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Investment Letter

2nd Quarter 2015

The sizzling temperatures of summer are here and it’s time to soak up the sun, enjoy summer vacations, visit family and friends, and recharge for the 2015 home stretch.

Investors were hoping the financial markets would heat up during the second quarter, but the lackluster performance in most areas disappointed.  The Dow Jones Industrial Average (DJIA) made some noise by closing at a new all-time high of 18,312.39 on 5/19/2015, but quickly withdrew from the peak to close out the quarter at 17,619.51.  The S&P 500 Index also hit a milestone in the month of May by closing at an all-time high of 2,130.82, but like the DJIA, fell during the last several weeks of the quarter to close at 2,063.11.  Year-to-date, both indices have done little to inspire investor enthusiasm.  The S&P 500 Index had a 2015 year-to-date total return of 1.23% while the DJIA returned a paltry 0.03%.  The real estate asset class was the big loser during the quarter.  The double-digit decline over the last three months pushed the index into a negative year-to-date total return of 5.75%.  Unless we see a turnaround in performance, it appears that 2015 might be the end to an outstanding six-year positive run for this asset class.


The table below recaps the 2nd Quarter and year-to-date performance of other major indices:

Asset Class

Index

2ndQtr. 2015 Total Return

2015 Total Return

Cash

ML Three-Month U.S. Treasury

0.01%

0.01%

U.S. Bonds

Barclays Intermediate-Term Treasury

-0.47%

0.81%

U.S. Large Co. Stocks

S&P 500

0.28%

1.23%

U.S. Small Co. Stocks

Russell 2000

0.42%

4.75%

International Stocks

MSCI EAFE (net div.)

0.62%

5.52%

Real Estate

DJ Select Real Estate Securities

-10.00%

-5.75%

                                   Source: Morningstar

The financial market performance during the quarter was disappointing to investors.  However, economic conditions in the U.S. are still in good shape.  According to the U.S. Department of Commerce, the first quarter revised estimate for Gross Domestic Product (GDP) decreased at an annual rate of 0.2%.  Despite the negative growth reading, the estimate was an upward revision and an indication that the slowdown in the economy was not as severe as previously estimated.  The harsh winter in the Northeast and the port strike on the West Coast were two of the major reasons for the sluggish economic reading, but economists believe the statistical formula that helps smooth out seasonal fluctuations could also be overstating the fall in GDP.  Second quarter growth estimates will be released at the end of July, and it appears that the decline from the first quarter will be followed by a positive jump in growth albeit a subdued rebound.  

Elsewhere in the economy, the labor market continued to show strength. Nonfarm payroll employment increased by 223,000 in June and the unemployment rate fell to 5.3%. Consumer confidence rose for the second straight month.  Business and employment circumstances improved and have consumers more optimistic about the future.  Optimistic consumers have a greater willingness to freely spend their hard earned cash thus increasing consumer spending and helping to accelerate economic growth.  The housing sector showed areas of significant improvement.  Starts were up 9.8% and building permits were up 7.4% over the previous month.  The bump in activity is an encouraging sign that builders and lenders are becoming more confident in the housing market.  Manufacturing improved during the quarter, but a strong U.S. dollar and weak global demand are keeping activity restrained.  Inflation remained low, but consumer prices have increased slightly over the past couple of months.  It appears that oil prices have stabilized.  After bottoming out on March 17, 2015 at $43.39/barrel, crude oil prices for West Texas Intermediate (WTI) finished the quarter up to $59.48/barrel.[1]  Oil prices are now in a range that is forecasted to be sustainable for the rest of 2015 and into 2016.[2] Based on the data above, the U.S. economy remained supportive and resilient. 

The situation in the global economy is not as optimistic.  Eurozone economies are struggling to maintain economic strength and further policy movements may be needed to accelerate the European recovery.  The massive quantitative easing program and structural reform in Japan is ongoing.  China is still adapting to slower economic growth.  Chinese officials insist that the outlook for future growth is promising, but the recent stock market mayhem in China might destabilize economic stimulus efforts.  Emerging market economies remain a mixed bag.  The heavy manufacturing exporting countries are enjoying more success while the heavy commodity exporting countries continue to disappoint.  For most of the year, the global economic landscape was dominated by news of the Greek debacle and default…part two.  In 2010, the Greek debt crisis reached a critical point and Eurozone officials intervened.  The preceding bailout by the European Central Bank, European Commission, and International Monetary fund was an attempt to avoid a wave of debt defaults and financial chaos across Europe by helping Greece stabilize their finances and get their economic house in order.  The financial aid came with some heavy reform (austerity) conditions that were wildly unpopular with Greek citizens.  Furthermore, high unemployment and the collapse of economic growth gave rise to anti-austerity activists and a political escalation of the crisis.  Despite some economic improvement, the bailout did little to solve Greece’s financial woes.  Foreign investors and international banks executed their own exit strategy and sold Greek bonds and other holdings to remove their vulnerability to this failing economy.   Even some Eurozone countries previously at risk to a Greek collapse took proactive measures to improve their fiscal health and avoid the spread of financial contagion.  The recent election of a far-left political party aimed at reversing many of the austerity controls started the ball rolling towards another round of Greek defaults.  Currently, officials are trying to hammer out a deal for the latest fiasco, but eventually a Greek departure from the Eurozone (Grexit) might be the only way to regain their financial autonomy.  Regardless of the outcome, the impact to the global economy should be minimal due to the small influence of the Greek economy.

Data from the Federal Open Market Committee (FOMC) meeting in June confirmed that domestic economic growth was increasing moderately after the first quarter slowdown.  Despite less than impressive GDP numbers, the Fed believes that the financial stability in the economy still makes it appropriate to raise the federal funds target rate at some point this year.  Of course, the big question is the timing of first rate hike since June of 2006.  The Fed has made it very clear that an increase in the federal funds rate will depend on further improvement in the labor market and medium-term inflation moving towards their 2 percent objective.  Based on this, the FOMC decided to keep the federal funds rate at the current target range of zero to 0.25 percent.  With only four meetings left this year (July, September, October, and December), the Fed’s highly anticipated rate hike decision is imminent. 

Our economic outlook for the remainder of 2015 remains positive.  We think the recovery will continue at a modest pace, but investors should not assume the market will deliver returns like we have seen the last several years.  We believe the fall in oil prices will continue to benefit consumers and eventually work its way back into the economy through discretionary spending.  We expect the dollar to maintain its strength relative to other foreign currencies, and we anticipate some improvement in international economies due to the decline in oil prices, weaker currencies, and more accommodative monetary policies.  We are confident the FOMC will raise rates later this year.  We anticipate a September or October start for a series of rate increases, but would not be shocked in the decision to start the rate increase as early as the end of July based on economic conditions.  As we indicated last quarter, the effect of a rate hike on investors should be minimal at first.  However, as the federal funds rate moves higher, the cost of financing debt and purchasing goods (homes and cars) will increase, but liquid assets (certificates of deposits, money market funds, savings and checking accounts) will benefit after earning next to nothing for several years. 

As I have often stated, our investment philosophy remains based on the fundamentals.  We believe that it is time---not timing---that matters most.  That is why we believe the successful long-term investor is patient, weathers market swings, and adheres to a disciplined investment process that includes a diversified asset allocation strategy based upon a tolerance for risk and need for return.  In other words: Don’t use your emotions to make investment decisions; separate your money from your moods.

In closing, I want to thank you for the opportunity of working with you and for your continued confidence and trust.  Please contact me if you have any questions. 

With kindest personal regards, I am

Very truly yours,

WILLIAM HOWARD & CO. FINANCIAL ADVISORS, INC.

 



[1]Source: Federal Reserve Bank of St. Louis – Federal Reserve Economic Data. Crude Oil Prices: West Texas Intermediate (WTI). https://research.stlouisfed.org/fred2/series/DCOILWTICO#

[2]Source: U.S. Energy Information Administration. Short-Term Energy Outlook. July 2015. http://www.eia.gov/forecasts/steo/report/prices.cfm


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