2013 4Q Investment Letter
January 10 2014 — by Ryan Wilson

As an investment advisory firm, we feel investors should have an information outlet for the financial markets that is thorough, but does not require a prerequisite degree in economics. Thus we have included a glossary of terms at the end of this commentary.  Each term with an asterisk has a corresponding definition in the glossary. We hope this makes our commentary informative and educational for all levels of investors.

The fourth quarter of 2013 rounded out one of the most impressive years for the U.S. equity markets in recent history.  With a return of 32.4%, the S&P 500 index notched it’s best year since 2003.  The stock market was fueled by below average interest and inflation rates, both of which wreaked havoc on bond and commodity market returns. The U.S. bond market, as judged by the Barclays Aggregate Bond index, had it’s first negative year in over a decade while the broad commodity market suffered a similar fate, posting its third consecutive negative annual return.

Below is a sample of how different asset classes performed in the past year:

The best performing sectors in the U.S. were consumer discretionary and health care, while the normally defensive sectors* of telecommunications and utilities lagged the broader market.

Quarter in Review

It was déjà vu for U.S. company earnings in the 4^th quarter. Approximately 75% of companies beat earnings estimates, with revenue growth lagging behind earnings growth and margins* continuing to expand. These results were nearly in lockstep with results from the 3^rd quarter.

October saw fears of a government shutdown realized for the first time since 1996, as Congress was unable to find common ground on debates over the federal budget and debt ceiling. Fortunately the shutdown was short-lived, with minimal damage to the economy, but Congress was only able to enact temporary measures to keep the government open with another shutdown date looming in mid-January.

Improving unemployment numbers throughout 2013 culminated with the November unemployment rate hitting 7%. This triggered the Federal Reserve (Fed) to announce the much-anticipated taper or reduction of bond purchases that have been in place to keep interest rates low. While the taper of bond purchases is minimal, it does signal that the Fed believes the U.S. economy is strengthening and should continue to strengthen in 2014.

Outlook 

With the stock market on a roll and the economy showing increased strength, there are two things that we feel are worth watching in the coming months.

      1.  Path to Stable Inflation

The Fed’s dual mandate* is to achieve maximum employment and price stability. The current policy of low interest rates is supposed to act as a lubricant to the employment market, but typically results in higher inflation. With interest rates low, companies should be more willing to borrow to expand their businesses, creating jobs with wages that will be spent on the economy. With more money chasing goods, demand increases and higher prices will usually follow. The drawbacks to increasing inflation are fairly clear. Continually higher prices reduce the purchasing power of money, meaning the value of a dollar decreases over time.

Strangely, despite low interest rates and lower unemployment rates, the economy has shown little in terms of higher inflation. Inflation in the U.S. in 2013 averaged 1.5%, which is below the Fed’s target rate of 2% and marks the third straight year of declining inflation.  On the surface this would appear to be a boon to the economy and the U.S. consumer, but a lack of inflation can be particularly troublesome for an economy.  Lower inflation rates can mean that people and companies are hesitant to spend today believing that goods will be cheaper tomorrow, which could slow down a full economic recovery.

If interest rates remain low, unemployment continues to decline, and the stock market pushes higher, inflation should return, but it’s mysterious absence to date is cause for some attention.

2.     Performance of Momentum-Driven “Investments”

In 2013 there were a number of stocks that showed outsized gains well above that of the indexes. In most cases, such gains are attributed to higher profits, but what is perplexing about some of the best performing stocks of 2013 is that they have little or no profits at all. For example, Facebook focuses on the number of daily users and Amazon touts its progress in drone deliveries, each without regard to the impact of current profits.

These so-called “momentum stocks” are bought on the premise that outsized yet-to-be-seen future profits justify the elevated prices. The future of the stocks that fall in this category are unclear, but if history is a guide, some may become household names a century from now, while others will be lessons on the danger of chasing future growth.

Glossary

Sectors – The stock market is commonly broken down into ten business sectors to which every company is assigned. Examples include Bank of America in the financial sector and Exxon Mobil in the Energy sector.

Defensive Sectors – Sectors that have stable earnings and are not as susceptible to changes in the overall economy.

Margin – Sometimes referred to as profit margin, is calculated by dividing the profit of a company by its revenues or sales. Higher profit margins can be driven by positive factors (more profitable products) or negative factors (cutting the workforce).

Debt Ceiling – the maximum amount of money that a government can borrow. This was first implemented in the U.S. in 1917 and currently stands at $16.7 Trillion.

Dual Mandate –The unemployment and inflation rates (the dual) are two measures monitored by the Federal Reserve to determine their interest rate policy. This interest rate policy is used to promote economic growth or slow an overheating economy as determined by unemployment and inflation.

IMPORTANT INFORMATION

The information presented here is not specific to any individual’s personal circumstances.

To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances.

These materials are provided for general information and educational purposes and represents Wilson Capital’s views based upon publicly available information from sources believed to be reliable—we cannot assure the accuracy or completeness of these materials. The information in these materials may change at any time and without notice.

Wilson Capital is a Registered Investment Advisor (“RIA”), registered in the state of Massachusetts. Wilson Capital provides asset management and related services for clients nationally. Wilson Capital will file and maintain all applicable licenses as required by the state securities boards and/or the Securities and Exchange Commission (“SEC”), as applicable. Wilson Capital renders individualized responses to persons in a particular state only after complying with the state’s regulatory requirements, or pursuant to an applicable state exemption or exclusion.

† Indices used to represent asset classes:

U.S. Large Cap Stocks – S&P 500
U.S. Small Cap Stocks – Russell 2000
International Stocks – MSCI ACWI ex-U.S.
U.S. Bonds – Barclays Aggregate
Commodities – Dow Jones UBS Commodity

Click Below to Download a Printable Version of the 4Q Investment Letter
Wilson-Capital-4Q-Investment-Letter.pdf (692 downloads )

2013 3Q Investment Letter
October 11, 2013–by Ryan Wilson

This is Wilson Capital’s first quarterly commentary. We hope it serves investors well by reviewing the past quarter and providing our outlook for the financial markets. We feel that investors should have an information outlet for the financial markets that is thorough, but does not require a prerequisite degree in economics. Thus we have included a glossary of terms at the end of this commentary.  Each term with an asterisk has a corresponding definition in the glossary. We hope this makes our commentary informative and educational for all levels of investors.

The third quarter of 2013 saw the continued rise in the U.S. equity markets, but was most notable for the escalation of conflict in Syria and the anticipation of the Federal Reserve’s (Fed)* next monetary policy* move. The S&P 500* closed the quarter with a 5.2% return, in spite of uncertainty that surrounded U.S. involvement in Syria’s ongoing civil war and expectations that the Fed would begin to reverse course in their massive quantitative easing* program that has been in place since 2008. With neither event occurring in the third quarter, the equity markets seemed to focus on the slow, but steady path to economic recovery.

Quarter in Review

Second quarter earnings were solid with approximately 70% of the companies in the S&P 500 reporting earnings* above the analyst expectations. However, while company margins continue to expand, the trend of lagging revenue growth persists. July’s earnings season was followed by fears of U.S. involvement in Syria over accusations that Syrian leader Bashar Al-Assad was using chemical weapons against its own citizens. Crude oil rose to its highest levels in 2013 over fears of a conflict in the Middle East, but without support of allies and members of congress the prospect of intervention receded, causing the rally in the stock market and lower oil prices.

September was largely shaped by the anticipation and reaction of the Fed policy meeting notes. In June, Fed chairman Ben Bernanke announced parameters in both the unemployment (below 7%) and inflation* (above 2.5%) rates where the Fed would consider economic improvement significant enough to begin “tapering”* their bond purchases that have worked to lower interest rates and spark economic growth.  As economic data showed improvements throughout the quarter, longer-term interest rates climbed in anticipation of the taper. Despite almost unanimous expectations by Wall Street that they would announce tapering in their September meeting, The Fed announced no such thing citing conditions still too fragile to remove their support.

Outlook 

The markets in the next 6 to 12 months will most likely focus on the slow, but steady improvement of the economy and the actions of the Fed. With the price-to-earnings ratio* of the S&P 500 hovering around 18x the broad stock market, it is still moderately valued by historical measures, but approaching the highest levels since the financial crisis in 2008. The opposite can be said for the bond market as the recent rise in interest rates for medium to long-term bonds* has made bond prices more attractive (bond prices move inversely to interest rates) than they have been in recent years. We are hopeful that the Fed will reduce the stimulus in a timely manner once economic conditions improve enough for the markets to handle a higher interest rate environment. However, despite the gradual economic improvement we believe there are two factors that could hinder Fed tightening.

1. Inability for the Fed to control long-term interest rates

Despite the Fed purchasing $85 billion in long-term bonds per month, yields on longer dated bonds have increased. With individual investors reducing their positions in bond mutual funds, the Fed’s purchases barely nullify the influx of selling taking place in the broader market. Since longer-term loans are more common for mortgages and corporate bonds used for capital expenditures, higher yields on those bonds reduce the incentive to take on new debt and thus reduce the efficacy of the stimulus.

2.  A reversal of the improving employment situation or sudden rise in inflation

Since the monetary stimulus was announced in 2009, the Fed has seen the employment picture improve in a gradual manner. While steady, the improvement to the employment picture has not been as robust as expected, leaving some doubt as to the sturdiness of the economy. Should jobs growth slow, the fed would be left with few arrows in their quiver to improve the economic picture.

We remain optimistic that the stock market still has room to increase at current levels. More specifically, we see stocks in some sectors such as energy and basic materials that we believe could offer significant upside in a more inflationary environment. The bond market is a little trickier. While the recent run-up in interest rates does make the case for longer dated bonds more attractive; we believe that rates will continue higher in the years to come.

Glossary

Federal Reserve – The United States’ central bank, which is responsible for regulating the banking industry and controlling the money supply through monetary policy.

Monetary Policy – The act of controlling the money supply in order to attain certain objectives concerning the health and stability of the economy. The two main objectives of the U.S. Federal Reserve are maximum employment and stable prices.  The primary method of controlling the money supply is by targeting short-term interest rates which is accomplished by buying (lowers rates) and selling (increases rates) bonds.

S&P 500 – Stock market index of 500 U.S. companies

Quantitative Easing – Monetary policy used in addition to policies to lower short-term interest rates. The intention of the policy is to reduce longer-term interest rates to further spur economic growth.

Earnings – In the U.S. all publicly traded companies release reports on a quarterly basis indicating their financial standing. “Earnings season” occurs 4 times a year with most companies reporting at the end of the month following each calendar quarter (January, April, July, October).

Tapering – In the context of quantitative easing this means the reduction, but not the end, of bond purchases.

Bond terms – Bonds are issued with a term, or length of time, when the bond will make interest payments. In order to compensate investors for setting their money aside for longer periods, interest rates tend to increase the longer the bond term.

Price-to-earnings ratio – a standardized measure of how much investors are paying for each dollar of earnings. An 18x p/e ratio means investors are paying 18 times each dollar of earnings.

IMPORTANT INFORMATION

The information presented here is not specific to any individual’s personal circumstances.

To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances.

These materials are provided for general information and educational purposes and represents Wilson Capital’s views based upon publicly available information from sources believed to be reliable—we cannot assure the accuracy or completeness of these materials. The information in these materials may change at any time and without notice.

Wilson Capital is a Registered Investment Advisor (“RIA”), registered in the state of Massachusetts. Wilson Capital provides asset management and related services for clients nationally. Wilson Capital will file and maintain all applicable licenses as required by the state securities boards and/or the Securities and Exchange Commission (“SEC”), as applicable. Wilson Capital renders individualized responses to persons in a particular state only after complying with the state’s regulatory requirements, or pursuant to an applicable state exemption or exclusion.

Click below to download a printable version of the 3Q Investment Letter:
Wilson-Capital-3Q-Investment-Letter.pdf (709 downloads )