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Investment Letter

3rd Quarter 2015


Uncertainty and speculation by investors during the 3rdQuarter finally forced U.S. Large Company stocks into correction territory (drop of 10% or more from a recent high) after avoiding it for over four years.  While equities experienced many smaller corrections during the current six-year bull market run, investors were surprised in late August when the Dow Jones Industrial Average (DJIA) fell over 1,800 points and the S&P 500 Index declined over 230 points in a stretch of six consecutive trading days.  The stock market rebounded briefly, but volatility continued to impact equities during the last 25 trading days of the quarter.  The DJIA and S&P 500 Index experienced six days of point changes in excess of positive 1% and six days in excess of negative 1%.  The roller coaster ride came to a halt on September 30, 2015 as the DJIA closed at 16,284.70.  The index declined a total of 1,334.81 points from the previous quarterwith a -6.98% 3rdQuarter total return and a 2015 year-to-date total return of -6.95%.  The S&P 500 Index finished the latest three-month period at 1,920.03 or down 143.08 points from the previous quarter.  The -6.44% 3rd Quarter total return was the worst quarterly performance for the S&P 500 Index since 2011 and ended the streak of 10 consecutive quarters with a positive return.  Performance for the first half of 2015 was already flat, but the recent results pushed the year-to-date total return negative for the S&P 500 Index at -5.29%.  As the calendar closes on 2015, returns have been disappointing for most asset classes.  Investors will need a strong close to the year if domestic and international equities are to finish in positive territory.


The table below recaps the 3rd quarter and year-to-date performance of other major indices:


Asset Class


3rdQtr. 2015 Total Return

2015 Total Return


ML Three-Month U.S. Treasury



U.S. Bonds

Barclays Intermediate-Term Treasury



U.S. Large Co. Stocks

S&P 500



U.S. Small Co. Stocks

Russell 2000



International Stocks

MSCI EAFE (net div.)



Real Estate

DJ Select Real Estate Securities



                                Source: Morningstar


The recent declines in equities may have spooked investors, but the economic data does not support a significant drop in confidence.  The latest Gross Domestic Product (GDP) report released by the Bureau of Economic Analysis stated that second quarter 2015 Real GDP increased at an annual rate of 3.9%.  The increase from the previous quarter was mainly attributed to a rise in consumer spending, higher vehicle sales, increased exports of goods (industrial supplies and materials), higher business investment, increased spending by state and local governments, and higher residential investment.[1]

Overall, the economy is on solid ground:

·         Oil prices are stabilizing and inflation is minimal. 

·         Consumer spending (the largest component of GDP) is moving upward.

·         Consumer balance sheets are strong due to rising home and financial asset prices.

·         Household net worth is high and debt accumulation is low. 

·         Inventory levels, home affordability, and low rates are boosting housing sector activity.


Despite the favorable environment, there are some soft spots in the economy.  Manufacturing and corporate profits are being dragged down by the strong dollar and the poor performance of the energy sector.  Job growth was projected at 203,000 in September, but the recent jobs report showed that the unemployment rate remained unchanged at 5.1% and nonfarm payroll employment only increased by 142,000.  The prior two months were also revised lower by 59,000 jobs indicating that the weakness was not a one-time aberration.  In addition, wage growth remained low and labor force growth was slowing.

In the latest edition of the Beige Book, the Federal Open Market Committee (FOMC) report pointed to a continuation of modest expansion in economic activity during the period from mid-August through early October.  They confirmed that consumer spending grew moderately; manufacturing activity was mixed but generally weaker; housing and commercial real estate markets improved; banking and finance conditions were generally positive; agricultural conditions were mixed and labor markets tightened.[2] It was anticipated that the FOMC would initialize their policy normalization strategy (raise interest rates) during the September meeting.  However, the committee decided to postpone the start until they had additional time to collect and analyze updated economic data.  They felt the recent global economic and financial developments could restrain economic activity and put further downward pressure on short-term inflation.  With only two meetings left this year (October and December), the chances of an interest rate hike in 2015 will depend on further improvement in the labor market and medium-term inflation moving towards their two percent objective.

The global economy has been focused on China’s woes.  After years of outstanding growth, the annual growth rate has slowed, and Chinese officials want to stimulate their economy to help sustain higher growth rates.  They recently devalued the yuan in an effort to boost exports, lent money to Chinese brokerage firms so those firms could buy stocks to help support stock prices, announced a large stimulus plan, increased government spending, and China’s central bank recently cut rates to help foster growth.  Unfortunately, Chinese officials are not as transparent with their economic data, and these significant steps are raising questions by economists whether China’s real economic growth is a solid annual rate of seven percent or perhaps much lower.  While China’s problems are unsettling to the global economy, developed economies are partially insulated from Chinese growth issues because exports to China (as a percentage of GDP) are a small fraction of total goods exported from the U.S., Eurozone, U.K., Canada, Germany, and Japan.  Emerging market economies and large commodity exporting countries that depend on China for their prosperity are more likely to feel the impact of slower growth. 

Our economic outlook for the remainder of 2015 remains positive.  We think the modest pace of growth in the U.S. will continue to be supported by strong consumer spending and improvements in the housing sector.  Inflation should remain subdued and lower energy prices will be a welcome change for consumers as colder weather approaches.  We expect the dollar to maintain its strength relative to other foreign currencies which makes U.S. goods more expensive to foreign buyers and will further widen the trade deficit.  We still anticipate a small rate increase by the FOMC this year.  The December meeting is our best guess as far as timing, but the Fed surprised us in September by not raising rates.  They could easily push back their timetable to early 2016 if they feel the data does not support a rate increase. 

The prospects for international economies are not as bright.  China’s slower growth will dominate the global economic news cycle for the short-term as they search for the right combination of economic stimulants.  We expect a mixed bag of prosperity from emerging markets.  Countries more dependent on China will probably struggle until that region can stabilize their economic situation, and falling oil and commodity prices should continue to benefit commodity importing countries.  Overall conditions in the Eurozone are sluggish.  Growth, inflation, and investment are at low levels and additional monetary accommodations by the European Union will be needed to help spur growth. While we expect conditions to improve in Japan, their struggle to sustain economic growth could also require another round of government stimulus this year.

The recent decline in stocks was a shock to most investors, and it brought back memories of the drastic declines we witnessed in 2008-2009.  However, a stock market correction is not always a bad event.  History illustrates that it is a natural part of the investing cycle, and that stocks often experience significant corrections during long runs of positive stock returns.  While it is impossible to predict the timing of a stock market correction, long-term investors should remain focused on their overall retirement goals and consider a stock market correction as an opportunity to buy high quality stocks at attractive prices.

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,



[1]Source: Bureau of Economic Analysis, Gross Domestic Product: Second Quarter 2015 (Third Estimate).  http://bea.gov/newsreleases/national/gdp/gdphighlights.pdf

[2]Source: Federal Reserve System. Monetary Policy Beige Book Report. 14 October 2015. http://www.federalreserve.gov/monetarypolicy/beigebook/beigebook201510.htm

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