted from profit.

Buffet believes that the intrinsic value of Berkshire Hathaway’s stock far exceeds its book value.

Positive News for the Future

  • New Business in 2017
    • GEICO led by Tony Nicely has signed up 700,000 new policy holders.
    • Berkshire Reinsurance led by Ajit Jain received a $10 billion premium for a new reinsurance contract with AIG.
  • Stock Investments
    • Warrants from the purchase of Bank of America Preferred Stock are now worth $10 billion in addition to the $5 billion originally invested.
  • Tod Combs and Ted Weschler
    • Each of these investment managers brought into Berkshire Hathaway by Buffett are now managing $10 billion dollar portfolios and additionally have subsidiaries reporting to them.
  • Stock Repurchases and Dividends
    • Buffett explained that if the size of Berkshire Hathaway’s cash available for investment makes it increasingly difficult to employ, dividends and stock repurchases would be considered.
  • Taxes
    • Buffet said that reduction of corporate income taxes would increase profits of Berkshire Hathaway’s subsidiaries (with the exception of public utilities that have electric rate setting commissions which control profit levels).
  • Management Succession
    • Buffett explained that when he retires or otherwise can no longer be CEO, his successor will come from within Berkshire Hathaway.  While he is not prepared to disclose the name of his successor as long as he plans to continue as CEO, he said that there is ample talent within the company from which to choose.
  • Berkshire Hathaway Without Buffett
    • Buffett said of Berkshire Hathaway’s stock, “If I died tonight, I think the stock would go up tomorrow.”  He attributed the reason why to the market perception that the sum of Berkshire’s parts is worth more than their whole as a single company.  However, he has a loyal board and loyal managers who want his principles for Berkshire Hathaway to continue for the long term benefit of its shareholders.

Past performance is not indicative of future results. The information provided in this commentary should not be considered financial advice or a recommendation to buy or sell a particular security. You should not assume that any of the investment strategies or securities discussed herein are or will be profitable. The opinions expressed herein are those of Edgemoor Investment Advisers, Inc. (Edgemoor) and are subject to change without notice. You should always obtain current information and perform due diligence before investing.  All recommendations for the last 12 months are available upon request.

Edgemoor Investment Advisors, Inc. is a registered investment adviser registered under the Investment Advisers Act of 1940, as amended. Registration does not imply a certain level of skill or training. More information about Edgemoor including our investment strategies, fees, and objectives can be found in our ADV Part 2, which is available upon request.

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A Good Start to 2017

In this latest installment of our quarterly report, my colleagues and I share some observations on the first quarter of 2017 and offer our outlook for the economy and markets.  Click here to go to the full report on our website.  Following are a few highlights:

  • Continuing the rally that began last fall, the S&P 500 index returned 6.1%, including dividends, in the first quarter of 2017.  Foreign markets also surged amid fairly consistent global economic expansion, optimism about the potential for higher corporate earnings, and generally low inflation and interest rates.
  • We believe the backdrop for continued U.S. economic growth is currently favorable, with consumer and business confidence high, unemployment low, and inflation nearing the Federal Reserve’s target level of 2%.
  • Commodity prices have risen in response to global demand.  Oil prices have eased recently but remain near $50 per barrel, a price far above the $26 of last February.
  • The U.S. dollar has declined, partly due to concerns about potential policy changes that would restrict trade.  This pullback is good news for U.S. exporters, whose goods are more competitively priced when the dollar declines.
  • Tempering the outlook are ongoing political squabbles in the United States and concerns about the economic implications of protectionist and anti-immigration movements around the world.
  • Since the U.S. elections, investors have bid up stocks partly in anticipation of tax reform, regulatory easing, and infrastructure spending promoted by the White House.  More recently, investors have become warier of the timing and magnitude of the policy changes that will actually be enacted.
  • Analysts expect first quarter 2017 S&P 500 index earnings to increase about 9%, which would be the strongest result since 2011.  Robust profits would confirm the health of the economy and provide support for current stock prices.
  • We believe U.S. stock valuations are now a bit lofty overall, with the S&P 500 index trading at a multiple of earnings that is above its historical average.  Nevertheless, we remain confident regarding the long-term prospects for our holdings.
  • For income investments, we continue to favor other asset classes over most bonds, given low bond yields and our expectations of further rate increases, which would cause bond prices to drop.

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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