The second quarter of 2015 exhibited a shift in performance as stocks fell to the point where year-to-date returns are minimal. The Dow Jones Industrial Average is down 1.14% while the more forward-looking Dow Transportation Average is down 11.46%. High dividend paying utilities have declined 10.96% so far this year. The technology laden NASDAQ 100, buoyed by a plethora of new companies issuing stock, rose to an all-time high by gaining 3.79% so far in 2015. The small-cap index, Russell 2000, also attained a new high, up 4.09% over the first six months.
Overseas, China’s stock market continues to be a roller coaster ride, losing 20% over the last month but still reporting a 25% gain year-to-date. The Chinese government is encouraging its citizens to become involved in their equity markets but their experience is quite limited. The Asia-Pacific markets as a whole have gained 7.1% in 2015 with Japan, benefiting from its central bank’s torrent of money production, leading the pack, up 16.5%. The more circumspect Singapore markets are down 1%. In Europe, Germany continues to show strong stock market gains in their local currency, though for US investors, the appreciating dollar has offset most of that increase. German stocks are up around 4% in US dollar terms.
Most high-quality bonds have lost money in 2015. US corporate bonds are down 1% overall with long-term bonds, those maturing in 10 years or more, down almost 5%. Municipal bonds are down around ½ of 1% while global government bonds have declined about the same amount. Interestingly enough, emerging market government bonds have increased in value 2.3% while junk bonds are up between 2% and 4% as investors continue to search for yield, ignoring the risks associated with that sector. The European Central Bank and the Bank of Japan continue to create new bonds in order to subsidize their economies. This in turn has pushed their currency values down, making it easier for their domestic industrial companies to export to the United States.
A long list of woes faces stock market investors: Greece, lower corporate earnings, and a shrinking US economy during the first quarter. Many investors expect the Federal Reserve to raise interest rates later this year and that is keeping expectations low for stock returns. The Standard & Poor’s 500 fell .2% during the second quarter after nine consecutive previous quarters of gains.
Many highly respected investors are warning about the general market’s overvaluation. Carl Icahn has been sounding an alarm for over a year now, echoing our comments that the Fed is flooding the market with cheap money resulting in overvalued stocks. He also points to high-yield bonds, which did well during the first six months but are clearly in a potentially dangerous bubble. Warren Buffett and hedge fund manager, Paul Singer, have agreed with Icahn’s comments, and even the Fed’s chairwoman, Janet Yellen, has expressed warnings about stock valuations being quite high. The largest US companies’ stock prices are now at their most expensive level since 2004.
Precious metals overall declined 8.2% during the first part of 2015 while commodities as a whole are down around 1%. Crude oil actually has made a small recovery, up 7% since the start of the year, but natural gas is down 4%. Gold is only slightly down at -1.26%.
The main focus of US economic policy makers is now on employment levels. One major conundrum they face is that after six years of a lackluster economic expansion, hiring is strong but wage growth is weak. This has resulted in millions of job seekers staying on the sidelines and forced others to stop looking for work. The well acknowledged widening of the income gap between wealthy asset owners at the top and wage earners on the bottom and middle rungs of the economic ladder is now a strong incentive for many state legislatures to consider increasing the minimum wage level. Overall, the US unemployment rate fell to 5.3%, the lowest level since April 2008. However, there were a declining number of Americans participating in the labor force. It is estimated that around 2 million people are so discouraged that they are no longer actively looking for work.
The statistic that tracks this aspect is called labor force participation. It declined to 62.6%, the lowest level since 1977. Wages are up slightly, around 2%, in line with inflation expectations, but many workers have seen little or no change in their take home pay since 2008 due to increased pay-based taxes. Businesses often cite the increased cost of healthcare and other regulations as reasons they cannot raise salary levels. New jobs being created are about 50% in retailing, healthcare, and leisure/hospitality. The Federal Reserve previously targeted an unemployment rate around 5.5% before it would initiate its first interest rate increases, but it is now constrained by low-inflation and lack of growth in pay levels.
It may not seem like much of an economic expansion to many of us but according to government statistics, we are about to enter into the longest economic expansion since 1854. It just goes to show that beauty is in the eye of the beholder! The rapid and so far persistent decline in the price of oil has helped consumer sentiment, though much of the savings from lower gasoline prices has gone into paying off debt as opposed to increasing consumer spending. People who are worried about their future earnings potential have chosen to improve their credit scores and not buy more expensive homes. Sluggish manufacturing activity, due to the strong US dollar, has made some economic forecasters doubtful about the likelihood of another recession occurring here anytime soon, and predictions are for a mild one when it does come.
Due to the weak economic activity in the 1st quarter of 2015, it is likely that when the Fed does eventually raise rates, it will do so gradually. A return to normal interest rate levels from the artificially low rates of the past eight years will take a very long time. Economic and or political upsets in other parts of the globe could derail the Fed’s planned normalizing activities. Central bank stimulus is still the bedrock on which the world’s stock markets depend and hopefully, most investors who are in the stock market know this to one degree or another. Much of the confidence people have in stocks depends on ever rising profits. Investors having the best access to information, such as private equity firms, have begun to cash out. Bond markets are often the first to signify future trouble and we have seen several articles about the lack of liquidity in government bond markets in the US and Europe. This could make for some very volatile market action and is a contributor to our strong feeling that raising and keeping cash on hand is a priority.
Gold is much despised these days and it may well be subject to more price downward pressure over the next six months. Precious metals do serve as insurance against geopolitical risks. We look to gold-mining stocks as providing an extremely cheap way to own gold and also receive a healthy dividend.
Europe and China
Some of the economic risks most challenging to Europe originate in other parts of the world, and these continue to increase in 2015. China’s economy has slowed sharply and if this persists, which is likely, it could be a big problem for Europe which relies heavily on trade with China. Any devaluation of the Chinese currency would hurt Europe as well because it depends greatly on Asia as a whole to provide a destination for its export goods.
The prospect of defaults in Greece and Puerto Rico are interesting to compare. The size of Puerto Rico’s economy, compared to the United States, is similar to Greece’s size in comparison with the rest of Europe. The governor of Puerto Rico has asked Washington to allow it to file for bankruptcy which if it happens, would be the largest municipal bond default in history. Puerto Rico is highly dependent on government spending, and it is losing ground each year due to waste, inefficiencies and an outward migration of talent to the continental US. This sounds like Greece, which faces similar problems, but Greece has a much more complicated political matrix to navigate than does Puerto Rico.
Greece represents only 3.2% of the European Union’s population and about 1.5% of its economic output. A Greek departure from the European Union would cause some disruption in the short-term, but the Eurozone is probably stronger without Greece than with it. There is a political problem, however, which is that other countries would look at the benefits the Greeks might receive from departing and consider defaulting as well. Spain, Portugal and even France might be tempted which would spell the end of the European Union experiment. This is why European leaders will likely bail out Greece, even after defaults and lack of reforms.
Europe faces external threats from Russia and the Middle East, alongside the rise of extremist right-wing nationalistic parties who are vehemently opposed to further immigration. Greece is the underbelly of Europe and represents a potential strategic foothold, both economically and militarily, for Russia. The Greek population is suffering greatly from the austerity programs and nothing is likely to alleviate their problems. One possible compromise is to float a special form of Greek money, which would need to be backed by the rest of Europe but priced on its own to give Greece a chance to devalue against the rest of the world. This would help Greece’s export and tourism businesses. The short spurt of growth the Greek economy might experience upon implementing a new plan would give them some flexibility and control over the pace and severity of reforms that the rest of the euro zone feels it needs to impose on them. No matter what happens, it’s going to be a rocky road for the next few years. We wish the Greek people well and sympathize with their predicament.
Upcoming events and Personnel news
Rob: It’s been a hectic few months here in NM with lots of changes. Everything is unfolding well, especially our summer garden which is quite lush due to the El Nino rains. Robyn is living in Southeastern Mexico, close to Belize and Hannah is focused on chemistry and anatomy, as she prepares to apply to schools in Oregon.
Jeff: I am slowly recovering from the surgery to repair the rotator cuff tears in my right shoulder. At least I don’t have to wear the arm sling anymore. I go to physical therapy twice a week and that is no fun at all. I can raise my right arm up to about eye level, and that’s it so far. My daughter, Stephanie, recently returned from attending the Oklahoma Horseshoeing School and she is already being kept very busy with requests for trimming and horseshoeing.
Lauren: This spring was quite busy with travelling including trips to San Francisco and Yosemite National Park, both for the first time. The first night in Yosemite, we had an unexpected snow storm and were able to experience several seasons in just a few days. When I returned to Santa Fe, I made some time for a couple extra days off to work in my weaving studio and finish some ongoing commissions. The extra rain that we have been getting this season has made for a successful small garden at my house and I am looking for another round of planting in the next several weeks.
Kyle: It has been a good start to the summer and I have been enjoying spending a majority of my free time outdoors attending community events, camping, and swimming with the family. Later this summer I will be taking a trip to New York for an intensive course on corporate valuations. Although I enjoy the lifestyle New Mexico offers, it will be good to get my fill of city life for a few days.
Dana: This is the time of year when conversations turn to gardens. Let’s just say that mine is decidedly Santa Fe au natural which means my main activity is pulling weeds. I’m not complaining though because there is a lot of forage for the bees this summer. Despite the fact that all three hives swarmed early on, there has been ample time for them to build up honey stores. I expect a decent harvest sometime in August.
Local tea and conference call in dates
The next Rikoon Group gathering will take place at our offices at 2218 Old Arroyo Chamiso in Santa Fe on Wednesday, August 19th at 3:30 pm. Please bring a friend or anyone you think would benefit from participating in this open ended review that Rob hosts quarterly in regard to the markets and the economy. The next day, Thursday, August 20th, our quarterly phone conference will take place at 3:30pm MST. The call-in number is 1-626-677-3000 and the Access Code is 425993#. Please email us before the call if you want Rob to respond to your particular questions or areas of interest.