Thus far in 2014, the broad equity and bond markets seem to be acting reasonably well on the heels of such strong performance last year. Clearly, there is a lot of information for investors to consider and digest and so far, it seems the markets are taking these considerations in stride and very simply consolidating last year’s remarkable gains at or near the highs. To the extent this pattern continues and some of the concerns facing investors can be settled, it’s quite conceivable that prices could work higher later this year from a continually improving macro-economic environment in the U.S.
In our view, the biggest factor the markets seem to be processing is the new Chairwoman of the Federal Reserve, Janet Yellen. So far, Ms. Yellen has continued to lead the Fed in a similar direction as her predecessor by continuing the Fed’s Quantitative Easing tapering program. Under her leadership thus far, the Fed has given no indication that the Fed might alter the pace of reducing its bond purchases (currently set at $10 billion per month) with the intent of fully winding down the QE program later this year. While many had postulated that removing such a large buyer of US treasury and mortgage debt would necessitate higher interest rates, we have been more skeptical. Our belief is that the biggest reason interest rates have remained low and relatively stable in spite of the Fed’s buying contraction is quite simply that the supply of new debt is also contracting. Keep in mind, the US deficit has fallen dramatically in the last few years, from $1.6 Trillion in Q4, 2008 to less than $500 Billion currently. Further, the GAO has revised its projections such that Federal government will operate at a surplus for the next few years should the US economy continue to improve. Assuming the Federal government can continue to work towards a balanced budget, we believe interest rates should remain remarkably low for at least the foreseeable future.
Another big factor that we are seeing in several Q1 earnings reports lately is the impact of the particularly harsh winter throughout the country, with the exception of the far western states. The hard winter seems to have negatively affected many of the transportation companies, particularly railroads, and construction related firms. However, it also seems to have only delayed a lot of economic activity by a few months as a lot of backlogged activity seems to now be catching up. For this reason, it will be important to balance what may be a misleadingly strong Q2 against the seasonal weakness from Q1 to try to derive an accurate annualized estimate of economic growth. At this point, we seem to be pretty close to consensus in looking for US GDP growth this year of 2 - 2.5%. However, our bias given the low interest rate environment is to raise that projection depending on how Q2 performance comes in.
Finally, there is a lot of concern over Russia and its intentions towards Ukraine. Unfortunately, attempts to handicap these types of geo-political events are usually pointless because too often irrational actors are involved. For instance, in the Russian-Ukrainian case, our tendency would be to recognize that in the current global economy, there is no rational reason for Russia to annex any more territory in Ukraine. From a political and economic perspective, both sides are better off engaging in mutually beneficial trade agreements, likely along the lines of energy (Russia) for agricultural goods (Ukraine). However, in Vladimir Putin, we may have an apparently irrational actor who either doesn’t understand the economic ramifications of an invasion (both in terms of lost economic opportunity, but also from international sanctions) or simply doesn’t care about the ramifications.
Consequently, in such an irrational situation, we prefer to consider the most likely worst case scenario and step back from there. Applying that logic, our sense is that Russia will likely invade Eastern Ukraine in the coming weeks under whatever nonsensical justification Putin wants to apply. On a positive note, such a move would actually do more overnight to unify the rest of the EU than the past 14 years of Maastricht Treaty negotiations. There would likely be a quick market selloff response, however, we don’t feel any selloff would be very big and would likely be very short-lived as the markets have had weeks to price in the likelihood of a Russian invasion. In addition, neither Ukraine nor Russia are particularly significant trading partners with the US. Any selloff would likely be a simple emotional response, which is usually reversed pretty quickly.
The larger impact would obviously be to Europe and the broader region’s GDP. For that reason, we did sell a portion of your Ford Motor Co holdings recently, which is the only holding with any significant operations in Europe. We’ve also refrained from adding any European holdings, in spite of an otherwise improving economic climate there.
Our feeling is that if Putin advances into Eastern Ukraine, Russia will be limited from moving beyond the Eastern regions as Europe and the US would impose very harsh economic sanctions on Russia, which would likely include frozen Russian assets. In addition, there could very well be political/military ramifications that could see Western Ukraine, which includes the very pro-European Kiev, negotiating with the West for NATO inclusion. Under those sorts of unifying conditions, it’s difficult to imagine Putin wanting to push any further west. We believe, if he still has an appetite for expansion, he would probably turn his sites to the former Soviet states in central Asia.
So that leaves the US markets trading at price levels near all-time highs (and very reasonable forward valuations) in spite of a new Fed Chairwoman, weak industrial earnings from the harsh winter, and a contentious geo-political scene. As these issues resolve themselves in the coming months, and Congress sits idle ahead of the mid-term elections, we get a real sense that markets could resume the secular bull market later this year. In spite of the above tenuous conditions, which have acted upon investors to favor more value-oriented stocks recently instead of some of the growth-oriented companies you own, we continue to favor these companies. We are continuing to hold these companies, such as Celgene Corporation, Gilead Sciences, Amazon.com, Netflix, and 3-D Systems under the expectation that investors will once again seek out such great growth stories once their confidence is restored.
As always, please feel free to contact us if you have any questions or if you need to schedule an appointment to discuss your account or financial plan with us. This is particularly important if you have experienced a big change in your life recently (got married, retired, changed employment, bought/sold a business, etc.).
2013 Form ADV Notice and Offering – the firm’s 2013 Form ADV Part 1 & Part 2 filings with the State of Colorado Division of Securities and other regulatory bodies were filed timely on 3/31/2014. There were only minor modifications to the prior filing made in 2013. However, if you would like a copy of this important disclosure document, please contact us at (303) 442-3670 or email@example.com and we will be happy to deliver it to you at no charge.
Mark P. Culver
Culver Investment Company, LLC
360 Interlocken Blvd
Broomfield, CO 80021
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