Hall Capital “Market Views” Newsletter July 2016
This is the 25th edition of Market Views from HALL CAPITAL. Our aim is to provide concise views of where we see risk and opportunity for investors.
The Brits Vote to Exit the EU
- political chaos ensues
While US markets quickly recovered from the initial shock of Brexit, we give some credence to the judgement of investors around the world who sold down global equities by $3 trillion, the worst two day drop in history. We concur that this surprise event is a clear negative for the investment outlook. HOW negative is not at all clear. Were it only a recession in the UK to be concerned about, this would not be significant to US investors. However, the vote created far greater uncertainties, including the viability of the European Union itself and some of these uncertainties including how exactly the UK exits and on what terms may not be known for years.
The US market shrugged off Brexit based on the comfort that this event, though negative for growth, will stay the second interest hike by the Fed. What is needed even more now is some economic growth which has been extremely hard to come by in the major world economies. We will need to see an improvement in US employment growth and GDP growth before we can see much in the way of robust stock gains over their interest rate driven value.
"Stock Prices Will Fluctuate"
- more and more
There are several factors influencing the volatility of the markets and it is certainly not volatile fundamentals. The trend in growth and inflation has been relatively steady for years. Two main factors are: acute uncertainty and the psychological hangover from 2008.
Uncertainties loom large: How will Brexit play out? Is Italy the next crisis? Will the US employment growth turn up? When and by how much will the Fed raise interest rates? How will China transition to a lower growth outlook? Who will become the next US President? etc.
Furthermore, investors who have to contend with these unknowns remember all too well how it felt to see their portfolios decline by 30% or more in 2008. While a new crisis may very well be around the corner, it is hard to imagine one as severe as 2008. For one thing US banks are in a MUCH better capital position than they were in 2008 and could easily survive a Lehman like failure.
Nevertheless, each threat that starts a market slide causes investors to immediately ask, "Is this the beginning of another 2008?" and many run for cover. This exacerbates the volatility.
In addition we we have an unprecedented low UST yield of some 1.4%. Any further change in these interest rates EITHER WAY will likely increase the volatility of equity prices.
No one knows how this all this will play out but the goal of a successful investment strategy is to take advantage of volatility rather than falling victim to it. This is generally done best when you take the other side of a trade on an issue which the market seems to have figured out clearly when you know it is not clear. The dire predictions this January of the failures in the oil patch and the resulting historically sharp sell off is one example. Rest assured there will be more. Many concerns will be warranted of course, but investors have a way of over extrapolating the impact.
In asset allocation we still lean toward quality stocks with strong balance sheets, such as those on the FL, but we wish to hold some dry powder to take advantage of volatility. In bond land, 9% high yield appears more attractive than risk free bonds even if an ample portion of that yield is given back in defaults.
Individual Stocks Engender Confidence
- more so than the overall market
I have more confidence in stocks that are listed in the Focus List than the entire market. Will Apple Computer sell significantly less iPhones if the Fed hiked interest rates by 1/2%? Probably not. Will Sanderson Farms sell less chickens because of Brexit? Probably not. Will CVS fill less prescriptions if China's growth slows further? Probably not. While there are specific uncertainties associated with the fortunes of individual stocks, they are not as imponderable as the larger factors that impact the overall market.
Broad stock diversification is frequently preached by investment advisers. One reason is that it help keeps them out of trouble with their clients. Broad stock diversification is overrated. If you had owned the Wilshire 5000 in the last several years your results would have fallen well short of the S&P 500. A group of "all world" equity funds would have performed even worse. (Diversification across asset classes is a different matter).
I have argued that the Focus List is less risky than the market. Currently there are no financial stocks (which are sensitive to interest rates and credit quality), no energy, no rank commodities, no go go high p/e stocks like Tesla, or even over priced staples like Kimberly Clark.
For the second quarter our Focus List edged higher by .2%. This brings the six month return up to 8.6% vs 4.0% for the S&P 500. Since inception over five years ago the published Focus List has generated 14.4% average annual return compared to 11.5% for the S&P 500.
For individual stocks as well as selection strategies, past performance is not necessarily indicative of the future.
Hall Capital Focus List
Follow Up – from our letter one year ago
"... Greek citizens are facing difficult times. ... Greece is not that large relative to the European economy. Contagion is not likely."
- Greece continues to struggle but indeed bigger countries are now the focus. No contagion due to Greece has been felt.
"We do not believe the threat of higher rates warrants a full scale retreat from stocks. Nor do price levels justify an aggressive stance."
- The S&P 500 returned 4% over the last year.
NOTE: Now in addition to ALL our quarterly letters, on our website is a tab with just the Follow Ups.
About HALL CAPITAL
HALL CAPITAL, LLC is a registered investment advisor and was formed by Principals from Arcturus Capital in 2010.
For more information, contact Donald Hall 626 578 5700 x101 dhall@hallcapitalmanagement.com
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