Tuesday, March 11, 2014

You Can't Sell Cars Covered in Snow

From the Desk of Joe Rollins

I recently read an article which contained an interview with the CEO of AutoNation and found it to be very informative. There seems to be an enormous amount of hand-wringing and confusion caused by the financial media’s reports that the economy seemed to pause during the months of January and February. This did not seem all that unusual to me since the United States was experiencing some of the worst weather of all time.

It is unbelievable how cold it has been in the U.S.- grinding many industries to a halt and forcing them to lay off workers, thus cutting productivity. Virtually all industries that were required to work outside suffered through low productivity over the last two months. It is quite naïve to view this as a trend or a significant change in the economy.

I will get back to that thought shortly as I would like to report on February - another excellent investment month experienced by many. It is amazing how many people continue to avoid investing under the unfounded belief that the markets cannot continue to rise. As I have pointed out on many occasions, the rise of the market is based on a combination of good earnings and low interest rates. Nothing we have seen so far in 2014 will change that formula for success. During February the Standard & Poor’s Index of 500 stocks had an excellent month as it was up a sterling 4.6%. The NASDAQ Composite was even better with a 5.1% increase. The Dow Jones Industrial once again was excellent at 4.2%. The year-to-date returns are the S&P at 1%, NASDAQ Composite at 3.4%, with only the Dow Jones at negative 1.2% for the months of January and February combined.

Another perplexing but rewarding trend is that the Barclay's Aggregate Bond Index is up 2.1% for the first two months of 2014. That is particularly encouraging given the fact that this return is almost double that of the S&P 500. Although promising, I still forecast that bonds will have only a marginally profitable return for all of 2014. As you know, often times when the economy is weak the Federal Reserve will cut interest rates, positively impacting the value of bonds. However this is implausible since the Federal Reserve cannot cut interest rates below zero (the Federal Reserve has had rates at or near zero since 2008).

It is a misplaced hope that the Federal Reserve will stimulate the economy through lower interest rates when in fact they are moving towards a neutral approach on the economy by tapering their bond purchases. It is just a matter of time until interest rates begin to rise again. Since bonds move inversely with interest rates, the return on bonds is more likely to fall than rise as we approach the summer, forcing them into negative territory.

Recently we were notified by the government that the gross domestic product (GDP) for the final quarter of 2013 was revised down to 2.4% from its previously reported 3.2%. That is even more drastic than it appears, given that the third quarter of 2013 had a positive return of 4.1%. It would appear on the surface that there was a significant reduction in GDP as the year wrapped up in 2013. By implication, many forecasters were assuming that the first quarter GDP would also be equally timid, and are therefore predicting the worst for the economy in 2014; thus my comments above regarding the weather.

There is currently nothing I see in the economy that surprises me or should surprise you either. As has been the case since 2008, the economy continues to move along at a very low level. While certainly the economy is likely to pick up as the weather improves going into the summer months, I think it would be unrealistic to assume that you would see a liftoff in the GDP. Although I continue to believe that the economy for 2014 could have a GDP growth of 3%, anything higher than that would be somewhat unrealistic.

How all of this affects the stock market is of major importance to investors like us. Based upon a mild GDP growth environment, we fully anticipate that earnings will continue to be good in 2014 as U.S. corporations have already adjusted their workforces and industries to accommodate for this slow growth. I also find it highly unlikely that you will see a drastic increase in employment either since a smart businessperson would never add employees until an increase in demand is seen.

I do not anticipate that the Federal Reserve will increase interest rates at all in 2014 since they are reducing their bond purchasing program. Based on the current trend, by the end of 2014 the Federal Reserve will not be buying any excess bonds and therefore will not be increasing interest rates. I see this as a positive sign; if the Federal Reserve is reducing the stimulus to the economy they must believe that the economy is getting better.

As we go into the transitional weather month of March, I am encouraged by the outlook for investing in 2014. It looks like corporate earnings will be higher again this year, interest rates will be low, and the economy may in fact pick up marginally from 2013. All of this leads me to believe that my forecast for a 13% total return in the federal markets for 2014 to be founded in good economics and without speculation or hyperbole. In everyday language, I think that number is “right on”.

On a totally unrelated subject, my son Joshua and I attended the National Championship game in Pasadena, California on January 6, 2014. It was a pretty exciting game between the Auburn Tigers and the Florida State Seminoles. While the game itself was very entertaining, it was not the primary reason for the trip – it was the rare opportunity to spend four uninterrupted days with my son. As a freshman in college, I do not see him very often so this trip was very meaningful to me. We also went on a private tour of Beverly Hills and the Hollywood Hills and even pulled into Leonardo DiCaprio’s driveway (and were promptly chased away by security guards). Needless to say, it was quite an enjoyable trip and I look forward to the chance to do it again - but I am guessing it will be awhile as I have barely seen him since…

As always, the foregoing includes my opinions, assumptions and forecasts. It is perfectly possible that I am wrong.

Warm regards,

Joe Rollins