Hall Capital “Market Views” Newsletter October 2016

This is the 26th edition of Market Views from HALL CAPITAL. Our aim is to provide concise views of where we see risk and opportunity for investors.

Low Interest Rates are Stimulative
- but only to a point

That lower interest rates boost economic activity has both theoretical and empirical support. Clearly asset prices - stocks, bonds, home prices - are boosted by lower rates. But lower interest rates in this cycle have done little to boost growth. Even negative rates in Europe and Japan have not worked as expected. Could it be as rates approach zero traditional economics break down? Like Newtonian physics do not explain the behavior of the very small sub-atomic particles.

As rates are lowered the cost of borrowing goes down which allows consumers and businesses to buy more cars, houses, plants and equipment. Though consumers ARE buying, spending about 3% more than last year, they are also saving yet more. The savings rate of 6% is twice that of what it was ten years ago before QE began. And business investment in new plant and equipment has been subdued relative to expectations. With interest rates so low, why is the consumer savings rate going UP and why are businesses not expanding more?

One answer is that there is a hangover from the financial crisis increasing financial conservatism. Another is that we are in a different world of economics (quantum economics?) when interest rates approach zero. Consumers may spend more and save less when rates drop from, say, 8% to 6%. But when rates drop to near zero, savers may think, "Hey, my bank account is making no return. I will have to save MORE to reach my retirement goals." No one can say what the threshold is for psychology to reverse from spending to saving based on interest rate levels, but that this impact has occurred is plausible given that the amount in consumer savings of cash and fixed income is twice that of household debt.

Businesses will not expand plant and equipment without demand for the output, even if interest rates are low. Consumer spending represents over 80% of the economy so if the consumer's savings rate is climbing, then the lack of incremental spending will limit the demand for products and services from businesses. This may explain why this recovery has been slower than average.

If this new quantum economics theory holds, then when interest rates ultimately rise meaningfully we will no doubt see the traditional drop off in stock and bond prices. But then consumer spending may buck tradition and actually pick up which will add to growth and aid stocks down the road. In any case, this will not happen quickly because interest rate changes will be slow and there are many cross currents in play. One is the political environment.

Elections are Not Key to Our Outlook
- except this time

With espoused policies of lower taxes and regulations, Republicans are traditionally viewed as friendly to the "investor class". However, in the post war era since 1945 the US stock market has actually performed better under a Democratic president, 9.7% per annum, than under a Republican president, 6.7% per annum. The only two presidents who presided over negative returns during their tenure were Republicans: Richard Nixon and George W. Bush. President Obama is on track to be the second best Democrat for the stock market since WWII behind Bill Clinton.

Of course, there are many factors behind the stock market performance, and who occupies the White House is one of the least important. Presidents don't deserve much of the credit OR blame for stock market performance during their tenure. Who controls Congress may be more important.

We have two highly imperfect candidates running for POTUS. The stock and bond markets face complex challenges but if we were to isolate the impact of this year's outcome, a Trump win will likely be unwelcomed by investors. Why? Without passing judgement on character issues, it's abundantly clear that if all of Trump's espoused policies -- increased trade barriers, immigrant limitation, withdrawal of support to NATO, encouragement of nuclear weapons in Japan and Korea, massively increasing the national debt, "build a wall" -- were implemented, the policies would be very damaging to the economy and the markets. The uncertainty alone would unnerve many investors, regardless of political persuasion.

The good news is that if Trump were elected, he would probably not even try to pursue all of these policies. And even if tried, Congress would not approve, or at least not most of them. (If Mexico actually agreed to pay to build a wall -- fat chance -- Congress might let them.)

Our view, given the stock market is near record highs, is that it reflects the polls showing an expected Clinton victory. A Trump win would likely cause a sell off. This does not mean that the market could not sell off some even if Clinton is elected, but the move would be muted compared to a Trump victory.

While the direction of interest rates is always a factor in the outlook, this year the election outcome also weighs on investors.

Focus List Returns 15% Annualized
- not that this can continue

For the third quarter our Focus List jumped 6.2% which compares to 3.9% for the S&P 500. The Focus List return was boosted by a 19% rebound in Apple, a 17% jump in Corning and a 13% gain in Sanderson Farms. The two health care stocks backed off some.

This brings the year to date return of the FL up to 15.2% vs 7.8% for the S&P 500. Since inception in 2010 the published Focus List has generated 14.9% average annual returns compared to 11.7% for the S&P 500.

We are making a refinement in the FL by trading one large European pharma stock for another. We are replacing Novartis with Novo-Nordisk. We are also taking profits in Sanderson Farms (up 26% since added a year ago) in favor of depressed shoe retailer Genesco.

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

"Nevertheless, a steadily growing US economy, reasonable, if not cheap stock prices, and seasonality patterns bode well for a much better quarter than the one we just experienced."
- The S&P 500 indeed returned a much better 7.0% in Q4 compared to (-6.4%) in Q3.

"We are doubling down on an oil recovery by swapping Exxon for the more upstream focused Chevron."
- Chevron is up 35% since 9.30.15, not counting a 5% dividend. (Chevron was removed from the FL earlier in the year due to price.)

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

<< Back to Newsletter Index

Go to July 2016 Newsletter >>