Cyber security has become a giant topic over the last couple of years. With all the different companies talking about breaches of client information, we often forget about all the individuals that could potentially have their own cyber breach. With the tax season well on its way, we at Gamble Jones wanted to arm you with some easy do-it-yourself procedures that can help protect you from a cyber-crime.Read more
During the past week, we have seen some wild swings in the market. A number of factors have likely contributed to this spike in volatility, including:
1. We are long overdue for a market correction.
2. Investors are concerned that an increase in inflation could lead the Federal Reserve to raise interest rates faster than expected.
3. Electronic trading by ETFs and institutions flooded the market and heightened the volatility.
Given the unusually low volatility in the market over the past couple of years, a sharp pullback can be a little unnerving to investors. However, rest assured that corrections such as this one are a natural part of the long-term investment cycle. We believe that our long-term investment strategies are sound and that you should continue to stay the course.
Alison J. Gamble, President
Gamble Jones Investment Counsel
Our past three quarterly letters have discussed the reasons why the stock market continues to do well. As we enter 2018, none of these reasons have changed in any meaningful way. Corporate earnings growth continues to be strong and will receive an additional boost in 2018 from the recent reduction in corporate tax rates. Earnings should also continue to benefit from a steadily improving economy. In addition, while the Fed has slowly begun the process of normalizing monetary policy through gradual interest rate hikes and a reduction in its balance sheet, the low interest-rate environment that has supported stocks in recent years is likely to continue for some time to come. Still, with the stock market at record highs and many stocks trading well above their historical averages on a price-to-earnings basis, we will remain disciplined and selective as we continue to ferret out investment opportunities.
If you would like to review our past quarterly letters, please visit our website at www.gamblejones.com and select the News tab.
Over the past couple of years, Gamble Jones has been working to increase the offerings provided to our clients. One of these new offerings is our client portal. The portal allows us to communicate more securely and efficiently with our clients, and vice versa. Clients can view their portfolios, check capital gains/losses for the year, and run various other reports that can be exported for personal use. Clients can also securely send us confidential information, such as copies of legal documents, via the portal. We plan on adding additional functionality to the portal over time. Please give us a call if you have not already set up your portal. It is a simple process, and our client service team is here to help along the way.
Through the addition of new technology, we can also now provide clients with an in-depth financial plan. A financial plan is a great tool to help identify whether you are on track to meet your financial goals, such as being financially prepared for retirement. The plan sets up a financial road map for you that can be adjusted as life changes come along. It also helps us to provide you with wealth management advice for your total financial well-being. When a financial plan is completed, you will receive a probability of success for meeting your goals based upon the current value of your assets. You will also have access to the financial plan through the portal and will be able to make necessary adjustments to the plan as your circumstances change. If you feel you would benefit from a financial plan, please contact your relationship manager.
Gamble Jones has served as a fiduciary for our clients since Mr. Gamble founded the firm in 1956. We feel it is important that our clients know what being a true fiduciary means. In the financial industry, a fiduciary is one who has a legal obligation to act for another’s benefit before oneself. As a Registered Investment Adviser (RIA) regulated by the SEC, we stand in a special relationship of trust and confidence with our clients. While many firms that are not subject to this fiduciary duty have an inherent conflict of interest based on their compensation structure, the investment recommendations we offer must always be made in the best interests of our clients. This is an important distinction and an obligation we will always take very seriously.
On a personal note, Tom Bent has retired from Gamble Jones, effective December 31, 2017, after 33 years of service to the firm. Tom served as our president from 2007 – 2010 and was our Chairman of the Board for the six years after that. We are most grateful for his loyalty and contributions during his career.
All of us at Gamble Jones wish you and your family a happy, healthy, and prosperous new year.
Gamble Jones Investment Counsel
The Golden Century is the name of the period in Dutch history between 1600 and 1700 when the port city of Amsterdam was one of the richest of all cities in Western Europe due to its strong role in international trade. Many commodities crossed Amsterdam’s ports, including tulips. Tulips were first introduced to Europe from Turkey, and shortly thereafter, in 1554, these seeds were sent to Amsterdam, where their popularity began to rise. A rudimentary derivatives market in the early 1600s eventually arose so that traders could conduct trade in tulips year-round. Traders entered into tulip contracts by signing contracts for future tulip purchases. The very active tulip contract market eventually became an integral part of the overall booming Dutch tulip industry. Tulip bulb speculation even spread to exchanges in Paris and England. As the popularity grew, investors bid up the price of tulips to an extraordinary level. At the peak of what is known as “Tulip Mania,” some single bulbs sold for more than 10 times the annual income of a skilled crafts worker. In the winter of 1636-1637, the rapid ascent of tulip bulb prices ended abruptly as a default on a tulip bulb contract caused a violent market implosion as sellers overwhelmed the market and buyers virtually disappeared altogether. Within a few days, tulip bulbs were worth only a hundredth of their former price. Tulip Mania is generally considered to be the first recorded financial bubble.
At this point, you may be wondering what this story has to do with current financial markets. In our opinion, there does not appear to be excessive optimism, which generally coincides with most financial bubbles. However, we do feel irrational behavior is starting to appear in certain areas. One of these areas that has seen widespread news coverage and popularity is the crypto currencies, which act as a digital asset and digital medium of exchange. Bitcoin, the most popular crypto currency, utilizes disruptive block chain technology and seems to have relevance in an era of constant central bank stimulus, which makes its rise in price and popularity hard to question. However, upon further inspection, investor optimism may be misguided. Recently, the Wall Street Journal published an editorial about Bitcoin which contained some sobering data. Thomson Reuters GFMS estimates there were 2,155 metric tons of gold held in exchange-traded funds. If all of that were switched into Bitcoin, it would justify a price of about $5,500 for the 17 million Bitcoins currently outstanding. This is only about $500 from the $5,000 high Bitcoin reached in early September. Investor optimism is so high that the commonly traded “Bitcoin Investment Trust” recently traded at a level of 2 times the underlying net asset value of actual Bitcoin held in the trust! This would be the equivalent of paying $2 for a $1 bill.
The Federal Reserve and global central banks have worked in overdrive the past 9 years trying to mend the global economy after the Great Recession with measures such as quantitative easing, zero interest rate policy, and even negative interest rate policy in some parts of the world. While growth has been steady, it remains tepid, and inflation has been below target. Despite unprecedented monetary stimulus, developed markets have remained subject to deflationary pressures brought on by an aging population, lower productivity growth, high debt levels, and stagnant wage growth. We believe this prolonged period of monetary stimulus and zero interest rate policy has led to some complacency amongst investors. Risk does not appear to be appropriately priced in many areas of the market. Earlier this quarter European high-yield corporate bonds, which are below investment-grade bonds, traded at a lower yield than similar maturity U.S. Treasuries, which are backed by the full faith of the U.S. government. This does not make any sense to us at all and is likely a byproduct of the European Central Bank’s bond buying, which has distorted asset prices. Similarly, allocations to equities continue to increase as investors search for higher returns in a low yield environment. The opportunity set in U.S. equities is becoming less attractive with measures such as price to sales, market cap to GDP, and many others showing U.S. stocks being priced at some of the highest valuation levels in history. The Federal Reserve has embarked on its quest to normalize monetary policy by continuing to raise the federal funds rate and beginning its balance sheet reduction. We expect both of these measures to occur at a slow pace. However, as this normalization occurs, it is very possible that volatility in financial markets will increase from the historic lows we see today.
Throughout our 60+ year history, we have taken pride in navigating financial markets and working with our clients to help them achieve their goals and objectives. Our commitment to our investment philosophy and approach is as strong today as ever. We continue to favor high-quality companies with strong balance sheets, durable cash flow streams, and strong competitive advantages. In our opinion, investors are not being compensated appropriately to go out on the risk spectrum. Our valuation discipline helps guide us when determining what price we should pay for these high–quality businesses. We feel it is important to convey that today’s opportunity set and low interest rate environment likely warrants lower future investment return expectations. This could include periods of higher cash balances as we patiently wait for investment opportunities to present themselves and seek to protect capital. Helping our clients determine the correct asset allocation and staying disciplined when it is tempting to chase markets higher will likely lead to better long-term outcomes. Thank you for your continued trust and confidence in our firm.
Gamble Jones Investment Counsel
It seems about the only thing that has remained calm amid all the recent turmoil here and abroad is the stock market. Bolstered by an improvement in corporate earnings growth, the market has continued its steady climb higher despite facing issues that could have easily wobbled a less resilient market.
It is safe to say that the stock market is no longer being driven by the so-called Trump rally. The rise in stocks in the first few months after the election was in large part due to investors’ hopes that the new administration would be able to quickly push through business-friendly policies such as corporate tax reform and infrastructure spending. However, with so much political controversy and gridlock continuing to bog down our nation’s capital, it is unlikely that any such measures will be enacted in the near future. Still, the market has proven to be strong enough to shake this off and continue its march forward.
The market has also so far been able to successfully absorb the Federal Reserve’s recent interest rate hikes. After boosting rates only once in the prior ten years, the Fed has raised rates three times since December. Historically, a series of rate increases has tended to serve as a headwind for stocks. Hence the old investment adage, “Don’t fight the Fed.” And, in fact, the market did not react well in recent years to even the slightest hint that the Fed might be moving closer to raising rates as investors deemed the economy was not healthy enough to withstand that process. However, with increased investor confidence that the global economy is on more stable footing and that the Fed’s path toward a normalization of monetary policy is likely to be very gradual, the market has so far handled the rate hikes without a hitch.
The pickup in corporate earnings growth has been the biggest contributor to the market’s rise in recent months. The market is far better equipped to deal with obstacles such as interest rate hikes and political dysfunction when companies are churning out strong profits. Following an earnings recession that included five consecutive quarters of profit declines, S&P 500 earnings have rebounded nicely with three straight quarters of growth. In fact, the 14% rise in overall earnings in the first quarter marked the fastest pace of growth since 2011. And while that pace will likely slow a bit as the year goes on, earnings growth for the year is still expected to come in at a very solid 10%. It is no coincidence that the earnings recovery has occurred as the global economy has started to improve. While the U.S. economy continues to grow at a steady but uninspiring pace, global growth this year is expected to accelerate to its highest level in seven years. With about 45% of the sales of S&P 500 companies coming from overseas, this has provided a significant boost to overall corporate profits.
We think the most significant issue the market is facing is a valuation that is pretty rich. The forward price-to-earnings ratio of the S&P 500 has steadily risen throughout the eight-year bull market to around 18 today, above its historical average of 15. While this is not exorbitant, particularly in the context of an equity-friendly low interest rate environment, it is a level that we believe prices in a lot of optimistic expectations. Should earnings growth decelerate or Fed rate hikes come at a faster pace than expected, it could result in a long overdue correction. As a result, we have become a bit more cautious on the market as a whole in recent months.
While we view the overall market as fully valued, our focus continues to be on investing in high-quality individual stocks that are trading at a discount to what we deem their intrinsic value to be. To be sure, as the market has risen, the number of attractive long-term investment opportunities has dwindled, and we have become even more selective with our purchases. Should a pullback occur, we stand prepared to more aggressively add new positions. In the meantime, there are always opportunities to be found, and we will continue to work hard to identify them for you.
Gamble Jones Investment Counsel
As we head into the second quarter of 2017, about the only thing we know for certain is that we indeed live in interesting times. A complete political outsider has taken the reigns of the world’s most powerful and influential country, and while many fear President Trump’s lack of political experience and apparent disregard for “how things have always been done,” others are excited about the exact same qualities. Thus far, it appears that the market is comfortable with a Trump presidency and his early agenda as the S&P 500 is up more than 10% (not including dividends) since the market opened on November 9th.
While a lot has changed over the past few months, the fundamentals of investing remain the same. They are timeless and often tedious. It is our belief that in the long run, earnings drive stock prices. As investors, we are really investing in a stream of future earnings discounted to today’s value. So it doesn’t matter what the New York Times, Fox News, or “All Things Considered” tell us to think. What truly matters are the earnings of the companies we follow and purchase on behalf of our clients.
So what about the earnings? S&P 500 earnings declined for five consecutive quarters beginning with the 2nd quarter of 2015. This “earnings recession” had some experts and economists worried that the United States economy would also experience a recession. However, corporate earnings growth has since found its footing, led by a rebound in the energy sector. Earnings as a whole resumed growth in the 3rd quarter of 2016, are estimated to have risen a strong 8% in the fourth quarter, and are expected to grow at a near 10% clip in 2017.
While a number of factors have contributed to the “Trump Rally” over the past few months, an expectation that earnings growth is poised to pick up has likely been the main driver. Like it or not, it is clear that the new administration will attempt to follow through on virtually all of its campaign promises, including many that are business-friendly. Thus, whether the current market rally continues will have much to do with whether the administration is able to effect meaningful change in areas such as corporate tax reform, business deregulation, and infrastructure spending, all of which would serve to boost corporate earnings.
Federal Reserve policy has also had an impact on the market in recent months. Historically, rising interest rates have been viewed as being negative for stock prices. This is in large part because higher rates reduce the present value of a company’s future earnings stream. With that in mind, we at Gamble Jones, along with many other market participants, are following Fed policy with a keen interest. On March 15th, Federal Reserve Chair Janet Yellen announced the decision to raise the federal funds rate to 1.0%. The increase was greatly anticipated, and the initial market reaction was positive as fears the Fed would begin to aggressively raise rates dissipated upon Ms. Yellen’s comments that the Fed would “continue to be accommodative for some time to come.” Though the Fed is expected to follow up with two additional hikes this year and will likely continue to raise rates gradually after that, interest rates are still poised to stay well below historical averages for the foreseeable future.
At any given time, there are a whole host of events ranging from geopolitical issues to natural disasters that can spook investors and impact stock prices in the short term. The upcoming elections in France and Germany as well as political drama in any number of forms right here in our own backyard have the potential to add to market volatility in the near future. However, our focus will remain centered on projecting the long-term earnings potential of the companies that we follow and determining the price that we are willing to pay for them. It is our opinion that the market as a whole is currently fully valued. However, we still see pockets of value and will continue to take advantage of such long-term opportunities.
Gamble Jones Investment Counsel
Instead of experiencing “the calm before the storm” this year, the markets experienced “the storm before the calm.” Right out of the gate, the U.S. stock market dropped nearly 9% in the first few trading days of the year. It then continued its downward move until February 11, when it bottomed out. On this day oil prices hit $26.05 – their lowest in 13 years, junk bond yields skyrocketed as fearful investors sold their securities, and U.S. government bond yields hit 1.66% as investors piled into these “safe-haven” assets. Things then calmed down a bit until the end of June when an unexpected approval of Britain’s exit from the EU went through. Following this “Brexit” vote, U.S. government bond yields again plummeted, with the 10-year Treasury rate eventually hitting 1.36% in early July, the lowest level ever recorded. The U.S. stock market dropped significantly as well, and the British pound fell to its lowest level in decades.
Since these volatile days following “Brexit,” the “storm” seemed to be over. With Donald Trump being elected November 8th and all the optimism associated with the expectation for an expansive fiscal policy coupled with less regulation, interest rates and stock markets have increased significantly. In the end of November, OPEC (The Organization of the Petroleum Exporting Countries) made a groundbreaking agreement to cut oil production for the first time in eight years. A few days later, in early December, Russia and other large producers agreed to follow suit and cut their production as well. With these cuts oil prices rose as intended, touching prices of over $54 a barrel – more than double the prices seen in January. Following the strength in capital markets and a strong economic outlook, the Federal Reserve finally raised short-term interest rates for the first time during the year and only the second time since the recession began in 2007.
Since the election, the S&P 500 has continued to hit new highs and the Dow Jones Industrial Average has come within just a few points from hitting 20,000 points, a milestone value never reached before. At the same time interest rates have climbed considerably. The 10-year Treasury rate went from 1.85% the day before the election to a 26-month high of 2.6% in mid-December. With Trump’s plans to likely cut taxes while also building the U.S. through roads, bridges, etc., the bond market deemed it highly probable that the funding would come from increased debt issuance. This increase in money supply would likely lead to inflation, which is one of the main drivers of longer-term yields, so it is logical that both inflation expectations and the 10-year Treasury yield have increased together. Although the U.S. stock indices have increased a large amount since the election, not all stocks have risen. With interest rates improving, rate-sensitive stocks such as defensive dividend-paying stocks and REITs did not receive the same positive enthusiasm as others. Moreover, many technology stocks with global exposure did not rise as much as others either, as Trump’s trade policies seemed potentially detrimental to some of these companies. The stocks that performed the strongest were those in the Financials sector that do best when interest rates increase and those in the Industrials sector and other cyclical sectors. Industrial companies would potentially benefit as they take on new business in areas such as building bridges.
Since our inception in 1956, Gamble Jones has prided itself on its conservative investment philosophy. Although some of the aforementioned more volatile stocks may have increased more than your holdings in the short-term, we want to remind our clients that owning more conservative stocks of companies that grow their profits and dividends, even during tough times, has been a philosophy that continues to work successfully. The stocks we select have more downside protection, often due to strong economic moats and/or recurring revenues and cash flows. These stocks can stand the test of time and stay strong during difficult times. Ultimately, it is still unclear what exactly Trump’s plans are, when they will take effect, how exactly they will affect companies here and abroad, how they will impact other countries, and what the other ripple effects may be. Rather than operating under a “herd mentality” and following others into the more volatile stocks that have been doing well as of late, we will continue to hand-pick individual companies that have a strong likelihood of staying healthy in the face of difficult times while also growing earnings and cash flow. We feel fairly optimistic about what 2017 holds for the U.S. economy but are keenly aware that the U.S. equity market as a whole is fully valued. Our investment process, therefore, is especially valuable at times like these, as we can select individual companies with attractive valuations rather than buying an entire market index that may not be trading at what we deem to be an attractive valuation. We look forward to continuing to manage your hard-earned assets with prudence and care.
From all of us at Gamble Jones, we wish you a Happy New Year!
Alison J. Gamble, President
See clearly, invest wisely, grow reliably.
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