Review & Outlook

Our take on the investing, financial, & economic themes of the day

Ideas to De-risk, not Re-risk a Portfolio

13 August, 2017 by Mark O'Brien in Commentary

The stock market fell in price three days in a row this week.  This hasn’t happened in a long time, and we are not used to it.  Curious how little it takes to bring out the fear.

So is this the start of the big one?  The answer is, it could be.  Whether a stock market correction (defined as prices down 10%), a bear market (defined as prices down 20%), something worse than a typical bear market, like the collapse of 2008-9, or something altogether better, like a resumption of the rally we have enjoyed in recent years – – you just don’t know.  These events come unannounced.  One thing is for sure, though, you cannot jump in and out of markets and expect to accomplish any benefit of a long-term nature.  You may be able to get it right once, but never double-lucky enough to get back in in time to do better than if you had just stayed put.

Having said this, there are ways to “de-risk” a portfolio to mitigate the pain of a correction, a bear market, or the something worse, if indeed that’s what lies ahead.

Figure out where the excesses are and stay away. Readers of this space have heard it before: excess, not the passage of time, is what kills a bull market.  So the fact that the stock market has been ratcheting higher for 9 years is not in itself the problem.  We would look instead to the price action of a handful of “can’t lose” stocks, and avoid these, because they are excesses.

In the last year, Amazon, Apple, Facebook, Google and Netflix have contributed almost as much to the total value of the S&P 500 as the other 495 stocks combined. While all five stocks are expensive, Amazon and Netflix fall into the irrational exuberance category.  With valuations at 200 times earnings, they are about where high-tech stocks were in the late 1990s, just before the Internet bubble burst.  This is an easy one.

What about lesser stars like Apple, Google and Facebook? They are not cheap at 17, 30 and 38 times earnings, respectively, but that’s a long way from 200 times earnings.  And they are great businesses suitable for the long term. With these we would sell the amount of the recent gain.  For instance, with Apple up 40% in the last year, we’d sell 40% of the position.   Same for other big winners, like Boeing.  Sell the amount of the last year’s gain.

What to do with the sale proceeds?  This is tricky. You want to be careful you don’t inadvertently increase risk. Utility stocks and government bonds, for instance, used to be the automatic place to hide.  Not anymore.  NextTera, a Florida utility, is more expensive at 24 times earnings than Apple!   As for Treasury bonds, their prices are the highest in history, their yields the lowest. No help there.

Earlier I spoke about excess.  Typically one thinks of stock prices through the roof.  But excess can cut the other way too.  I am thinking of excessive fear.  This is the case today in regard to just about any stock in the retail sector.  Investors are behaving as though Amazon will shortly be the only retailer left in America. Way over done. One idea is to buy shares in Tanger Factory Outlet Centers.  The stock is down 37% in the last year, despite earnings that are doing just fine, and a 4% dividend.  This looks like a risk-adjusted value a lot safer than old standards like utility stocks and government bonds.


Mark O’Brien



Inflation Quandaries

12 July, 2017 by Mark O'Brien in Commentary

Monday’s Wall Street Journal (July 10, 2017, page A2) contains a remarkable article. It is remarkable because it reveals the assumptions and attitudes of the experts who are trying to administer the global economy in which we find ourselves.

The headline of the article provides the background: “Weak inflation vexes Central Banks.”  Anyone who has followed financial news over the last 9 years knows that  central bankers in the developed world, including the United States, are trying to kindle a measure of inflation.  That’s because the economy has been anemic, if not stagnant, and the troupe of Keynesian and monetarist central bankers think that a little inflation will get things going again.   Problem is, there is no inflation, and the central bankers have no explanation why not.  According to their models, we should have lots of inflation but we have none.  Indeed, deflation and stagnation continue to dog their best efforts to the contrary.

Page three of our quarterly appraisal letter, which is today going into the mail to clients, and which is available to read nearby, discusses a curious parallel to this time.  For it is a matter of record that we in the United States have been in this place before.  In the late 1920s  the government’s efforts to promote inflation in the farm belt had the contrary effect, and for predictable reasons.   I urge readers to read the nearby account.  But the point I want to make here is a bit different than drawing an historical parallel.  It is about the assumption and attitude of the central banks, and those who cover their efforts in the press.

If a theory does not explain experience (and the current mix of Keynesian and monetarism does not), then you would think the theory is wrong, and people would recognize it, especially in the press.  That’s how it works elsewhere.    But rather than admit their kit of monetary and fiscal tools aren’t working,  the central bankers, and the press that cover them, wait for the people to start behaving the way they are “supposed to”.  As I said, this is a remarkable story.  One wonders how long it will take to scrap the tool kit.

The Bizarro Market in Europe

1 June, 2017 by Mark O'Brien in Commentary

The chart below is amazing.  It originates from Bank of America’s Merrill Lynch and shows the yield of European stocks currently exceeding the yield of European junk bonds.

So why do I think this state of affairs is “amazing?”  First there is one’s reaction or reactions.  In my case, at first blush, I wanted to run out and buy European stocks in order to collect the appreciation potential of stocks along with all the high current income of junk bonds.  It would appear to be the best of all possible worlds.  That was my first reaction.  My second reaction,  which emerged  upon further reflection, was one of alarm.

Several years ago we had something similar here in the U.S., when American stocks yielded more than government bonds.  I had never seen anything like that, either.  But this European situation is even more extreme. Junk bonds are not government bonds.  They are called junk for a reason.   And so “normally” they have to pay a huge yield premium to compensate investors for their inherent risk.  But now European junk bonds have tiny yields, even lower than those of common stock dividends.  To express it differently, in order to have such low yields, European junk bonds have to have  sky-high prices.  That is the way the bond yield/bond price dynamic works: low yields translate into high prices and vice versa.  I don’t want to get lost in an explanation of how bonds work.  For purposes of discussion here, it is enough to say that financial assets are out of whack in Europe.

It is one thing for central banks to prop up government bonds (that’s been going on for a long time), quite another for them to prop up the junk bond market.  And it is this course that the European Central Bank appears to have take. Two really big questions stand out.  First, how long can this buying go on?   Second, what happens when the central banks reverse course?  No one knows the exact answers to these questions, but it is save to safe this policy is high risk.

European Central Bank policy has many moving parts, though all are related to the lowest interest rates in 400 years.  In subsequent posts I’ll comment on a few of the consequences, intended and unintended, as I see them.

Thoughts on Our ‘Tranquil’ Markets

19 May, 2017 by Mark O'Brien in Commentary

“Investor fear gauge lowest since 1993,” said a recent Wall Street Journal headline (5.8.17).

While I am a tad skeptical about trying to quantify sentiment (what is an “investor fear gauge” anyway?), I am prepared to accept the central thesis that investors feel pretty good right now.  There was a momentarily blip when the market sold off on Thursday of this week, apparently in response to worries about President Trump.  But on Friday the sell-off reversed itself, and in any case,  corporate earnings for the first quarter 2017 are coming in at around 14% above the year-earlier period, which is respectable and certainly more than expected. Employment continues to tick up; the government sets the statistic at 95.6%, which is close to “full employment.”

To be sure, the government measures employment in funny ways (some would say phony ways), but there’s no denying the jobs picture is improving. As for stocks, they are not cheap, but neither are they off the chart, as they were in the late 1990s.  Nor are they gyrating in price, as often happens in times of speculation.  Said another Wall Street Journal article (5.04.17): “stock price volatility has vanished.”  Indeed, the apparent tranquility of the markets is remarkable, maybe even astonishing, given the rancorous state of our politics.

So what are smart-money investors doing in this time of tranquility? According to the Wall Street Journal and other financial media, many have been shifting money from U.S. stocks to European and emerging markets.  Since 2009, runs the rationale, U.S. stock prices are up a towering 165%, as compared to 100% for European stocks and a mere 75% for emerging markets. Now its time for emerging market and Europe to step out, goes the thinking, and the preferred vehicle is passive investments (index mutual funds and exchange-traded funds or ETFs), where you can own all the stocks in, say, Brazil, Russia, China, Germany, with the press of a button, at relatively little expense. “Now that growth is picking up around the globe,” says the cover of Barron’s magazine (5.15.17), “it’s time to start buying.”

Barron’s offers a shopping list of emerging-market index fund investments, which might well be a good speculation, and we would not hesitate to consider a few — in a limited sort of way, say 5% of assets. It is always good to have some place for lightning to strike. But anything more we would hold off. Rather we would use this time of relative tranquility to get to know even better the individual stocks we already own. Knowledge of a company’s business can give staying power when the storm comes — and it will.

2016 Year-End Market Review

9 January, 2017 by Matthew O'Brien, Ph.D. in Commentary

Below is a review of market sectors in the fourth quarter of 2016 jointly written by our investment team.



Energy stocks were the best performers for the year, posting gains of 25%.  In the fourth quarter, the energy sector was up 8%.  Over 100 oil and gas produces have declared bankruptcy since the beginning of the downturn in the energy sector, but prices appeared to have bottomed out in 2016 and are expected to be stable or higher in 2017.  Oil prices closed the year at $54/barrel; up from around $29/barrel at the beginning of the year, the biggest annual gain since 2009.  In September, OPEC announced plans to put a ceiling on production to reverse the decline in oil prices.  The coming year could be a good one for energy stocks, the companies who survived the downturn put dramatic cost reductions into place, so they are well-positioned for the recovery.  EOG Resources (EOG) is one of our best performing stocks for the year, up 42.47%.  It was up about 5% in the quarter.


Material stocks were up 15% for the year and almost 6% for the quarter.  The trough in the commodity cycle seems to have passed.  Rising commodity prices and an expectation for an increase in infrastructure spending are supporting prices.  Inflation tends to be good for material stocks as it increases the ability to lift prices.  Our lone material stock is Ecolab (ECL), a company that makes cleaning and water treatment products.  This material stock is more removed from the cyclical nature of materials and tends to have very steady growth.  The stock was up just 2.5% for the year.


Industrial stocks gained 18% for the year and nearly 8% for the quarter.  One of our best performing stocks was Cummins (CMI), up 55% for the year and 7% for the quarter.  Support for this strong rally came from increasing oil prices, strengthening mining activities, and Trump’s promises of higher spending on infrastructure.  The industrial sector has a positive outlook for 2017 if infrastructure and defense spending picks up as expected under the new administration.  Inflation is typically a positive for industrial manufacturers.  The recovery in the energy sector should benefit industrials, while a stronger dollar and weakness in Europe may be an offset.

Consumer Discretionary

In a year where consumer sentiment reached its highest level (in December) since January 2004, it’s a little surprising that Consumer stocks lagged the market, up about 3% for the quarter and 5% for the year.  Unemployment is low and wage growth has picked up, but there are a number of disruptive forces in the sector.  Increased price transparency as a result of online/mobile shopping has led to greater competition and lower margins.  We sold out of Magna International, a maker of car parts, out of concern for the automotive industry, which faces multiple headwinds:  Rising oil prices and higher interest rates tend to be a drag on auto sales and higher material costs may price many customers out of the new car market.  Our best performing consumer stock was Priceline (PCLN), up 16% for the year.  Travel-related stocks seem to be a good place to be.  Disney (DIS) was flat for the year after recovering 13% in the fourth quarter.  In terms of large purchases, consumers tend to be leaning toward the purchase of a new home:  Rising interest rates and increasing home prices seem to be pushing potential home buyers to take the plunge and buy a home.  In general, the housing market is considered strong right now.

Consumer Staples

Consumer Staples stocks were down about 1% for the quarter and are up just 3% for the year.  Part of the weak performance in Consumer Staples stocks may be a good sign:  Investors showed a willingness to rotate out of defensive, income-oriented stocks and into more cyclical companies like oil and industrials.  There were real reasons for weakness, too:  Many consumer staple stocks are large multinational companies with a large portion of sales from abroad.  A stronger dollar and relatively weaker growth outside the U.S. hurt companies like Nestle (NSRGY), for example, which was down about 5% for the year.  A shift in U.S. consumer appetites toward organic, whole foods is also a headwind for makers of processed foods.  Also, rising rates puts pressure on richly valued dividend-paying stocks in the sector.

Health Care

Health Care stocks declined 3% for the quarter and 4% for the year.  The unsustainability of escalating health care costs and concerns regarding the future of health care policy in the U.S. have put pressure on the sector.  Tenet Healthcare (a large operator of hospitals) was down 25% the day after Trump’s election on concerns regarding the potential repeal of Obamacare.  Once the dust settles, this sector could see a recovery in 2017 driven by aging demographics and new products.  Some of these products include transcatheter heart valves ; medical devices that continuously monitor glucose levels, and biotherapeutics.  Lighter regulations under a Trump administration and corporate tax reform could be positives for many companies in the sector.  Since the stocks did not participate in the recent run-up there are some comparably good valuations in the sector.  Johnson & Johnson (JNJ) was our best health care stock for the year, up 12.43% (but down 2.23% in the fourth quarter).


Financial stocks have been on fire since Trump’s election.  As a whole, financial stocks were up about 22% in the fourth quarter (and 20% for the year).  Goldman Sachs has been the big winner since the Trump election (up over 30% since early November).  The Trump White House includes many ex-Goldmanites including Treasury Secretary nominee Steven Mnuchin and Gary Cohn, picked as chair of the National Economic Council.  Northern Trust (NTRS), a relatively new purchase, is up about 30% in the fourth quarter, too.  Discover Financial (DFS) was up 27%.  The general hope is that rising rates and deregulation will benefit banks.  Trump vowed to dismantle Dodd-Frank; the increased cost of compliance has been especially burdensome to smaller banks.  At this point, the expectations have been set so high and the pressure to outperform is so intense that it might be a good time to be cautious in this sector.  Furthermore, Trump’s promises included re-regulation of banks in some respects as well, such as re-establishing the Glass-Steagall separation between investment and commercial banking.

Real Estate

Here’s another curiosity:  Trump will be the first landlord in chief, but real estate stocks tumbled 7% in the quarter and are down 2% for the year.  Bond yields have gone up, which makes high yielding stocks less attractive.  But there are reasons to like Real Estate:  Rising business confidence and the potential for lower tax rates and fiscal stimulus are good for both office properties and multi-family/apartment buildings.  The REITs we own have done exceptionally well, particularly compared to the sell-off that many REITs experienced in the second-half of 2016: Digital Realty Trust (DLR) is up 30% for the year and 1% for the quarter.  Tanger Factory Outlets (SKT) is up 9% for the year and 3% for the quarter.

Information Technology

Technology stocks were up about 3% in the fourth quarter and 14% for the year.  It was an especially good quarter for Automatic Data Processing (ADP), which was up 17%.  The company benefits from higher interest rates and stronger job markets.  Apple (AAPL) was up 3% in the quarter and 7% for the year.  Services such as Apple music, Apple Pay, and iCloud back-up experienced strong double digit growth in the prior year.  It’s hard to believe, but the New Year brings the 10th anniversary of the iPhone.  Something else that may benefit Apple shareholders in 2017:  Tax reform may incentivize companies like Apple to give foreign cash back to shareholders through increased dividends or share buybacks.  Microsoft (MSFT) had a good quarter up 8% and (and up 12% for the year).  The company acquired LinkedIn for $26 billion.  Trends in tech include:  cloud computing, big data, artificial intelligence, the Internet of things.  Tech stocks have record cash generation and record levels of cash on their balance sheets.  Merger and acquisition activity has been accelerating especially in the software and semiconductor industries.

Telecommunication Services

Telecommunication Services were up 7% for the quarter and 19% for the year.  Verizon (VZ) our largest telecom holding was up 3% for the quarter and 16% for the year.  The big trend in the sector has been the race for content that began when Comcast announced its intent to purchase NBC in 2009.  Verizon announced its acquisition of AOL in 2015 and Yahoo in 2016.  AT&T joined the party in October by announcing its acquisition of TimeWarner.  As subscriber growth has slowed and further consolidation within the sector has run into antitrust troubles, telecom companies are seeking growth through using their extensive networks to enter new industries.  Live video streaming and augmented reality games like PokemonGo have been driving the demand for high quality mobile phone service.


Utility stocks were down 1% in the fourth quarter, but up 13% percent for the year.  Utility stocks shined during the year as investors sought out safety and income.  The Trump election has significant consequences for the energy and utility sectors.  The difference between Trump and Obama may be most extreme in the energy and environmental fields.  Some of the clean energy trends will likely persist due to improving technologies, declining prices, and ongoing state/federal incentives.  All of the major utilities have expressed the commitment to renewable energy, and tech giants, including Apple, Amazon (AMZN), Alphabet (GOOGL), and Microsoft (MSFT) have pledged to consumer nearly all electricity from sustainable sources.

Trump promised to put coal workers back to work, but he is more likely to do so by encouraging infrastructure (coal is used to make steel) or by encouraging the export of liquid natural gas (which could drive up the price of natural gas and make coal more competitive).  Right now, no major utilities have plans to build coal plants, but this is largely because of the availability of cheap and abundant natural gas.   Even though the trend is away from coal for electricity generation, coal still makes up 40% of the world’s energy mix.  Carbon capture and storage remains an elusive technology.

A Trump administration will likely reduce regulation for the sector. Trump’s EPA pick, Scott Pruitt, fought to overturn the Clean Power Plan, which faces a Supreme Court Challenge (and could easily now die in court).

A Final thought on Earnings and Stock Prices

In a short while, 4th quarter earnings for 2016 will come into focus.  Overall earnings for the S&P 500 companies are expected to be up 3.4% year-over-year on 4.1% higher revenue.  For the year ahead, Wall Street analysts are predicting strong earnings growth across sectors (up about 12% in 2017 on 5.6% higher revenue). These are good numbers and cause for hope.  At the same time, sell-side analysts are naturally optimistic, and one must understand that earnings alone do not determine the direction of asset prices, at least not in the short run.  Higher earnings are better than not, but there are no guarantees in this business.

 Comment on Bonds and Interest Rates

A relative of one of us reported over New Year’s  that the rate on his adjustable-rate home-equity mortgage just reset.  His old rate, which was in place for a period of years, was 2.74%; the new rate is 7.05%. Wow!

After 30 plus years of falling, interest rates appear, finally, to be moving in the other direction.  The yield of the bellwether 10-year Treasury bond was 2.27% at the start of 2016.  It got as low as 1.36% in the summer, which may mark the turning point.  By year-end the 10-year Treasury yield stood at 2.47%.  The latter is still very low compared to the historical average, which is in the 5% range.  How long will it take interest rates to return to normal?  Will they overshoot the mark on the way up?  Will they snap back and go “lower for longer”?  No one knows and it is a fool’s errand to try.

So long as bonds generate inflation-adjusted or real income and have a fixed and certain maturity date, they belong in most portfolios.  We intend to conduct our bond investing in 2017 with a continued emphasis on quality (A-Rated and better) and laddered maturities.  The advantage of laddered maturities is that every year a bond comes due and the proceeds can be invested at the new and  higher level.  The advantage of high quality is you can worry about something else.  Bonds should reduce risk; they are the ballast that lets you put on sail with stocks.

Sally Sulcove, CFA, CPA
Mark B. O’Brien
Matthew B. O’Brien