Where there's Smoke…
The phrase "Where there's smoke..." typically ends with "...there's fire". Today, we are not convinced this is the case. Certainly there is smoke in the political sphere, both in the US and abroad. We also see smoke billowing out of the conflict between internet-based retail versus traditional 'brick and mortar' establishments. On the positive side, the smoke, or perhaps steam, continues to build in the US economy. This strength is prevalent in most economic data.
It is critical to keep these observations in perspective. In spite of the day's pressing geopolitical issues, we enjoy the highest standard of living supported by the greatest level of wealth that has ever existed. Contrary to the 24 hour news cycle, society is doing more than a few things right. It is this view that underpins our optimism for the future. For further evidence of faith in capitalism, look no further than Omaha, Nebraska in a couple of weeks.
During the first weekend in May, shareholders will gather for the Annual Meeting of Berkshire Hathaway where two of the most time-tested and savvy investors will share their pragmatic approach and wisdom. At ages 93 and 86 respectively, Charlie Munger and Warren Buffet have proven their skill. What astonishes us is the amount of analysis this meeting generates. Their message and the stories they use to convey it have seldom changed during the past half-century. Market conditions evolve and sectors gain and fall in favor, but their discipline remains constant. Undoubtedly, they will once again share their optimism for the future and for capital markets.
Similarly, there is little change in our overall outlook from previous missives. Productivity enhancements and the acceleration in the deployment of new technologies will lead to improved goods and services at lower prices. Employment conditions will continue to evolve and those who do not possess relevant skills must retrain or be left behind. Overall, the positives outweigh the negatives which should lead to more constructive returns.
We maintain our guarded posturing within fixed income, favoring prudent credit exposure with limited interest rate risk. The returns over the last generation have come with relative ease save for only a couple of notable, compressed time periods. With near record low interest rates still present, the markets seem to be adapting slowly to a changing environment. Our expectation is for short-term rates to continue to increase at a slow and measured pace, while longer-term rates increase at an even slower rate, if at all. The result will be a flattening of the yield curve. As the chart below highlights, this type of movement has resulted in below average returns in fixed-income markets during subsequent quarters.
Analogous to society as a whole, the equity markets have been divided into two camps, the haves and the have nots. The haves are the businesses driving a disproportionate share of the broad market returns. In the first quarter, market averages increased due to the influence of leading companies that sport very high valuations and hence, contain much fundamental risk. Online juggernaut Amazon is a prime example. This company's shares rose 18% in the first quarter and 34% annualized over the last five years. Many traditional competitors experienced significant declines as Amazon continues to grow market share.
Tesla is another example. Its stock increased 30% in the first three months and now sports a market capitalization that exceeds both Ford and General Motors, yet Tesla only produces a fraction of the cars and has never turned a profit. In evaluating Tesla, it is challenging for value oriented investors to rationalize current pricing based upon traditional measures of revenue or profitability, which at some point will be relevant to its valuation.
We believe US equity markets are reasonably pricing in potential regulatory and tax reform. If these reforms become reality we could see continued gains as a positive feedback loop is reinforced. The economy should also experience greater growth supporting higher valuations. However, should these reforms not materialize as quickly or as broadly as anticipated, returns in the short run may stall out or correct to revised expectations.
The robust stock market of the first quarter may or may not subside over the summer. However, the smoke we see originating from the political environment and elsewhere will eventually be understood and any impact will be short-term in nature. We continue to pursue and hold solid investments that produce stable returns in an unpredictable world.
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We would like to take a moment to recognize Ben Frey for passing the Series 65 – The Uniform Investment Adviser Law Examination. Congratulations, Ben.
And mark your calendars for an EPIQ Education event at our the EPIQ Partners' office.
May 18th, Thursday – 4:00pm – 7:00pm
2919 Knox Avenue South, Suite 200
Minneapolis, MN 55408
Alzheimer's Disease: New Approaches to Treatment and Prevention
William H. Frey II, Ph.D. - Founder & Senior Director
HealthPartners Center for Memory & Aging at Regions Hospital
Follow these links for information on Dr. Frey and his research: