Q2 2015 Client Letter
July, 2015
The stock market for the past six months has been surprisingly calm. The S&P 500 Index closing price has not been up or down more than 3.5% at any point in 2015. In fact, in the history of the S&P 500 Index there has never been another year when the index hovered so close to even so far into the year. Despite the often dramatic and exciting headlines, it has been a remarkably unremarkable year in terms of equity market performance, at least thus far. There are signs though that this period of historic calm might be over. The unseemly European debate over Greece, lack of confidence in the Chinese economy, and uncertainty about the sustainability of U.S. equity prices weigh increasingly heavily on market sentiment, especially with stock valuations higher than normal.
The S&P 500 finished the first half of 2015 up 1.23% while developed international equities and emerging market equities were up 5.52% and 2.95% respectively. U.S. small cap stocks were up 4.75% and the Barclays U.S. Aggregate Bond Index was essentially flat at -0.10% for the first half of the year.
The never ending Greek drama garnered more attention as the quarter came to a close. Will the Greeks stay in the Euro or will they go off on their own? Each day brings conflicting narratives and increased uncertainty as to the ultimate outcome. The drama has led to the creation of new words. First we had “Grexit”. Now we have “Grexhaustion” and “Gretigue”, all for a country according to The World Bank with 11 million people and a GDP of $238 billion. For comparison, metro Atlanta has a population of 6 million people and a GDP of $270 billion (according to World Population Review). The continued back and forth between the Greek government and European creditors has led to an elevated level of uncertainty and highlights the inadequacy of financial markets to price political risk.
Greece has not been the only source of drama. China is the world’s second largest economy behind the United States. Chinese stocks have experienced a dramatic decline, falling nearly 30% since the middle of June after increasing more than 145% over the previous twelve months. The Chinese government has stepped in with a number of actions to mute the decline, including lowering interest rates, providing additional liquidity, halting the issuance of new IPOs, and reducing margin requirements. Despite these actions, prices remain under pressure. We have also seen weakness in copper, oil, and other industrial commodities, which could be an indication of further weakness in one of the primary engines driving global economic growth.
Closer to home, attention has been focused on the Federal Reserve and the timing of their first move away from the zero interest rate policy that has been in effect since December, 2008. The latest Federal Open Market Committee minutes indicate 15 of the 17 board members and presidents believe it is appropriate to raise rates by the end of this year. The Fed Funds futures market indicates a 54% probability of higher rates following the next Fed meeting on July 29 and a 64% probability of higher rates following the September 17th meeting.
Meanwhile, U.S. economic data continues to come in mixed. Housing has been a bright spot with both Existing and New Home Sales beating expectations and extending favorable trends. The median home price is back to levels not seen since 2006. The threat of rising interest rates has had little, if any, impact thus far and leading indicators like Mortgage Purchase Applications continue to show strength. The Federal Reserve appears to be accomplishing its goal of reflating the U.S. housing market.
With home prices rising, unemployment falling, a stronger dollar, and lower gasoline prices, U.S. consumers are feeling more confident. The latest University of Michigan Consumer Confidence Survey notes confidence increased at the fastest pace in over a decade during the first half of the year. Consumer spending accounts for roughly two-thirds of U.S. economic output so this is a positive development.
U.S. economic growth has been resilient but we are not immune to potential shocks from Greece, China, or elsewhere. In Europe, economic conditions are fragile and continuing to improve but the situation in Greece could derail further progress. In China, growth has slowed but it is uncertain as to what extent. Interest rates are widely expected to increase, but tepid growth may prolong the eventual rise. We continue to monitor these developments closely.
Despite the uncertainty and the prospects for increased volatility, we believe there are certain enduring principles that will lead to positive outcomes over time. These principles include 1) Diversifying portfolios across asset classes, geographical areas, and investment strategies. 2) Systematically rebalancing away from assets that have become relatively expensive toward more favorable assets that have become less expensive. 3) Minimizing the taxes, fees, and other costs associated with pursuing an investment strategy, and 4) Pursuing uncorrelated sources of investment returns that are more often found in the less travelled and less efficient private markets.
During the last quarter we welcomed one new member to the firm, Dan Hall, a graduate of the College of Charleston. As a Family Office Associate, Dan will be supporting all aspects of client service and the management of our private real estate platform. In addition, we are now publishing the Weekly Commentary directly to our company blog (https://nhoffmanandco.com/blog) and encourage you review our weekly posts. Besides our Weekly Commentaries we are building a good library of content.
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.