Exit Stage Left


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Jason Norris of Ferguson Wellman

by Jason Norris, CFA
Executive Vice President of Research

Exit Stage Left
Wednesday’s release of The Federal Reserve’s meeting minutes raised more of a hawkish tone. On the surface, the minutes may be viewed as negative; however, due to an improving labor market and an indication of a better growth environment we would welcome an increase in the Federal funds rate next year. As expected, the Fed did formally end its quantitative easing (QE) program with its final active purchase of mortgage-backed securities and government bonds. This is a positive sign for the equity markets and the U.S. economy at large. Coincidentally, U.S. Gross Domestic Product (GDP) data was released this week showing a solid 3.5 percent growth rate, which was better than most expectations. Our forecast has been for the U.S. economy to pick up steam throughout the year, and this data has confirmed that call. This information has supported stocks, yet it has a minimal effect on the bond market with the 10-year treasury yielding 2.3 percent.

Third quarter earnings reports have reinforced our belief of continued economic growth. Seventy percent of the companies in the S&P 500 index have reported earnings to date and the results have shown year-over-year earnings-per-share growth of nine percent and revenue growth of four percent. Healthcare and technology companies have led the way with higher reporting of 11 percent and nine percent top-line growth, respectively. These are two sectors we favor in our equity strategies. These positive earnings reports have enabled stocks to reclaim their footing in this bull market. From the recent all-time high in September, the S&P 500 fell 10 percent over the subsequent four weeks. However, in the last two weeks we have seen a nice snap back with equities sitting just below the record of 2020 set on September 19, 2014. At current valuations (the market is trading 15.5x forward earnings) and with the strong earnings we are witnessing, we continue to favor stocks over bonds.

Different Stages
The quarter’s earnings season has not been friendly to the higher growth, momentum stocks. Last week Amazon “cautioned” investors that they are going to reinvest more money into “growth”. Historically, this wouldn’t have been viewed very negatively but it seems investors may be getting impatient for their return on investment as the stock declined by almost 10 percent. Over the last 10 years, Amazon’s profit margins have fallen from six percent to under one percent, while the stock has been a stellar performer. It looks like investors are shortening the leash. Twitter suffered a similar fate this week. Twitter’s growth metrics (advertising, users, etc.) were disappointing, resulting in a 20 percent decline this week. The overall growth of the company is still strong, but investors may be getting anxious when they are paying over 100x future earnings. While many of us are big users of both of these companies’ services that does not make the underlying stock a great investment. Investors need to make sure that the price they are going to pay for future cash flows allows them to earn a competitive return. We just don’t see that in these two names at this time.

Our Takeaways for the Week: 

  • U.S. economic growth is improving which will lead to the Fed raising the funds rate earlier rather than later
  • Third quarter earnings growth is healthy which supports a reasonably valued equity market


Fourth Quarter 2014 Investment Outlook Video: Not Too Hot, Not Too Cold


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We are pleased to present our Investment Outlook: Fourth Quarter 2014 video titled, “Not Too Hot, Not Too Cold.”

This quarter, Chief Investment Officer George Hosfield, CFA, addresses the factors contributing to recent market volatility and what that means for our outlook going forward.

To view our Investment Outlook video, please click here or on the image below.


CPI: The Underestimation of Inflation?


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Furgeson Wellman

by Brad Houle, CFA
Executive Vice President

Inflation is an obtuse concept to fully comprehend. For the month of September, the Bureau of Labor Statistics indicated that the rate of inflation, as measured by the Consumer Price Index (CPI), was 1.7 percent for the last year. This would hardly be considered a noticeable price increase for most items. As a consumer, it seems that everything other than flat screen televisions is more expensive all the time, particularly if you consume prescription drugs, go to the doctor or pay for any type of tuition.

It is a fairly consistent complaint among the investment community that the CPI understates the rate of inflation. In fact, there are often conspiracy theories around the measure of inflation because the CPI is the basis for cost-of-living increases for Social Security recipients and other government payments to individuals which is consuming an ever greater percentage of the national income.

In looking at the detail of how the CPI is calculated, it is apparent that a great deal of thought went into the methodology while its value in measuring the true rate of inflation is questionable. As for the conspiracy theories around the inflation measure, it is unlikely that a giant bureaucracy is organized enough to pull off anything like that. No doubt well-meaning people work hard to produce these statics.

Too much or too little inflation is a bad thing. Excess inflation, such as was experienced in the late 1970s in the United States, or hyper-inflation that often occurs in developing nations can create an environment where costs spiral out of control. Conversely, negative inflation or deflation is also a troublesome scenario. In deflation, prices continually drop and as a result, consumption also goes down as consumers wait for lower prices. Japan has suffered from this condition to some degree for the last decade and is attempting to climb out deflation via aggressive economic stimulus.

Following aggressive monetary policy action taken by the Federal Reserve following the financial crisis, there was great concern that excess inflation would follow. Thus far, there has been no excess inflation despite the flood of liquidity put into the financial system to stimulate the economy. In fact, inflation is below where the Fed would like to see it. The Fed’s preferred measure of inflation called the PCE Deflator which last month has a yearly increase of 1.5 percent and generally is lower than the CPI. The primary difference between the two measures of inflation is the PCE Deflator allows for the substitution of goods by consumers. The Fed would like to see the PCE Deflator closer to 2 percent.

Unemployment_10_24_14The attempt to control and measure inflation produces more questions than answers. Inflation is very difficult to quantify and measure. There is no such thing as an average consumer and people are going to experience inflation very differently depending upon their stage in life and level of income. We believe that inflation is muted due to the long, slow recovery we’ve experienced since the financial crisis. The slack in the labor market and broader economy is just now beginning to get wrung out.

Our Takeaways for the Week

The equity markets were strong this week, up around 3 percent as we move through third quarter earnings season. According to data compiled by Bloomberg, about 79 percent of S&P 500 companies that have posted quarterly earnings this season have topped analysts’ estimates for profit, while 60 percent beat sales projections. In addition, the hysteria around Ebola now being called “Fearbola” has hopefully subsided.




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by Shawn Narancich, CFA
Executive Vice President of Research

Up, Down & All Around

Hello, Volatility. After having very little of it for nearly two years, stocks and bonds rode a roller coaster this week on trading volumes that exploded to the upside. Investors were forced to come to grips with how much could have really changed in such a short period of time. In our view, not nearly as much as the markets would imply. But whatever your persuasion on the topic, what we witnessed this week is exceptional. Blue chip stock gains for the year evaporated Wednesday on nearly 12 billion shares traded and benchmark 10-year Treasuries surged on decade high volumes, all in a remarkable flight to quality bid driven by concerns about a weaker Europe teetering on the edge of recession, plummeting oil prices, and concerns about Ebola. That markets promptly reversed themselves mid-week and stocks moved back into positive territory for the year is a testament to what we believe are still solid fundamentals for the U.S. economy. Healthy levels of job growth, slowing inflation aided by lower energy prices, and newly diminished interest rates that should help extend gains in housing activity all argue for domestic economic growth of 3 percent or better in the second half of this year.

Black Gold?

Unusual markets sometimes elicit misleading interpretations, and no shortages of would-be pundits have attempted to explain a 25 percent free-fall in oil prices since the summer solstice. The Wall Street Journal, as much as we read and respect this quality newspaper, did readers a disservice by proclaiming on Wednesday’s front page banner: Global Oil Glut Sends Prices Plunging. What we observe is that developed market inventories of the black stuff now stand below five-year average levels and, despite the International Energy Agency’s recent minor 200,000 barrel/day reduction in expected global demand for this year, the world is still using more oil than it ever has.

Yes, Chinese demand growth has slowed, the U.S. energy boom has added new production to a global oil market, and OPEC member Libya’s exports have risen by about 500,000 barrels/day recently, but all the hub-bub about swing producers Saudi Arabia, Iran, and Iraq (combined export volumes = 15.5 million barrels/day) cutting official selling prices is nothing more than these countries acceding to recently lower prices on stable sales volume. Although oil demand is unquestionably tied to economic growth, which recent developments have called into question, we still see growing demand for oil tied to what we believe will be record levels of economic output globally. The lack of any smoking gun supply surge and evidence that hedge funds have been exceptionally active in trading oil contracts leads us to conclude that the downside in oil has been more about speculation than physical supply and demand. As seasonal refinery maintenance concludes and crude demand rises into winter, we expect oil prices to climb out of their hole in the low $80’s.

And They’re Off. . .!

Third quarter earnings season has begun and results from the 50 or so companies that have reported to date have been relatively encouraging. Banks like JP Morgan and Citigroup are beginning to benefit from rising loan volumes and higher trading volumes in fixed income, currencies, and commodities, while benchmark industrials like GE and Honeywell are demonstrating the ability to navigate a stronger dollar environment without reporting excessive hits to the bottom line. In part because of the industrials’ foreign currency exposure, investor expectations for earnings in this group were muted into earnings season, so decent results are being met with enthusiasm. Next week the floodgates will open wide, as hundreds of additional companies across industries come to the earnings confessional.

Our Takeaways from the Week

  • Modest losses in the stock market belie what was one of the most volatile and actively traded weeks in recent times
  • Third quarter earnings season is underway, and results so far are encouraging