Happy 239th Birthday, USA!
“The Future ain’t what it used to be!” Many are declaring the doom of the greatest country in modern history. From time to time, we enter the doomsday era and people sell books and scare those into believing that the best is in our past. Doomsday sells! If we take a trip down American History Lane, the country has brushed close to disaster on several occasions whether it be its humble beginnings breaking away from King George of England enduring through the War of 1812, or the Civil War between the North and South in the 1860’s, or the Great World Wars I and II. The great spirit of America seems to rise to each occasion. To quote the late President Ronald Reagan, “the Best Days are Yet to come!.”
“You can observe a lot by watching!” The U.S. stock market continues to remain volatile. Although, stock prices reached all-time highs during the most recent quarter as the Dow Jones Industrial Average traded at 18,350 during May, we expect low returns for stocks based on low short-term interest rates. The recent economic data continues to suggest improving conditions in the broad economy. The U.S. Commerce Department states that the unemployment rate has dropped below 6% indicating the economy is better than the Great Recession rates approaching 10%. Job creation since 2009 is reported at +8.7 million jobs although many are low-paying, part time jobs. Henceforth, housing starts remain soft at 1.0 million on an annualized basis which is significantly lower than the 2006 level of 1.5 million on an annual basis.
“It’s like déjà vu all over again!” The current stock market is trading at 16.1 times 2016 earnings and yielding 1.9% based on current S&P 500 prices suggesting very low inflation and anticipating continued improving economic conditions. The current U.S. Treasury yield curve has zero percent for 90 day T-bills with the 2, 5, 10 and 30 year yields at 0.71%, 1.75%, 2.47% and 3.24% respectively. The recent steepening of the yield curve suggests that the U.S. economy should grow with modest inflation. In any event, we believe that barring some unseen event, the financial markets should remain stable despite all the negativity advertised on paid-commercials.
“It gets late early out there!” The Great Inflation has yet to occur. The stated targeted inflation rate of 2% has not been achieved through three major Fed asset purchase programs that theoretically should have inflated hard assets and wages. We do believe ultimately that worldwide inflation should occur. The million dollar question remains on when that inflation occurs. Years ago when the USA was a major manufacturing economy we would already be seeing prices rise. Commodity prices remain depressed as deflationary forces dominate all sectors of the economy.
“I always thought that record would stand until it was broken!” The Oil market continues to be oversupplied. The number of operating oil rigs has dropped in the US by well over 1000 rigs since 2012. Additionally, natural gas supplies remain high suggesting a return to a natural gas bubble which keeps gas prices low for a very long time. The oil market has well over 100 million barrels more than is necessary. We do believe the oversupply situation will clear out by the fall. The US market uses approximately 22 million barrels of oil per day. Prices will remain low until the oversupply goes away.
“If you don’t set goals, you can’t regret not reaching them!” The 2015 U.S. Defense Budget is targeted at $598 billion. The rest of the major countries in the world total defense spending totals $600 billion including China, Russia, Germany and Japan. The U.S. intends to keep its war machine live and well presenting reasonable investment opportunity amongst the defense contractors whose stocks are quite rich. The major contractors trade at or above market price earnings ratios already. Of course the more conservative utility companies trade at or above 16 times 2016 earnings as well.
“Nobody goes to Coney Island anymore, it’s too crowded!” At some point, we would invest in financial stocks including bank stocks. The ideal time to buy bank stocks is when the Treasury yield curve is inverted. The current yield curve is normal and steep. Yet, bank profit margins remain narrow between deposit rates and loan rates. The money center banks trade at a slight discount to regional banks. We do believe the banks are out of the danger zone regarding capitalization and financial leverage. Yet, we believe banks need to separate investment banking from commercial banking eliminating the inherent conflict of interest that banks obtained in 1999 when Glass-Stegall regulation was repealed. Even today, most banks still have TARP money in the form of preferred stock used to bailout the financial system in 2008. Financial leverage has improved for most banks since 2007. The average price earnings ratios for money center banks is currently 12.6 times 2016 earnings versus 17.5 for regional banks. Regional banks may be a bit overpriced.
“Always go to other people’s funerals; otherwise they won’t go to yours!” Greece and Puerto Rico are having problems meeting debt payments hampering stock markets in Europe and the United States. Greece has an estimated 11.03 million people with approximately 315 million Euros of outstanding debt, or roughly 29,000 Euros per person. Puerto Rico has 3.54 million people with outstanding Province debt of $70 billion, or approximately $20,000 per person. Interestingly enough, the USA has 319 million people with outstanding debt of $18.4 trillion, or $57,577 per person. The ECB has 503 million people with outstanding debt of 12.3 trillion euros, or 24,500 per person. We believe none of this debt will ever be repaid. Most will just be inflated and rolled over for future generations. The debt levels are rapidly spiraling up all around the world which ultimately will drive borrowing costs up with higher interest rates.
“Baseball is 90% mental, the other half is physical!” We believe that the low interest rate structure should continue to foster improving economic conditions for the next eighteen months. We believe that industrial companies that are economically sensitive will provide reasonable rates of return for the patient investor for the coming months. We like higher dividend stocks including pharmaceuticals, energy, chemicals, telecommunications, and large cap technology companies. With the current market decline, we believe this is an excellent time to invest.
We continue to consider it an honor to manage your investments. We believe that long term investors will continue to do well for the foreseeable future.
Russell L. Robinson
Robinson Investment Group
5301 Virginia Way, Suite 150
Brentwood, Tennessee 37027
Titles from Yogi Berra quotes posted at www.imposemagazine.com