Always Look To Fundamentals…

Happy Memorial Day and many thanks to those who have served and are serving our country without hesitation and with distinction.  Barbeque party conversations today seem to have an overhang of gloom, tinged with worry and spiced with mockery. Politics still are “front and center” and nervousness about the future for America and for the post War institutions, which have created an era of peace and prosperity for many, is palpable.

But markets around the world have been of a different mind. Above, the reader will note the S&P 500 performance over the last few years depicted by the blue line. The red line looks at a measure of “worry”, which compares the VIX Index (volatility) to the 10-year Treasury yield (a measure of safety). Periodically, when the VIX/10-yr ratio spikes (times of great investor concern) the equity markets swoon. Interestingly, at the far right of the chart the reader will note the time of the Trump Presidency, from election to today, and the level of the VIX ratio – which has declined since his election. Investors have not seemed to be overly concerned about the main topic at most cocktail parties and cookouts, and “fodder” for jokesters on late night TV. So far, investors around the world have looked to fundamentals.

In Q1, earnings at US companies grew at the fastest pace in nearly six years. Earnings were up about 14% from the year earlier period and the gains were broad based – i.e. no one sector dominated. Further, the quality of earnings improved (and were not hyped by accounting methods) and company sales picked up almost 8% year over year – a demonstrable improvement vs. the recent past. This is happening around the world. S&P 500 companies have now posted earnings growth for three quarters in a row, which is expected to continue through the next quarter and the full year.

Recently, Robert Schiller, a Nobel laureate, who famously published his book “Irrational Exuberance” just before the Internet bubble burst in early 2000, opined that he thought stocks could rise as much as another 50% before the current bull market ends. For many who think this bull market is “long in the tooth”, this was a surprising comment from someone who is considered to be a very cautious prognosticator. Further, the European and Asian markets are thought to be of even greater “value”. How can this be after so long a rise in equity prices? Fundamentals – corporate earnings, sales, cash flow and dividends – are going up and so long as they rise while interest rates stay historically low, stock prices will rally in the US and elsewhere around the globe.

Capitalism rewards progress by enriching those who are innovative and productive. Incented to do better, millions of capitalists push the system to progress and historically have had remarkable success in doing so. Those who are pessimists, who fight capitalism, seemingly “swim against the tide”. Every now and again, the pessimists are correct in their worries and predictions. But history would strongly suggest that so long as fundamentals are strong, investors would be wise to be optimistic rather than pessimistic about world markets. Leave the worries with the barman.

Day 102

DAY 102…

The first major political milestone of the Trump administration has been passed with an environmental march in Washington and a speech for the faithful in Harrisburg. We are now on day 102. The press and the President have been focusing on the “first 100 days” like a marking period in school – but with little relevance to the real world. So let’s move on.

Since we last wrote, an initial measure (subject to revision, we might add) of Q1 GDP growth in the US was announced and it was a subpar +0.7%. If this number holds up to later recalibrations, it will be the slowest start to a new year for some years – not exactly for what our leaders in DC were hoping. Consumer spending was the “culprit”. It was weak despite high consumer sentiment measures which were recorded during the period. Employment has been strong and wages have been going up. So we think that the American consumer probably took “a pause that refreshed” and will be back later in the year.

Also during the quarter, gross private fixed investment jumped at an annualized 12% rate. This is encouraging for such investment boosts productivity of those who are employed and we have seen little such investment for a number of years.

Looking at the above chart, real gross private domestic investment grew at a 3.7% annualized rate from 1966 through 2007. At the same time, real GDP grew at a 3.1% annualized rate. From 2007 until March of 2017, private investment has posted only a 1% annualized growth rate and  the US economy has only expanded at a rate of 2.1%. There is a powerful “cause and effect”.

First quarter earnings have so far come in better than expected by analysts and earnings estimates for 2017 are being raised as a consequence. This is different than before when analysts would routinely lower their estimates for a year, as the year progressed. We hope (and expect) that better earnings will lead to more corporate investment, greater productivity and higher stock prices.

Focus and Embrace the Confusion

FOCUS AND EMBRACE THE CONFUSION

We would encourage readers not to stare at the “shiny” object. We would entreat people not to listen to the bombast from Washington or Mar-a-Lago. We would rather that investors focus on “what is happening” in the US economy away from the din of political skirmish.

It was reported in February that:

  • 227,000 people were added to the employment rolls in January
  • December factory orders increased 1.3% vs an expected 0.9%
  • Retail sales were up 0.4% vs +0.2% expected
  • The Small Business Sentiment Indicator rose (and did not decline) to 105.9 vs an expected result of 104.5
  • The Reuters/University of Michigan Consumer Sentiment Index for February increased to 96.3 from 95.7 and vs 96 expected
  • According to Thompson Reuters, fourth quarter earnings look to be up 7.5% year over year along with a 5% growth in revenue; further, the optimism amongst corporate managers helped boost full year earnings estimates for 2017.

In concert with political chatter about significantly reducing tax rates (both corporate and individual) and doing away with “mounds” of stifling bureaucratic regulation, the aforementioned economic/corporate results have fueled a rally in equity markets. As an example of the “good things” that are happening in the American economy, away from the political “noise”, following is a chart which monitors the health of one of the most important US industries – home building. As can be seen, builder sentiment is high and the trend for starts is rising. Combined with an ongoing rise in building permits (not pictured here) it is reasonable to expect residential construction growth for the foreseeable future.

Emotions from the recent Presidential election are still “running high”. Further, there is a lot of distraction with declarations of “fake news” and rampant voter fraud combined with gargantuan hubris. But to focus on this, to focus on the “illusionist” we think is a mistake. This enables misdirection. People who focus on the bombast miss the facts of economic and corporate advance. People who focus on the bombast worry and are underinvested. But investors who focus on the progress are invested and have benefited. So our advice is for people to …FOCUS AND EMBRACE THE CONFUSION…..

 


DISCLAIMER:

The opinions expressed in this Commentary are those of Baldwin Investment Management, LLC.  These views are subject to change at any time based on market and other conditions, and no forecasts can be guaranteed. The reported numbers enclosed are derived from sources believed to be reliable.  However, we cannot guarantee their accuracy.  Past performance does not guarantee future results. We recommend that you compare our statement with the statement that you receive from your custodian. A list of our Proxy voting procedures is available upon request.

A current copy of our ADV Part II & Privacy Policy is available upon request or at www.baldwinim.com/disclosure.htm

Merger News

MERGER NEWS

We are pleased to announce that as of the close of 2016, Baldwin Management LLC completed a merger with RKM Advisors, Inc. located in West Chester, PA.

Like Baldwin, RKM manages money for individuals and families as well as performing tax work for them and others. Their services are highly personalized and their philosophy is hallmarked by a “client first” attitude.

Joining us from RKM are founder Richard K. May and his wife Julie May. Richard has had a long and storied career in the investment management business after having earned his AB from Princeton University and his MBA from the University of Michigan. Julie is a tax specialist. She has an AB from Smith College.

Working closely with RKM’s tax clientele is Vanessa L. Geiger. Vanessa, who earned her BA from Millersville University, has many years of experience completing complicated tax returns for the firm’s biggest clients. Assisting Richard with investment management and financial planning work is Gary S. Hess, who received his BS from the Pennsylvania State University and earned a Chartered Financial Analyst (CFA) designation in 1993. Finally, Katharine P. Dunlevy, who received her BA from the University of Delaware and her MBA from Florida Institute of Technology, will be joining us and keeping the administrative tasks of RKM and the clients well in hand.

Unlike Baldwin, RKM utilizes mutual funds and ETFs to manage client portfolios. We welcome this different approach to money management, as it adds another “arrow” to Baldwin’s “investment quiver” allowing us to offer clients an alternative to individual security portfolio management.

With this merger, Baldwin has enlarged its money management business and brought a new discipline under “our tent”. We have also added new tax clients and tax preparation talent, which will also burnish the Baldwin business. We are excited about our future and working with our new colleagues.

Misdirection

Misdirection

The goal of an illusionist is to focus audience attention on something which is not what the magician is actually doing. Crowd senses are preoccupied by intentional stimuli away from what is really “going on” so that the magic unfolds undetected and tends to amaze the viewer. The “political” crowd in Washington and elsewhere around the world have been amazed by the first week’s activities of the new Trump administration. Incendiary comments uttered by our President about Inauguration Day crowd sizes, popularity, the Mexican wall and illegal voters have hurt Mr. Trump with quite a few of the “old political guard”. But his scores of supporters, those who voted for change from the conventional political path and who accept him for what he is, have reacted with more equanimity. The misdirection has been unfolding.

Substantively there has been action with a number of Executive orders. Pipelines which had spent years mired in regulatory purgatory were given the “greenlight” to proceed. The Trans Pacific Trade Partnership was “killed”. A scheduled meeting with the Mexican President was postponed because Mr. Trump again said, as he said many times on the campaign trail, that Mexico would pay for the wall, which upset the Mexican President on the eve of his arrival in Washington. There was a breakfast with a dozen major corporate CEOs with an important part of the conversation devoted to jobs. There was also an hour and a half meeting with union leaders with the President and the top members of Mr. Trump’s team – in the first week of his administration. Who says Big Labor belongs to the Democrats? Despite the fact that Labor voted for Mrs. Clinton, President Trump had Big Labor in for a visit immediately upon assuming office. In short, Mr. Trump has let it be known that he is not beholden to either of the established political parties. He is not a Democrat nor a conventional Republican. He is an independent, perhaps a populist who has taken Andrew Jackson as his “soul mate” by hanging his portrait in the Oval office.

Away from politics, it is corporate earnings season. So far, so good. Companies have just started to report their yearend numbers and to date the surprises have been to the “upside”. However we still have a ways to go before every company has reported. The fourth quarter GDP growth was not as good as hoped for, coming in at +1.9% vs. an expectation of over 2%.


So what can Mr. Trump do to “rev up” the American economic engine? Corporate investment has been anemic with a 0.1% contribution to Q4 GDP growth last year. Lower taxes and lighter regulation, two Trump promises, would help this effort. Government spending has also been weak and here an infrastructure investment would be a big help. Finally, our country’s trade deficit has been an anchor holding down US GDP expansion.

With quite a few of our trading partners, the US has had for some time a trade deficit which hurts US economic growth. Already President Trump has set his eyes on Mexico and China to renegotiate trade deals to make them more balanced. This would not be a bad thing – but will most certainly upset the “status quo” and quite a few politicians. So we would suggest that investors not focus on the incendiary statements, the bombast, the “misdirection” and rather focus on the substance – corporate investment, government spending and trade negotiations to get a better sense of which way the US economy and our markets may go in the future.


The opinions expressed in this Commentary are those of Baldwin Investment Management, LLC.  These views are subject to change at any time based on market and other conditions, and no forecasts can be guaranteed. The reported numbers enclosed are derived from sources believed to be reliable.  However, we cannot guarantee their accuracy.  Past performance does not guarantee future results. We recommend that you compare our statement with the statement that you receive from your custodian. A list of our Proxy voting procedures is available upon request.

A current copy of our ADV Part II & Privacy Policy is available upon request or at www.baldwinim.com/disclosure.htm

4th Quarter 2016 Commentary

POLITICAL RISKS AND MULTIPLE CONTRACTION

In early December, S&P Global, Inc., the credit agency stated that “the strength of institutions and quality of policy making can no longer be taken for granted”.  The research firm was sounding the alarm on the rise of populism in Europe and the U.S.  “We believe it may no longer be possible to separate advanced economies from emerging economies by describing their political systems as displaying superior levels of stability and predictability of policy making and political institutions”.  Events used to demonstrate their concern were the Brexit decision, the election of Donald Trump, the recent Italian referendum and upcoming French elections. Conventional “wisdom” has proved too often to be wrong.  The pundits are indeed fallible.  Expert knowledge in some cases was not considered a positive – but rather to be “expert” meant to be distrusted.  So as we turn to a New Year, voters decided in some important recent elections to be done with the “conventional” – sweep it aside –and to usher in something different.  This is a consequential change affecting markets around the world.  Historically, the “developed” markets (think Europe and the U.S.) have traded at superior multiples of earnings and cash flow to the “developing” markets (think China and India) partly because of their more stable governance institutions.  If investors agree increasingly that the governance “distinctions” between developed and developing economies are no longer as marked as they once were, and we think this is happening, then we believe there will be multiple compression between the two. In short, the developing markets will trade at higher multiples of earnings and cash flow than they have and the developed markets will trade at lower multiples than they have.

FOCUS ON THE U.S…….

Daily “tweets” from the President-elect set the stage each morning for the news cycle.  There have been a “parade” of cabinet candidates visiting Trump Tower this holiday season, disrupting New York traffic – but titillating political “junkies” and the media. Retired military generals seem to have taken any position connected with security or defense.  Business people look to be the winners at Commerce, Labor, Treasury and State. Housing and Urban Development will get an ex-doctor, Education will get a big campaign contributor, an Oklahoma Attorney General will lead the EPA, and Energy will get an ex-Governor who ran for President with a goal of abolishing the very department he will head.  The philosophy seemingly guiding the upcoming Trump Presidency is one of less regulation, lower taxes, greater infrastructural spending and a “transactional” foreign policy which will probably stress the conventional intercourse of current international relations.  Certainly some aspects (like less regulation and lower taxes) of the aforementioned philosophy is attractive to investors.  Some other characteristics (like an uncertain “transactional” foreign policy) will not be so welcome, because uncertainty begets increased risk – and markets do not like risk.  There will be “bumps in the night”.  Change is coming and change is rarely smooth. So far investors have chosen to see “the glass as half full” and have pushed up equity prices.

Importantly, the balance sheets of US households are stronger today than they have ever been with the collective net worth having recently reached a new high in nominal, real and per capita terms.

If the road ahead does get bumpy, Americans seem well positioned to withstand the “ride” – it seems to us.

OVERSEAS……

The emerging markets have been and continue to be “cheap” to the U.S. by at least one standard deviation.  China is often in the news amid concerns regarding its economy and debt, especially at State owned enterprises.  So far the Chinese have befuddled the “Bears” on Wall Street and we believe they will continue to do so.  A wild card will be Mr. Trump’s “transactional” foreign policy style, as the Chinese seem to be in his “crosshairs”.  This will bear watching. India is the fast ship at the moment. Prime Minister Modi, while not perfect, seems to be executing quite well in the eyes of many investors.  The Indian economy is outperforming every other large economy in the world, the markets are up and the future appears bright with a large and young population.  OPEC has reversed course after suffering mightily with low oil prices.  Production will be restricted beginning in 2017 in accord with an agreement reached among the members of the cartel and also with the concurrence of other oil producers (think Russia).  Skepticism about the “deal” is rampant. But compliance might be better this time vs. other instances because it was OPEC’s ox that was being gored and certainly the monarchy in Saudi Arabia, the prime player in OPEC, wants to avoid another Arab Spring.  Already energy prices have risen and will probably stay at a higher level ($55/bbl – $65/bbl) throughout 2017 which should help the oil industry.  In Europe, despite the fact that economies are doing better (i.e. in Spain, France, Germany and the UK),  politics has “stolen” and will steal some of the “thunder”.  Brexit unnerved investors.  The upcoming French election has people guessing.  Corporate Europe is moving forward.  On that basis, markets should improve and are still cheap to the U.S.  It’s just the politics that keep getting in the way.

THE BOND MARKET……

Bonds have been in a multi-decade “bull market”.  That has ended.  Yields have started to rise and will continue to do so as economies pick up speed. As employment levels increase, higher wages will be required to entice workers to fill open positions. Inflation, we think, is on the rise and as such the Federal Reserve will act to increase short term interest rates to make money more expensive.  This all is fine and the natural way of things as an economy improves.  Bonds will not for some time prove to be competition for stocks.  Interest rates are still very low and even as they rise, rates will need to get to around a 5% yield (historically this has been the case), on the 10 year Treasury for bonds to compete and “crowd out” equities in investors’ eyes.  But bond prices will not be going up in 2017.

 

PREDICTIONS – SO HOW DID WE DO IN 2016????

 

  • U.S. economic growth will continue at a pace of around 2.5% – 3%     Yes – Growth picked up nicely in the 2nd half of 2016
  • U.S. inflation will remain quiescent     Yes – Expect inflation to rise in 2017
  • The dollar will stabilize, perhaps strengthen a bit more     Yes – Uncertainty elsewhere has strengthened the dollar
  • During 2016, oil’s price will find a bottom not far away from now and will rally into 2017     Yes – This is headline news
  • Interest rates will rise – but the rate of increase will be slow     Yes – Expect more in 2017
  • Political reform will grow in South America     Yes – Rousseff in Brazil impeached, Maduro in Venezuela “on the ropes”
  • It will be another “Banner Year” for mergers and acquisitions     Yes – Headline news
  • Consumer spending will improve     Yes/No – “Big Ticket” items bought, smaller purchases “patchy”
  • Émigrés will continue to be a “hot potato” politically around the world     Yes – Immigration is a political “lightning rod” for populists
  • Amongst the popular investment alternatives, equities should do the best          Yes – Slow start to year, but strong finish

 

PREDICTIONS FOR 2017

  • S&P 500 corporate earnings +10% – 15%
  • Inflation to range from 2.5% – 3%
  • Business investment up due to cuts in corporate tax rates and overseas profits repatriation
  • Government spending up due to infrastructure investment
  • Personal consumption up due to tax cuts and wage gains
  • Real GDP growth +3%
  • The Federal Reserve will raise the Fed Funds rate by 0.75%
  • Bond prices will drop, yields rise (10 year Treasury yield 3.5% – 4.25%)
  • The Treasury will issue bonds with 40+ year maturities to take advantage of still historically low interest rates
  • Equity prices will rise on the back of higher earnings and lower bond prices

 

A FEW FINAL THOUGHTS

The opinions expressed in this Commentary are those of Baldwin Investment Management, LLC.  These views are subject to change at any time based on market and other conditions, and no forecasts can be guaranteed. The reported numbers enclosed are derived from sources believed to be reliable.  However, we cannot guarantee their accuracy.  Past performance does not guarantee future results. We recommend that you compare our statement with the statement that you receive from your custodian. A list of our Proxy voting procedures is available upon request.

A current copy of our ADV Part II & Privacy Policy is available upon request or at www.baldwinim.com/disclosure.htm

Special Commentary: We Didn’t See That One Coming…

WE DIDN’T SEE THAT ONE COMIN’

It was a complete “sweep” – the Presidency, the Senate and the House of Representatives.  The Republicans won it all as well as more Governorships.  Who would have thought that the Democrats would successfully “snatch defeat” from the “jaws of victory”?  Certainly we were not so bold!  So with our clouded crystal ball let us try to divine what this political “thunderclap” might mean for the American economy and certain markets.

As enunciated so far, President-elect Trump’s economic policies are quite stimulative.  He has said that the infrastructure in the US is in bad need of repair and on that score he and the Democrats agree.  For far too long, government spending has been held in check to restabilize government balance sheets and this phenomenon has been a “drag” on overall economic growth.  Spending on projects, which might admittedly increase deficits, will increase corporate profits.  Companies which might benefit are industrials, transports and perhaps even energy.  Mr. Trump is also promising to reduce taxes on corporations and individuals.  To that end, we might well see some sort of tax overhaul and a special “tax holiday” for companies with accumulated overseas profits (think Microsoft, Apple, Intel) to entice their managements to bring the cash to America.  A tax on those profits (perhaps 10%) could be used to pay for part of the infrastructure repair and thereby may not increase the deficit as an offset. Lower taxes will benefit those who own financial assets and corporations.

Less regulation is also a promise by the Republican.  “Obamacare” is to be repealed and Dodd-Frank is to be edited heavily – just for starters.  Less regulation should help pharmaceutical companies and the finance industry, which have felt “under the gun” during the last eight years.  Energy firms would also welcome fewer rules which have inhibited their recovery.

Trade has been a hot topic of discussion in political circles throughout the campaign.  Mr. Trump has voiced many concerns about US trade policies and deals which have been struck.  There are quite a few in the country who believe that by “rejiggering” trade deals, Mr. Trump will be able to bring back lost jobs.  It will not happen.  What will happen is that prices for goods once made offshore and now made in America will go up – inflation will take hold.  By sending manufacturing offshore, the US lost jobs but got lower prices for goods.  Reversing that flow – getting some jobs back will likely mean higher prices for goods.  There is no “free lunch”.  We do not think anyone wants to start a trade war, which will do no one any good.  But there could well be more contentious relations with China, Mexico and Canada – which might mean more inflation and higher interest rates.  This would not be good for bonds.

We think fiscal stimulus will lead to higher profits, more inflation, higher interest rates and greater economic growth.  Lower company and individual taxes should spur investment and this should enhance productivity, which has been lagging for quite some time.  Greater productivity and higher employment should lead to more consumer spending which should further bolster the “animal spirits” of corporate chieftains to make further investments in capital expenditures.  President-elect Trump will be more market friendly than not and his compadres in other branches of government will be there “to lend a helping hand”

 A FINAL THOUGHT

                                                  scphoto1     scphoto2

The opinions expressed in this Commentary are those of Baldwin Investment Management, LLC.  These views are subject to change at any time based on market and other conditions, and no forecasts can be guaranteed.

3rd Quarter 2016 Commentary

IS THE WIND CHANGING DIRECTION???

On September 22nd, the American Association of Individual Investors (AAII) released their Sentiment Survey, which the reader will find below.

CHART 1

The bullish sentiment reading fell to 24.8% and remains 1 standard deviation below the norm at 28.3%.  The eight period moving average also fell.  A year ago we wrote that equity investors were unsettled.  They have continued to be.  There have been numerous pundits who have declared this seven year rally in most stock markets around the globe as one of the “most unloved”.

Skepticism/cynicism has been high.  “Animal spirits” have been absent as too many, twice burned by stock market “craters” since 2000, have refused to believe that “the bull” has any legs. Many investors have left the equity markets and have redeployed their capital into increasingly risky bond markets, searching for yield.  But stock markets have continued to trudge higher – not every day and not necessarily by a lot on any day – but higher. The following chart we find interesting as it looks at long term trends of investor sentiment and what has happened correspondingly in the US stock market as represented by the S&P 500.  The methodology is different from the aforementioned AAII as displayed in Chart 1, because Chart 2 combines the AAII sentiment measure (a retail investor look) with a gauge from Investors Intelligence (professional advisors) extracted from Thomson Reuters DataStream.

CHART 2

Please look at years when bullish sentiment has turned after a significant fall (e.g. 2009,2003 and 1994).  In those instances the S&P rallied significantly.  Now look at 2016 and please note the “turn” in “bullish” sentiment.  Retail investors might be feeling glum – but the “pros” might be sensing a change “in the wind”.

What could change attitudes?  At this juncture, we feel only one factor would be sufficient and satisfactory – corporate earnings growth. So far, equity markets have “ground higher” largely via the expansion of price/earnings (P/E) ratios.  P/E ratios are driven by investors to expand early in market rallies as investors become less fearful of market risk.  P/E ratios also expand as interest rates go down because bonds, the natural alternative investment to stocks, become more expensive as interest rates go down.  Thus stocks are allowed by investors to become comparatively more expensive.  But there does eventually come a time in each market cycle when P/E ratios can no longer expand only by themselves.  There comes a time when corporate fundamentals like earnings must reassert themselves in the calculation of an appropriate corporate valuation.

We believe we have arrived at that juncture in this market cycle. The E (earnings) in the P/E ratio must grow to shrink the P/E ratio and lend fundamental support to stock prices.  Fortunately, we think earnings are about to do just that.

CHART 3

Importantly from the chart above, we want the reader to note the directional change in earnings estimates from negative to positive year over year and to notice that the negative changes are becoming less negative and the positive ones more positive.  Throughout a year, analysts make earnings projections – usually the first projections are more positive than the later ones for any given quarter or year. It is human nature to be optimistic rather than realistic, until one has to be.  In the second quarter of 2016, the final number for earnings for the S&P 500 was revised down relatively little as compared to the first estimate for the quarter – that is, analysts got it right.  This was also the first time since Q3 2014 that the earnings were better than in the previous quarter.  In the third quarter, earnings are expected to be flat with the year ago mark (so no decline) and this would be another quarter of improvement quarter over quarter.  As to Q4, forecasts remain strong.  This could represent “the turn” in corporate earnings – enlarging the E in P/E and lowering the ratio, providing fundamental support for stock prices, besides a benign interest rate environment.

So to wrap our forecast with a neat bow, we think that current investor sentiment might be about to change to a positive view. Retail investors still are sour and not trusting of the market. Professional investors seem to be noticing a change “in the wind” and the cause for this change is earnings, which look to be turning up.

PREDICTIONS FOR 2016

  • Economic growth will continue at a pace of around 2.5% – 3%     No – Growth has slowed
  • Inflation will remain quiescent     Yes – Nowhere to be seen
  • The dollar will stabilize, perhaps strengthen a bit more     Yes – Brexit has given a boost to the “Greenback”
  • During 2016, oil’s price will find a bottom not far away from now and will rally into 2017    Yes – Might be an OPEC production deal in November
  • Interest rates will rise – but the rate of increase will be slow     No – Not Yet
  • Political reform will grow in South America     Yes – Rousseff has been impeached & Venezuela could change government
  • It will be another “Banner Year” for mergers and acquisitions     Yes
  • Consumer spending will improve     Yes/No -On cars & houses, yes; on clothing, no
  • Émigrés will continue to be a “hot potato” politically around the world    Yes – Central point of Brexit disagreement and of political debate in U.S.
  • Amongst the popular investment alternatives, equities should do the best     No – Not yet, but still believe

A FEW FINAL THOUGHTS
q3photo4 q3photo5

The opinions expressed in this Commentary are those of Baldwin Investment Management, LLC.  These views are subject to change at any time based on market and other conditions, and no forecasts can be guaranteed.

The reported numbers enclosed are derived from sources believed to be reliable.  However, we cannot guarantee their accuracy.  Past performance does not guarantee future results.

We recommend that you compare our statement with the statement that you receive from your custodian.

A list of our Proxy voting procedures is available upon request.

A current copy of our ADV Part II & Privacy Policy is available upon request or at www.baldwinim.com/disclosure.htm

2nd Quarter 2016 Commentary

Negative Interest Rates Or We’ll Pay You to Borrow from Us!

Imagine being a home owner in Aalborg, Denmark and receiving an interest check from your mortgage holder paying to you, the mortgagee, for borrowing money to buy the house in which you live. We think you would be forgiven for a shocked reaction thinking you had “died and gone to heaven.” Or for wondering which “party drug” your banker might be using.  This is a true tale. This did happen. Welcome to the new world of negative interest rates.

q2photo1 q2photo2

On a much larger scale, the European Central Bank (ECB) is about to embark on a new targeted lending program to commercial banks throughout the Eurozone called TLTRO II. The objective of this scheme is to encourage banks to lend to companies and households. The banks will initially be charged zero (0%) for their borrowings from the ECB. If a bank enlarges its eligible loan book by 2.5% by the end of January 2018, the cost of the bank borrowings could fall to the deposit rate, now -0.4%. In other words, the European Central Bank will pay commercial banks to borrow money under TLTRO II (Targeted Long Term Refinancing Operation) in an attempt to spur business and ultimately to increase inflation. In fact, the ECB is not the only authority to experiment with negative interest rates – so also are the Swiss and the Japanese central banks. It is still “early days” with this experiment. One of the results for which the Swiss and the Japanese had hoped was a “cheaper” exchange rate. Unfortunately, in both cases, the exchange rate has appreciated rather than depreciated. Nevertheless, central bankers in all three economies (especially the Japanese and the Eurozone) are hoping that the primary objective of more business being conducted will be achieved. The “jury is still out” on that score. It would certainly seem to make sense that eligible borrowers would “be frothing at the mouth” at the prospect of cheap money or even better, being paid to borrow money to invest in a venture. Certainly there is a lot of liquidity in the marketplace. People simply have to be persuaded to “take the plunge”. In the US, there has been academic discussion about negative interest rates. Money in America is cheap – but no US bank to date is paying interest to borrowers. Chair Yellen has said that negative interest rates are certainly in the Fed’s “toolkit”. But at the moment, the Federal Reserve Governors are not yet ready to “pull that trigger”.

We are now going back to a chart we have used in the past which looks at the correlation between weekly stock returns and interest rate movements.

q2photo3

A low interest rate environment is usually good for equity performance, as bonds offer little competition for investment flows. Further, even as rates rise from a low base and not until interest rates rise to approximately 5%, equities have historically done well.

Further on some comments we made in our last quarterly commentary regarding tough transitions, the following charts examine employment and income by educational attainment.

q2photo4

Graphically, the reader will understand the frustration felt by those who perceive themselves as “left behind”. Those with less than a college degree suffer the highest unemployment and earn the least by a large margin. With these circumstances, it is not hard to appreciate the discontent. In an election year, this disquiet has manifested itself in millions being mesmerized by certain candidates’ populist rhetoric and vague slogans which promise much, but which are founded on ideological “drivel” with little intellectual substance. The sirens are singing – and their songs are being heard. So far the US and other markets have not paid much heed to the possibility that one of these sirens could become the next President of the United States. We would agree with the markets so far. But we will keep a close eye on the race because we think that should a “populist sounding” candidate win the grand prize, markets around the world would not react well.

As an example of not “reacting well”, the United Kingdom (UK) just voted to leave the European Union (EU) – to Brexit. Around the world markets have declined, except those considered “safe havens” like the US dollar, US Treasuries, the Japanese Yen, gold and the Swiss franc. In a rare show of unanimity, reputable economic experts of just about any “stripe or color” agreed that the economic impact of Brexit was virtually all negative. According to the London School of Economics and Oxford, “…the risks here are asymmetric to the downside”. So the decision to leave seems irrational. Nevertheless, it is what it is. But what does it mean for investors? First, Great Britain is just 4% of global GDP – so not big enough to derail the world economy. A recession in Britain is bad for England, but the world shouldn’t “get pneumonia”. Also the UK will probably not be leaving the EU for years and until then will operate as it has within the EU.New trade treaties must be negotiated, “red tape” must be removed and new relationships put in place. Markets, however, have reacted as if everything will be decided and enacted by next Monday – no chance. Conspiracy theorists have already started to “spin webs” about the next four countries to leave the EU and the EMU. We may get there, but we are not there yet. Already in anticipation of such musings, the leaders of the Eurozone are circling their wagons in defense of the Eurozone. No one should expect the EU to give up easily. In fact, there is postulation that the upcoming divorce negotiations with the Brits will be especially difficult in order to dissuade others from pursuing a similar path. There is uncertainty in the world. Markets hate uncertainty and always trade down on perceived elevated risk. But the risk associated with only the UK leaving the EU is not massive and we believe that given a bit of time to settle, risk assets like equities will move ahead again, supported by higher earnings.

Let’s end this commentary with a look at an important segment of industrial America – the chemical business, a pretty fundamental force in our economy and an important indicator of its health. The Chemical Activity Barometer has been published monthly since 1919 by the American Chemistry Council and is up 2.5% in the past year. This barometer suggests that industrial production will pick up in the near future. Over a long time, as can be seen by the chart below, this index has correlated with overall economic activity quite accurately – which should hearten those who are concerned about the state of the US economy.

q2photo5

Further, the next chart demonstrates nicely that the Chemical Activity Barometer leads growth in industrial production and by inference, the overall economy.

q2photo6

PREDICTIONS FOR 2016

1) U.S. economic growth will continue at a pace of around 2.5% – 3% Yes – Growth picked up in Q2 to 2.5%

2) U.S. inflation will remain quiescent Yes

3) The dollar will stabilize, perhaps strengthen a bit more Yes – Brexit has given a boost to the Greenback

4) During 2016, oil’s price will find a bottom not far away from now and will rally into 2017 Yes – Analysts are now raising price projections for 2016

5) Interest rates will rise – but the rate of increase will be slow No – Due to Brexit uncertainty, “safe haven” US
bonds have rallied & interest rates are down

6) Political reform will grow in South America Yes – Rousseff impeached

7) It will be another “Banner Year” for mergers and acquisitions Yes

8) Consumer spending will improve Yes/No -On cars & houses, yes; on clothing, no

9) Émigrés will continue to be a “hot potato” politically around the world Yes

10) Amongst the popular investment alternatives, equities should do the best No – Not yet, but still believe

A FEW FINAL THOUGHTS

q2photo7 q2photo8

The opinions expressed in this Commentary are those of Baldwin Investment Management, LLC.  These views are subject to change at any time based on market and other conditions, and no forecasts can be guaranteed.

The reported numbers enclosed are derived from sources believed to be reliable.  However, we cannot guarantee their accuracy.  Past performance does not guarantee future results.

We recommend that you compare our statement with the statement that you receive from your custodian.

A list of our Proxy voting procedures is available upon request.

A current copy of our ADV Part II & Privacy Policy is available upon request or at www.baldwinim.com/disclosure.htm

1st Quarter 2016 Commentary

TRANSITIONS CAN BE TOUGH……

The North American Free Trade Agreement (NAFTA) went into effect in 1994. Most economists would hail the agreement as a breakthrough, which has helped propel the world’s economy for the past two decades.  We agree.  Since NAFTA, other free trade agreements have been signed based on NAFTA’s “broad based success” of delivering goods and services more inexpensively than had been the case when trade barriers existed.  Optimization of capital and labor have been enhanced.  The economic “friction” of trade duties have been lowered or eliminated.  People who had desperately wanted work and who would work for pennies found work in new factories or providing services.  As a result, inflation, heretofore a perennial risk, was seemingly relegated to the past.  New middle classes in Mexico, China and India were created.  New consumers were created.  New capitalist economies were created.

But the transition from being an employed American worker to an unemployed American worker and then importantly back to an employed American worker has been a tough transition for quite a few.  It has been for too many like shifting from 1st gear to reverse and then to 1st – without using a clutch.  It has been grinding.  Economic prognosticators in the nineties presumed that a flexible American capitalist system would adjust in a relatively short period of time.  Displaced workers would be retrained for new jobs.  Transferable skills would be transferred.  There might be a “hiccup” in some workers’ lives – but it would not last long and the “retooled” American capitalist system would “roar” another time after a cleansing irrigation.  This was the theory and if the transition had taken five years, it probably would have been OK.  But we are now twenty years “down the road” and it is not OK for the displaced but not re-employed. Please do not misunderstand our position – economically the world is in a better spot and we are firm believers in free trade.  The world has prospered – but those who lost their jobs with no replacement opportunity have not.

So why are we “blathering on” about free trade agreements?  We think that an unexpected result of these agreements has been the uprising of Donald Trump and Bernie Sanders – two very odd bedfellows.  But they are “bedfellows” nonetheless due to their populist rhetoric and they are political forces with which to be reckoned.  The Donald and Bernie come at the unemployed American worker from almost diametrically opposed positions and arrive at the same philosophical point – get rid of the trade agreements.  The shrillness of their arguments is upsetting to markets, which have adapted to and embraced free trade.  While it would take the agreement of Congress to upend any free trade agreement already put into law, thus the chances of success extremely low, having a voluble President that was seeking to alter in place treaties would not be well received by markets – something of a minor worry right now.

Since we last wrote, the oil markets have had a “rollercoaster” of a ride.  New lows came in the early months of 2016 and the first quarter looks as though it will close with oil up some 40% off its lows.  A few seers are saying that “a bottom” has been put in.  We would agree and said as much in our year end writing, because demand for oil and oil products (think gasoline) has continued to be strong and supply is falling with the drilling rig count at a decade’s low level.

Gasoline demand in the US

Q1 IMAGE 1

                                                      Global Demand for the rest of the World

Q1 IMAGE 2

Much like oil, other markets around the world have unnerved quite a few investors with their volatility.  As we have written in the past, “walls of worry” need to be climbed for markets to progress.  It is only after complacency has been eliminated that money can be made. It is hard for investors to remain steadfast in the face of declining prices – but “riding out” a storm with good assets will usually “win the day”.  Below, the reader will note the performance of the S&P 500 in comparison to the VIX/10-yr ratio (a measure of risk).  When the ratio jumps (i.e. risk rises) the stock index falls and vice versa.  During 2016, we have seen risk rise and fall with the end of the quarter being back to levels at which we started the year – lots of action, but not much progress.

Q1 IMAGE 3

Valuation is always a “touchstone” in our work.  We have thought for some time that US equities were fairly valued in an absolute sense.  Current P/E ratios are a bit above the long term norm, but not as high as has been the case.  On a relative basis, when compared to the bond markets, stocks look cheap.  In the chart below, the risk premium equity investors demand to be paid versus a 10 year Treasury is near its highest point since 1962.  It suggests that stock market investors are wary – a bullish sign.

Q1 IMAGE 4

 

Three influences have been a “headwind” for equity markets for months now – the US dollar, interest rates and oil prices.  We have already said that we think oil prices have put in a bottom and thus energy company earnings should be a help and not a drag on market earnings going forward after Q1.  The Federal Reserve recently had a meeting and “steered bond market makers” to two interest rate hikes this year, not four and small ones as opposed to large ones.  Other central banks around the world are lowering rates, not raising them.  So international bonds might well go up in price, while US bonds might be “soggy” at best – certainly no theoretical competition to US stocks.  Finally, the dollar probably had most of its run last year as interest rates around the world should be relatively stable throughout 2016.  So if the “headwinds” dissipate, perhaps stock markets will rally.  We still think this will be the case.

P.S – . Political mudslinging is not attractive, but neither is it new. American politics right from the start has been mired in the less than politic.  Some of our Founding Fathers (Adams, Jefferson and Monroe) were some of the worst with regard to name calling and scare mongering.  In a newly secular nation, Adams called upon Christians to reject Jefferson as an atheist.  Jefferson in return used a surrogate (who was later tried and convicted of sedition) to defame Adams.  Andrew Jackson’s wife, Rachel, was attacked as a bigamist because she and Andrew married unwittingly before her divorce from her first husband was complete.  So the “fireworks” of the current political season might seem crude, off topic, immature and nonsensical.  But they are not original.

PREDICTIONS FOR 2016 

  • Economic growth will continue at a pace of around 2.5% – 3%.     No – Q1 could be <1%, but we still believe
  • Inflation will remain quiescent.     Yes
  • The dollar will stabilize, perhaps strengthen a bit more.     Yes – Dollar is not on a “march”
  • During 2016, oil’s price will find a bottom not far away from now and will rally into 2017.     Yes
  • Interest rates will rise – but the rate of increase will be slow.     Yes – Still believe
  • Political reform will grow in South America.     Yes – Big changes are “in the wind” (think Brazil)
  • It will be another “Banner Year” for mergers and acquisitions.     Yes
  • Consumer spending will improve.     No – Has not yet happened
  • Émigrés will continue to be a “hot potato” politically around the world.    Yes
  • Amongst the popular investment alternatives, equities should do the best.    No – Not yet, but still believe

A FEW FINAL THOUGHTS

Q1 IMAGE 5     Q1 IMAGE 6

Q1 IMAGE 7

The opinions expressed in this Commentary are those of Baldwin Investment Management, LLC.  These views are subject to change at any time based on market and other conditions, and no forecasts can be guaranteed.

The reported numbers enclosed are derived from sources believed to be reliable.  However, we cannot guarantee their accuracy.  Past performance does not guarantee future results.

We recommend that you compare our statement with the statement that you receive from your custodian.

A list of our Proxy voting procedures is available upon request.

A current copy of our ADV Part II & Privacy Policy is available upon request or at www.baldwinim.com/disclosure.htm