Category Archives: Client Letters

Q3 2017 Letter

October 2017

It continues to be a good year for equity investors across the board. The S&P 500 Index finished the quarter up 14.2% year to date, including reinvested dividends. The Russell 2000 Index of small and mid-cap stocks was up 10.9%, developed international stocks were up 20%, and emerging market stocks were up 27.8% over the same period.

Many of the themes we have written about recently remain in effect including slow but positive economic growth, low interest rates, subdued inflation, and low market volatility. In addition, the stock market continues to move higher, building on the second longest bull market advance in history. Central bank policy is garnering more attention now that the Federal Reserve has announced its intention to gradually reduce the size of its balance sheet, shifting from a policy of quantitative easing to a policy some have called quantitative tightening.

Prior to 2008, the Federal Reserve’s balance sheet had been modest and stable for many years. In response to the Great Financial Crisis, the Federal Reserve and other central banks embarked on a series of unconventional policies which included large scale asset purchases known as quantitative easing. In simple terms, quantitative easing works like this: a central bank creates money and uses it to purchase securities in the open market. Central bank purchases inject cash into the system and take tradeable securities out of the system. The supply of cash goes up and the supply of securities goes down. This is intended to provide liquidity, lower interest rates, and increase the price of financial assets creating a wealth effect that will in turn spur growth.

It took 100 years for the Fed’s balance sheet to reach $800 billion. From 2008 to 2014 it grew to $4.5 trillion. In other words, the Fed more than quintupled the size of its balance sheet in order to stimulate borrowing and spending. Similar actions have been taken by the European Central Bank (ECB) and the Bank of Japan. As a result, global central bank balance sheets have grown to a whopping $14 trillion. To put this in context, in order to blow through a trillion dollars in a single year you would have to find a way spend $1.9 million every minute (with no sleeping allowed).

In the era of quantitative easing, global central banks have been price insensitive buyers of mortgage and other asset-backed securities, government bonds, corporate debt, and even equity securities. The Fed now owns approximately 30% of all outstanding mortgage-backed securities as compared with none before the financial crisis. The ECB has purchased the bonds of Nestle, Unilever, Shell and other publicly traded companies due to a scarcity of government bonds. The Bank of Japan owns 40% of all Japanese government bonds and a remarkable 71% of all shares in Japan-listed ETFs.

Many believe these massive and unprecedented purchases have distorted financial markets. Interest rates are lower than in prior bull markets, credit spreads are tighter than usual, and equity prices are higher than they ever have been, except for a brief period leading up to the peak of the technology bubble in 2000. A recent cover story in The Economist describes it as “the bull market in everything” and asks “is it time to worry?” While investors can always find sources of worry, long stretches of high returns and low volatility can lull investors into forgetting that risk exists.

All investors should take note that the heady days of quantitative easing are coming to an end. The Federal Reserve is beginning to reduce its balance sheet by $10 billion a month, gradually increasing the pace to $50 billion a month next year. The ECB is expected to gradually reduce purchases from $90 billion a month to around $50 billion a month and then completely end purchases by the end of next year. The good news is that these moves have been well telegraphed in advance and markets have reacted favorably thus far. The pace is slow and gradual but it remains a fundamental shift in the environment that has been so supportive of risk assets globally. We will continue to monitor these developments closely.

q3 2017

Source: DoubleLine Funds

We are pleased to announce that Lloyd Flood has joined our firm. Lloyd brings three decades of experience working as a portfolio manager, trader, and financial analyst. He is a CFA charterholder and holds an undergraduate degree in Business Administration from Auburn University and an MBA from Mercer. We are delighted to welcome Lloyd to the team.

As always, we welcome your thoughts and appreciate the confidence you have placed in our firm. We are grateful for the opportunity to work with you and your family.

Nicholas Hoffman & Co.

Q2 2017 Quarterly Letter

August 2017

It has been a good year for equity investors across the board. All but four of the world’s thirty leading stock indexes were positive in the first half, an occurrence not seen since 2009.  International stocks outperformed domestic stocks for the second consecutive quarter. The S&P 500 was up 3.1% in the second quarter while developed international stocks were up 6.1%, and emerging market stocks were up 6.3%. For the year-to-date period, the S&P 500 was up 9.3%, while developed international equities and emerging market equities were up 13.8% and 18.4% respectively.

One phrase we are hearing more often in calls with analysts and managers is “synchronized global expansion.”  Corporate earnings have picked up, not only in the U.S. but also in Europe and Asia. Global manufacturing surveys are pointing to continued broad-based growth at home and abroad. Moreover, central bank policy remains broadly accommodative, at least for now. All these factors contributed to an unusually strong and broad-based rally for global equities during the first half of the year.

q2 letter

Source: American Funds

We are beginning the earnings season which kicked off in July and runs through August. Analysts are expecting earnings growth of 6.4% for the second quarter and 9.8% for all of 2017. We will be watching earnings closely and listening for forward guidance to see if companies are raising or lowering their expectations. Early indications in this regard are positive.

We will also be monitoring developments around central bank policy. The Fed has continued raising U.S. short-term interest rates, most recently raising them another 25 basis points in June, while the European Central Bank and the Bank of Japan have begun to contemplate reducing their stimulative policies abroad. It will be interesting to see how equity markets respond as the environment shifts away from central bank easing and towards policy normalization. Thus far, confidence in central bankers remains high causing very little volatility in equity markets. Longer term, a shift towards tighter policy could be a headwind for equities, but we see little evidence of that at present.

Another intriguing trend is the shrinking number of public companies.  Over the past 20 years through 2016, the number of publicly listed US companies has fallen by about half.  One reason has been corporate consolidation through merger activity, enabled by companies being able to borrow at low interest rates.  Another contributing factor is decreased initial public offering volume, with fewer companies taking on the regulatory burden of becoming a public company.  Facing a slimmer public market opportunity set, we continue to think globally and devote energy to sourcing high quality opportunities in the private markets.  When suitable, we think that exposure to nonpublic companies can be additive to client portfolios.

Investors continue to debate the elevated levels of the equity markets. The combination of strong corporate earnings, steady and thoughtful normalization by central banks, and the shrinking supply of public companies, offers bright fundamentals for stock investors. At some point a pull back is almost inevitable. The test will be whether such a pull back undermines the market’s confidence and optimism.

We are pleased to present our new quarterly reporting format which you will find enclosed with this letter. Improved reporting has been a strategic focus for us as we have worked to convert years of historical data into a new system that will enhance our analysis and reporting capabilities. We look forward to discussing the new format with you soon.

We are delighted to be working with two interns this summer. Muhozi Aimable is a rising Senior at the University of Georgia where he studies Finance and competes in Division 1 SEC cross country and track and field events. Muhozi moved to the states in 2011 from Malawi.  Zach Scott is a rising Junior at Rhodes College studying Economics and Spanish. Zach hails from Boulder, Colorado and will be studying abroad in Madrid in the Fall.

Finally, we are humbled with a sense of profound gratitude as we continue to celebrate our first ten years in business. We have endeavored to create something unique and very special here at Nicholas Hoffman & Co. None of this would have been possible except for the extraordinary families we have been so fortunate to work with over the years.

As always, we welcome your thoughts, and appreciate the confidence you have placed in our firm.  We are grateful for the opportunity to work with you and your family.

Nicholas Hoffman and Co.