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Q2 WEALTH MANAGEMENT QUARTERLY COMMENTARY
Contacts
LEN A. HAUSSLER, CFA, CPA President and Portfolio Manager
KEVIN P. WHELAN, CFA Vice President and Portfolio Manager
NATHAN A. BISHOP, CFA Portfolio Manager
221 East Fourth Street, Suite 2700 Cincinnati, Ohio 45202
p (513) 621-6787f (513) 639-3072
www.opus.capital
15
Quick Look
» Large U.S. stocks edged higher by 0.3% in an uneventful quarter of trading. Smaller U.S. stocks and international equities were quiet as well, as both finished with a less than 1% gain to maintain their year-to-date lead on the S&P 500 Index.
» Momentum driven, low-yielding stocks were in favor as opposed to higher quality, dividend-paying value stocks that our portfolios are intentionally tilted towards.
» The larger story for investors in the second quarter was the struggle of the bond market. The Barclays US Aggregate Bond Index fell 1.7% last quarter and is down 0.1% for the year. Fixed income losses for the quarter for our clients, however, were mitigated by two factors; 1) shorter maturities in high-quality bonds and 2) our inclusion of high yield bonds, which finished positive for the quarter.
» Though the U.S. economy has improved enough for the Fed to move rates off of the emergency policy 0% level, the Fed seems committed to continued dovish policy, and investor concerns of rising rates may be overblown in our view.
» We compare and consider the parallels between today’s investment environment and those of the mid-1950s, which was the last time the Fed had held rates this low for this long.
Equity Markets Flat, Bonds Falter During the Quarter
About Opus Capital ManagementOpus Capital, headquartered in Cincinnati, Ohio, is a registered investment advisory firm specializing in assisting endowments, foundations, public funds, corporations, institutions and high net worth individuals develop and execute investment strategies and policies. Our team designs customized, integrated investment programs for each client based on individual goals and objectives.
Large U.S. stocks edged higher by 0.3% in an uneventful quarter of trading. The price change was actually negative for the first time in ten quarters, but dividends allowed investors to post a fractional gain. Smaller U.S. stocks and international equities were quiet as well, as both finished with less than 1% gains to maintain their year-to-date leads on the S&P 500 Index. Momentum driven, low-yielding stocks were in favor as opposed to higher quality, dividend-paying value stocks that our portfolios are intentionally tilted towards.
According to Strategas research, the S&P 500 has traded in a range of less than 8% so far this year, which is among the narrowest of the last 70 years. Given earnings, the flat returns and minor moves that we have seen year-to-date do make some sense. Earnings are projected to decline 5% in the second quarter, and for the calendar year are expected to grow just 2%. Revenues for this year are actually projected to decline 2%. The blame for these paltry projections can be directly attributed to the Energy sector, whose earnings are projected to decline a whopping 55% this year. Per FactSet, if the Energy sector is excluded from the index, the projected earnings growth rate for the year improves to 8%.
With little in the way of price or earnings growth, the valuation on the S&P 500 Index continues to hover around 18 times trailing earnings. While the index is trading above its 10-year average valuation of 16 times earnings, we think the premium valuation could continue given our current low-growth, low-inflation environment. As seen in the chart below, since 1950 the Index has averaged a P/E level of 17.9 times when inflation is growing between 0% and 2%.
The more notable story for investors in the second quarter was the struggle of the bond market. The Barclays US Aggregate Bond Index fell 1.7% last quarter and is down 0.1% for the year as the 10-year Treasury yield rose from 1.93% to as high as 2.49% before closing at 2.34%. Fixed income losses for the quarter for our clients, however, were mitigated by two factors; 1) shorter maturities in high-quality bonds and 2) our inclusion of high yield bonds, which finished positive for the quarter.
Investor concerns of rising rates may be overblown in our view. Though the U.S. economy has improved enough for the Fed to move rates off the 0% emergency policy level, the Fed seems committed to continued dovish policy, as evidenced by the reduction in their forecasted rates at their June meetings. As seen in the chart above, the futures market is betting Fed forecasts are still too high. Furthermore, aggressive tightening seems unlikely given that global banks
OPUS CAPITAL MANAGEMENT | QUARTERLY COMMENTARY
Review of Second Quarter 2015
2 2Q15 Commentary Opus Capital Management
U.S. EQUITY RETURNS (%)
As of 6/30/15 Q2 2015 YTD 2015 1-Year 3-Year 5-Year 10-Year
S&P 500 0.3 1.2 7.4 17.3 17.3 7.9
Russell 1000 (Large Cap) Growth 0.1 4.0 10.6 18.0 18.6 9.1
Russell 1000 (Large Cap) Value 0.1 -0.6 4.1 17.3 16.5 7.1
Russell 2000 0.4 4.8 6.5 17.8 17.1 8.4
Russell 2000 (Small Cap) Growth 2.0 8.7 12.3 20.1 19.3 9.9
Russell 2000 (Small Cap) Value -1.2 0.8 0.8 15.5 14.8 6.9
Source: Morningstar
Source: Strategas20x
16.8x17.9x
17.2x
14.7x
10.9x
9.5x8.5x 8.3x
18x
16x
14x
12x
10x
8x-2-0% 0-2% 2-4% 4-6% 6-8% 8-10% 10-12% 12-14%
3.5%
0.78%
1.89%
3.03%
3.00%
1.75%
0.57%
0.31%
1.07%
1.72%
FOMC as of June 2015Futures Market as of 6/30/15Primary Dealers as of April 2015
3.0%
2.5%
2.0%
1.5%
1.0%
0.5%
0.0%Dec-’14 Jun-’15 Dec-’15 Jun-’16 Dec-’16 Jun-’17 Dec-’17
Market is Less Optimistic than Fed on Rate RisesFederal Reserve vs. Market Expectations
Expectations of Federal Funds Rate
Source: Strategas
5051
1714
3429
2226
40
2009 2010 2011 2012 2013 2014 YTD
30
20
10# of
Cen
tral
Ban
ks
0
Source: Strategas
in Europe, Japan, China and other countries have become more accommodative during the year.
The rise in rates this quarter reflects not only expected Fed rate hikes this year but also an improving economic picture, led by the consumer. Consumer spending rose 0.9% in May from a month earlier, the largest jump since 2009. Auto sales are back to pre-recession level numbers, and consumers are trading up in regards to accessories and models. Existing home sales have now increased for eight straight months and are 9% higher than a year ago, and more than a third of home sales in April were at or above their asking price. Consumer confidence readings are near eight year highs, as the labor market has continued to improve and the trend in wage growth shows signs of finally accelerating.
The quarter ended in volatile fashion as markets pulled back on a Greek default of bailout money from the IMF and weakness in Chinese stock markets. Judging by the credit spreads of other European countries, the issue appears to be ring-fenced as opposed to the crisis spreading into other southern European countries. As for U.S. investors, according to FactSet research, not a single company in the S&P 500 in the month of June mentioned Greece on their earnings call, so the impact of the Greek debt crisis as it pertains to the U.S. economy or corporate earnings is likely immaterial, baring contagion into larger European countries. As always, we will monitor the situation closely for clients and take appropriate action should the crisis escalate.
Back to the FutureIf you are a movie buff, how fascinating is it to have reached the year 2015, which is of course the same year that Marty McFly arrived via Doc’s DeLorean time machine in his visit to the future? If the Back to the Future movie trilogy is used as our societal yard stick, mass production of hover boards is sadly way past schedule. On the plus side, the definition and size of our televisions are much higher and larger than what was depicted in the movie, and the Chicago Cubs World Series drought amazingly still continues (sorry, Cubs fans).
The gem of the Trilogy and the one we all remember is the first Back to the Future movie, made in 1985 and now 30
years old, exactly the same amount of time that Marty travels back to when he arrives in 1955. Because of the advent of the internet, harkening back thirty years to 1985 is as easy as pulling up a Huey Lewis & the News video on YouTube. The internet has compressed time, allowing us to satisfy our occasional thirsts for nostalgia. But when the Back to the Future movie came out in 1985, pre-internet, the 30-year gap between time periods just felt longer to the movie watcher. One of the many wonderful things about the movie was the feeling that you were getting a glimpse of what living in 1955 was like.
Coincidentally, from our viewpoint we may be getting a little glimpse of 1955 now, at least from an investment perspective. Consider the comparisons:
• In 1955, after years of low rates, the Fed was intent on raising the Fed funds rate. In fact, you have to go back this far to find the last time the Fed held rates this low for this long.
• In 1955, the 10-year Treasury opened at 2.6% and rose throughout the year, fueled by improving economic data. For years prior, interest rates were held at very low levels to help manage the high debt accumulated by the U.S. government after World War II.
• Inflation in 1955 was a non-issue. In fact, the CPI shrank 0.4% that year. Between 1952 and 1960, average annual inflation was less than 2%. Sound familiar?
• One year prior in 1954, The Dow Jones Industrial Average reached a new all-time high, finally regaining its pre-1929 crash level. The NASDAQ accomplished a similar feat this past quarter, as it finally climbed above its year 2000 dot-com bubble level.
• In 1955, valuations on stock prices had been climbing each year for seven years since bottoming in 1949 and were trading above their 10-year average, just as we are today.
• Frustrated by low bond yields, investors in need of income were increasingly turning to equity markets, as S&P yields at that time were jockeying at the same level as 10-year Treasury yields.
Continued from page 2 . . .
OPUS CAPITAL MANAGEMENT | QUARTERLY COMMENTARY
3 2Q15 Commentary Opus Capital Management
Source: FactSet
'06' 07 '08' 09 '10' 11 '12' 13 '142020
3030
4040
5050
6060
7070
8080
9090
100100
110110
US Consumer ConfidenceUS Consumer ConfidenceSource: FactSet
Opus Capital Management 221 East Fourth Street, Suite 2700
Cincinnati, OH 45202(513) 621-6787 • www.opus.capital
FIXED INCOME RETURNS (%)
As of 6/30/15 Q2 2015
YTD 2015 1-Year 3-Year 5-Year 10-Year
Aggregate Bond
-1.7 -0.1 1.9 1.8 3.4 4.4
Muni -0.9 -0.2 1.9 2.3 3.7 3.6
Int’l Bonds -1.9 -2.4 -5.3 0.7 2.8 3.9
High-Yield 0.1 2.4 -1.1 6.0 7.6 6.5
Short-Term -0.1 0.7 0.5 1.3 1.9 2.9
90-Day T-Bill 0.0 0.0 0.0 0.1 0.1 1.4
Source: Morningstar
OPUS CAPITAL MANAGEMENT | QUARTERLY COMMENTARY
INTERNATIONAL RETURNS (%)
As of 6/30/15 Q2 2015
YTD 2015 1-Year 3-Year 5-Year 10-Year
EAFE Int’l 0.6 5.5 -4.2 12.0 9.5 5.1
Emerging 0.7 3.0 -5.1 3.7 3.7 8.1
Source: Morningstar
• The U.S. was in between wars in 1955 but geopolitical tensions were rising, particularly with the Soviet Union. NATO’s focus was to resist Communist expansion and U.S. diplomatic relations with the Soviets were deteriorating.
Great Scott! No two time periods are exactly the same, as GDP growth in the 1950s was double what we have experienced since the Great Recession, fueled predominately by higher productivity and favorable demographics. However, the similarities are striking enough that if Marty would have purchased a copy of The Wall Street Journal rather than Grays Sports Almanac, Biff Tannen would have had a much more difficult time prospering from the stolen document.
The years immediately following 1955 were not kind to bond investors, as the 5-year average annualized return on the 10-year Treasury was less than 1%. The Fed consistently raised rates into 1957, which contributed to a brief period of recession. By 1959, the yield on the 10-year Treasury reached 4% for the first time since 1924 and would continue to ascend higher for an entire generation of investors, ultimately peaking in 1981 at over 15%.
Equity investors fared much better. Despite the fact that the Dow Jones Industrial Average had doubled from 1949-1954, stocks continued to march higher in the face of Fed tightening and higher valuations. Between 1955 and 1959, the five-year average annualized return on the S&P 500 was 17%. Interestingly, stocks fell 10% in the fall of 1957, but not
due to Fed rate hikes or geopolitical concerns. Rather, the reason for the correction was a heart attack by President Eisenhower, a great example of how market corrections are unexpected and nearly impossible to accurately time.
To quote Mark Twain, “history doesn’t repeat itself, but it does rhyme.” Using 1955 as our proxy, here is our 1.21 gigawatt powered guess at what we think is most likely in store for current times:
1. The Fed raises rates once or twice this year, but continued rate hikes are made at a more subdued pace than the speed taken by the mid-1950s Fed, which at the time was much more concerned with staying ahead of inflation than Ms. Yellen’s Federal Reserve.
2. The yield curve flattens, and 10-year Treasury rates move in a fashion more tied to the earlier part of the 1950s in which they drift flat to slightly higher rather than the precipitous rise of the late-1950s. The end result is likely positive, but nominal, returns that struggle to capture the current coupon rate.
3. The five-year returns for U.S. stocks are much more subdued than the run of the late-1950s, though valuations stay above historical trend, as they did well into the early 1960s.
4. Just like in 1955, a 10% market correction eventually occurs (obviously), but the cause is not from something discernable such as one Fed rate hike.
United States Government Bond - 10Y5
4.5
4
3.5
3
2.5
21/1/1948 1/1/1952 1/1/1956 1/1/1960 1/1/1964
Source: www.tradingeconomics.com | U.S. Department of the Treasury
S&P 500
100
1968
Index Value
196619641962196019581956
90
80
70
60
50
40
30
Sources: www.stansberryresearch.com, A Wealth of Common Sense
Stocks Bonds
1940s 8.5% 2.5%
1950s 19.5% 0.8%
1960s 7.7% 2.4%Source: Damodaran
