Off to a Shaky Start
Much like last year, the first quarter of 2015 was marked by sharp spikes and gradual drops in market volatility. U.S. equity markets eked out a small gain over the course of the quarter, but experienced a great deal of choppiness, driven by everything from geopolitical concerns to extreme weather to central bank policy. At least earlier on in the quarter, further weakness in crude oil prices weighed on markets to an extent, and a stronger dollar continues to leave many questioning how many larger U.S. companies will fare, given their global presence. Interestingly, such worries were seemingly apparent as we entered 2015 and part of the consensus view for the year. This raises some interesting points about market conjecture and forecasting. No matter how accurate a prediction, and no matter how seemingly priced into the market that prediction is, when prediction becomes reality, the outcome can look quite different. There are many events this year the market seems to perceive as inevitable, be it economic and policy divergence, timid inflation or increased volatility. All are possible and, quite frankly, likely. Nevertheless, we believe it is important to remember that no matter how accurate our predictions, we must always prepare for the unexpected.
Earlier this year, we saw renewed fears of a “Grexit” after the election of the anti-austerity Syriza party in Greece. This new government quickly sought to renegotiate Greece’s bailout agreement, much to the chagrin of the country’s creditors. While a temporary deal was made to avoid a Greek default, negotiations to reach a more long-term resolution remain ongoing. Though this roiled markets to some extent, the impact was less pronounced in Europe as it has been in past Greek scares, given the European Central Bank’s long-awaited announcement of full quantitative easing. The package, finally implemented due to continued weak economic growth and below-target inflation, was much larger than expected, and appears to have the potential to jumpstart the Eurozone economy. Equity indices in the region saw strong gains in the quarter, and Eurozone exporters are likely to see the added benefit of a cheaper Euro. While it will take some time for the story to play out, there is reason to believe that at least some segments of the Eurozone economy will begin to experience growth in this year and beyond, a major deterioration in the Greek situation notwithstanding.
While the ECB’s quantitative easing program undoubtedly made a great many headlines this quarter, plenty of attention was given to Federal Reserve policy as well. Data throughout the quarter showed signs of improvement in the U.S. economy, particularly due to an improving labor market and lower energy prices, implying a greater likelihood of an impending rate hike. In its March statement the Fed, as expected by many, dropped its pledge to be “patient” in tightening monetary policy, opening the door for an increase as early as its June meeting. However, in the press conference following the March FOMC meeting, Janet Yellen further clarified the Fed’s stance, stating that “just because we removed the word ‘patient’ doesn’t mean we’re going to be impatient”. Markets were driven higher by Yellen’s commentary, which was ultimately viewed as dovish.
The fact that the Fed’s ultimate decision to raise rates is a highly data dependent one leads many to wonder just when that time will come. Economic numbers, along with many other indicators, have been quite mixed, and just what will warrant a policy change remains to be seen. On the one hand, it appears as though there are reasons to believe the U.S. economy isn’t ready for rising rates. In its March statement, the FOMC itself even admits that “growth has moderated somewhat”. While employment data has shown that momentum in the U.S. labor market is persisting, the Fed desires “further improvement”. In addition, there are worries about what a stronger dollar and global growth headwinds will do to U.S. corporations. Underlying fears have already been realized, given that many companies saw these as issues for the second half of 2014 and are expecting more of the same for this year, especially if rates rise. Concerns about the strong dollar actually managed to move markets towards the end of the quarter, as investors sold U.S. equities in the face of what could be a rather disappointing earnings season.
With that all being said, by and large, the U.S. economy seems to be on track for continuing growth. Job growth numbers for the year were the best they have been since 1999, and GDP for 2014 has been estimated at 2.4%. Much of this was driven by increased consumer spending, driven not only by increased employment, but also by lower energy prices and increased consumer confidence. Markets have reflected this sentiment as well through rising indices, as well as a flood of capital markets activity throughout this quarter. Though IPO activity was relatively slow, debt issuance continued to show marked growth. What’s more, there was a noticeable uptick in M&A activity, with high profile deals like the Heinz/Kraft merger grabbing headlines. Undoubtedly, there are signs of a renewed confidence in the market, coming from consumer, investor and corporation alike.
This confidence, however, does give us a good deal of pause. While we recognize there is a lot of data to support a pretty bright story for the economy going forward, we believe that this is also an appropriate time to take inventory of some of the risks that could derail further progress. Many companies have expressed concern about their overseas operations, and while a stronger dollar plays a part in this, so too does lackluster global growth. The Eurozone, though potentially on the verge of a turnaround, still clearly faces risk from its still very weak periphery. The Greek situation has yet again deteriorated, and could destabilize this recovery. China also has the potential to have an impact, with many signs continuing to point to a slowdown in the world’s second largest economy. The Chinese government has expressed concerns on the health of its property markets and falling inflation, and the People’s Bank of China elected to cut interest rates in March, with further cuts possible later in the year. Though this easing has benefitted regional equity markets, it has begun to stoke renewed fears of a “hard landing” in China. While commodity exporting countries have already seen the effects, slowing Chinese growth would have implications globally.
Domestically, we believe there are reasons to be concerned as well. Unlike many market pundits, we have no desire to make blanket statements about equity valuations. That being said, we definitely feel that there is some froth to this market, and given the risks we’ve considered, it may well be prudent to reduce our risk profile in a measured way. We look at a vast number of companies every year, screening on many fundamental, bottom up measures on a regular basis. When such screens present few attractive opportunities, it makes us pause. We now seem to find ourselves in such a time, with the list of compelling new investments, especially in the U.S., quite short. While we intend to continue seeking out new opportunities, we do feel that it is ever more important to consider market currents and macroeconomic conditions. For every reason there is to be optimistic, there is a reason to tread more carefully. As such, we continue to work to position ourselves against risks while taking advantage of the likely diverging markets we see ahead.
As always, we welcome your thoughts, and greatly appreciate your support and trust.
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