Greece Is the Word – Or Is It?

In this latest installment of our quarterly report, my colleagues and I share some observations on the second quarter of 2015 and offer our outlook for the global economy and markets in light of recent events in Greece and China.

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

  • Stocks paused in the second quarter due to uncertainty about the global economy and U.S. Federal Reserve action along with meager corporate profits. Bonds and other income generating investments fell as investors parsed the Fed’s interest rate signals.
  • Recent market and economic news from Greece and China and ongoing U.S. Fed deliberations pose threats to economic prosperity and rising markets.  However, there are positive trends afoot that leave us still thinking that the U.S. stock market can show positive gains for the year.
  • The U.S. economy continues to expand at a slow pace and is on track for GDP growth of about 2% for the full year.  Consumer spending, supported by reduced energy prices and the ability of consumers to borrow at rock bottom interest rates, has been the primary factor helping GDP and has boosted sectors such as autos and housing.
  • Following the rise of price/earnings multiples over the past few years to levels that are in line with historical averages, the U.S. stock market is dependent upon corporate earnings to support higher prices.  Though second quarter earnings are expected to be on the weaker side, we anticipate better earnings later this year as the U.S. and foreign economies gain momentum.
  • Current indicators point to the most likely scenario being a first Fed move either late this year or in 2016.  We believe the Fed will most likely raise rates gradually as businesses hire more workers and the unemployment rate falls.  We also believe a gradual rise in rates due to improved economic conditions could be a good sign for the stock market, which has performed well in past times of incremental rate hikes.
  • However the Greek situation resolves, we believe there will be continued volatility in Europe over the coming months but limited long-term impact on the European economy or markets.  The European economy is improving, banks are much healthier, and we do not foresee Greece’s problems spreading to other members of the EU.
  • Having more than doubled over the past year due to government policies that encouraged investing, stocks in China reached unreasonably high valuations and may fall more than their recent plunge.  Even if the government succeeds in stabilizing the stock market, we believe the lower expected growth rate of the Chinese economy poses a long-term challenge.
  • We are optimistic about the markets due to what we see as improvement in the global economy and financial system, reasonable valuations that could be higher given current low interest rates and high profit margins, and our careful selection of what we believe to be undervalued securities 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

This material is not financial advice or an offer to buy or sell any security product. The opinions expressed within this blog posting represent an assessment of the market environment at a specific point and time and they are not intended to be a forecast of future events or a guarantee of future results. This blog post does not constitute a general or personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual investors. All the opinions expressed herein are subject to change without notice, and you should always obtain current information and perform due diligence before investing.

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More on Buffett and Munger

Here is another great summary of some of the comments from Warren Buffett and Charlie Munger at the Berkshire Hathaway annual meeting: The Warren Buffett & Charlie Munger Show.

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50 Years of Warren Buffett at Berkshire

2015 marks 50 years since Warren Buffett took the helm at Berkshire Hathaway and the roughly 40,000 attendees at this year’s annual meeting were in a celebratory mood.  The morning began, as usual, with a video.  The highlight of this year’s production was a hilarious bit featuring Warren Buffett as the Berkshire Bomber facing off in a grudge match against welterweight boxing champion Floyd Mayweather.

With the video feature concluded Warren Buffett and Charlie Munger took the stage for the main event, their annual question and answer session.  The Q&A was, as always, wide ranging and included audience questions from natives of Germany, Taiwan, China, Korea, and a seventh grader from Florida.

There was much well deserved praise for Mr. Buffett and Mr. Munger on their remarkable longevity and success running Berkshire, and the role of Berkshire’s corporate culture in creating and maintaining its success was a thread that ran throughout the Q&A session.  Choosing carefully those you associate with, nurturing your reputation and setting the proper tone at the top were all offered as key components for anyone seeking to create and sustain an enduring corporate culture.  They emphasized that Berkshire’s culture was not created overnight and that good fortune and being ready and open to opportunities when they were presented were also important parts of their success at Berkshire.

Not every questioner heaped praise on Berkshire.  The morning’s first question was probably the most pointed.  A shareholder asked Mr. Buffett to defend mortgage lending practices at Berkshire’s manufactured home subsidiary Clayton Homes.  Mr. Buffett, clearly anticipating a question on Clayton, offered a well-documented and persuasive defense of Clayton and its lending practices, pointing out that 97% of Clayton’s borrowers successfully pay off their mortgages and concluding that “Clayton has behaved very well.”

The same shareholder also questioned Berkshire’s association with buyout firm 3G Capital which has a reputation for cutting jobs at the companies it acquires.  With respect to 3G, Mr. Buffett remarked, and Mr. Munger seconded, that some of the companies it acquired had too many employees to work efficiently and that no one is required or expected to retain more people than needed to run a business.  He added that after being acquired by 3G, performance at those companies improved considerably.

Succession, which has been a frequent topic at Berkshire meetings in recent years, was discussed only briefly this year with Mr. Buffett stating his belief the person at the top must have extensive operational experience, not simply investing prowess.

On stock valuations Mr. Buffett was asked whether he felt that the ratio of total market capitalization to GDP, one of his favored market valuation metrics, was now too high.  He responded that in the current environment of exceptionally low interest rates current valuations were very reasonable.

They also remarked that the reinsurance business, where Berkshire is a major player, is not the attractive business it once was as competition has grown and made pricing unattractive.

Responding to a question about China and whether the principles of value investing have applicability there, Mr. Buffett and Mr. Munger agreed that the principles of value investing know no borders.  They added that China could benefit from shifting toward a more value-oriented approach to investing and away from the speculative fevers that tend to dominate markets in China today.

Turning to China again, both Mr. Buffett and Mr. Munger expressed admiration for the speed with which China has transformed itself over the past four decades and agreed that China and the U.S. must find a way to cooperate over the long term for their mutual benefit and for the benefit of world.

On the acquisition front, both expressed interest in doing more deals in Europe, having recently closed on the acquisition of a German motorcycle equipment retailer.

As the Q&A wound to a close Mr. Munger offered a fitting conclusion, saying that simply being a shrewd investor, passively holding stocks, is not enough to make a life satisfying and that we all should strive to contribute more.

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Waiting on the Fed

In this latest installment of our quarterly report, my colleagues and I share some observations on the first quarter of 2015, offer our outlook for the global economy and markets, and discuss several of the securities we are currently buying: Google (GOOG), Johnson Controls (JCI), and international mutual funds from Dimensional Fund Advisors.

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

- Stocks rose slightly in the first quarter as U.S. Federal Reserve chair Janet Yellen’s remarks about gradual interest rate increases comforted investors, who are adjusting to lower oil prices, a stronger dollar, and mixed economic conditions around the world.

- Whenever the Fed finally raises rates – likely before year-end – we expect the increase to be gradual and believe the U.S. economy will continue to expand.

- The United States is currently the strongest of the major global economies, even though real GDP growth has been limited to 2%-2.5% for several years and is likely to remain in a similar range in 2015.

- The dramatic fall in oil prices – over 50% since last summer – is both good and bad for the U.S. economy but should have a positive impact overall.

- Some of the world’s major economies are not faring as well as the United States and require more stimulus, so central banks abroad are easing rates in Europe, China, and Japan.

- The relative health of the U.S. economy provides select opportunities to make good investments here at home, and Europe and other foreign markets also present pockets of opportunity for disciplined, patient investors.

- For income, we continue to favor utilities, real estate investment trusts, preferred stocks, master limited partnerships, and convertible securities over bonds in the current environment of low interest rates that are likely to rise.

- We remain optimistic that the stock market, bolstered by the economic benefits of lower energy prices and low interest rates, will again provide positive returns in 2015.

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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What do lower oil prices mean for investments?

After a plunge of more than 50% since last summer, oil prices appear to be stabilizing – at least for now – around $50 per barrel.  Where they go from here is unknown, but easier to predict is the impact of lower oil prices on investments in certain sectors or regions of the world.  Click here to read a research report from Fidelity that forecasts continued low oil prices, compares the impact of lower prices on net importers like the United States (positive) to the impact on exporters like Russia (negative), and suggests sectors that will benefit from oil’s decline.

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