Q3 Market Commentary. HCM News. By Matthew Cheney, CFP

Transcription

1 HCM News October 2014 Q3 Market Commentary By Matthew Cheney, CFP 230 Schilling Circle, Suite 234 Hunt Valley, MD (410) (855) To-Horan horancm.com As always, please call our client service team at (855) To-Horan if you have any questions. Our Maryland Office 169 Indian Mound Trail Tavernier, FL (561) (855) To-Horan horancm.com Florida Office representatives can also provide you with up-to-date information about your holdings and discuss any changes in your personal After a strong second quarter performance, the market appears to have tread water in the most recent quarter, gaining 1.3%. We saw some reversals in the market brought on by geopolitical issues, uncertain business outlook in Europe and questions over interest rate guidance by the Federal Reserve. Despite the slim performance in the quarter, the S&P 500 has still posted a gain of 8.34% through the first three quarters of the year. In our opinion, the fundamentals still support stocks for the long term. News from across the pond has weighed on the domestic market and concerns of a spillover from poor economic conditions in Europe could derail the momentum. Tensions flared in Eastern Europe and the Middle East, with ceasefires ultimately being reached in the Israel/Hamas and Ukraine/Russia conflicts. The rise of ISIS has drawn the US back into conflict in the Middle East and the response so far has only slowed the territorial gains of the terrorist organization. Meanwhile, Italy and France have seen their economies enter a recession and Germany has seen a slowdown in economic growth. Attention continues to be paid to the Federal Reserve and when they will raise interest rates. While it appears they will continue to remain accommodative in their policy, there are the occasional conflicting signals. The Federal Reserve is approaching uncharted territory as they seek an exit strategy from their stimulus efforts and easy monetary accommodations, the question being can they achieve a soft landing. We do not expect a shift in interest rates until sometime in The headlines of financial news publications devoted a lot of coverage to the valuation of the market. The five year bull market continued to hit new highs and the S&P 500 crossed the 2,000 mark for the first time. Warren Buffett made recent comments which go right to the heart of those concerns about the market being topped out and our investment philosophy. He was asked why he does not get bothered by volatility in the stock market and he responded, I have no idea what the stock market s going to do tomorrow or next week or next month or next year. I do know it is going to be higher ten years from now. He went on to say, If you re going to try to buy and sell them [stocks] based on news or something your neighbor tells you, you re probably not going to do well. Find a good bunch of businesses and hold them. We devote all of our time to searching for and investing in good, quality businesses which we believe will compound over time. By filtering out the headline noise and focusing on factors that truly affect the value of a business, we will continue to grow and preserve your wealth. financial situation.

2 Valuation Perspective By John G. Heinlein The benchmark S&P 500 index ended the quarter trading at 17 times trailing earnings and a little less than 16 times estimated 2015 earnings. These valuations are in line with historical averages, so from a PE valuation standpoint, the overall market looks fairly valued. This does not mean there are no opportunities, but bargains are harder to find, especially when you consider the market has risen every year for the past five years. One issue that paints a negative light on using the PE ratio to judge the market s valuation is the earnings side of the equation might be inflated due to historically high profit margins. If we assume margins return to their historical norm (mean reversion), then the earnings would be much less and thus the PE would rise to a level that would indicate an over-valued market. However, there is a growing camp who believe profit margins should be structurally higher due to the advances in technology and future profitability will be permanently higher. At Horan Capital Management, we tend to side with the mean reversion camp since we are conservative by nature and rarely do we find that things are different this time to be true. The concern of historically high profitability has been talked about in many of our newsletters over the past few years and we are very aware of the potential for profit margins to decline to their historical average. We pay special attention to the profitability of the companies we We are long term oriented, focusing on business valuations and taking advantage of market swings. own and try to make a conservative estimate of future profits when judging return potential and investment merit of owning the shares. When you look at the merits of investing in stocks versus bonds, stocks look very attractive on a relative basis. The 10-year government bond ended the quarter yielding 2.38%. Thirty percent of the companies in the S&P 500 yield more than the 10-year and when you add the potential 5-8% growth in earnings over the next ten years, it appears much more attractive on a total return basis. While inflation is relatively tame at this point, we believe owning stocks is the best protection against future inflation. The reason being, inflation generally benefits companies over time as it helps grow their profits. While the costs to produce their goods rise, these increased costs are added to the selling prices which in turn lift their revenues and bottom line. With the market arguably at a full valuation, it is not surprising volatility has increased recently. We are not market timers nor do we pay attention to macroeconomic forecasting when making investment decisions. Instead, we are long term oriented, focusing on business valuations and taking advantage of market swings. 2

3 Portfolio Activity By John G. Heinlein John G. Heinlein Managing Director and Chief Investment Officer The following discussion mentions stocks that are widely but not universally held by clients of Horan Capital Management. Client portfolios are customized, so this commentary may or may not be directly applicable to any given client or account. Our intention is to provide general insight into portfolio holdings and into our overall approach and to highlight situations of interest, both positive and negative. The mention of any stock is neither advice nor a solicitation to buy or sell any particular investment and our opinions regarding securities are subject to change without notice. Investing involves risk of loss. See the legal disclosures at the end of this publication and on our website for more information. POSITIONS SOLD or REDUCED Molson Coors Brewing Co. (TAP) The brewer s share price has surged over 34% year-to-date due to takeover speculation and the shares now sport a valuation that looks full to us. We decided not to speculate on a takeover and used the price surge as an opportunity to lock in gains. Cisco Systems (CSCO) Positions of this networking leader were pared back for selected accounts during the quarter. Cisco is adapting to the everchanging technology landscape and is having challenges. We are still holding the shares for most accounts due to its extremely low valuation (12 times projected 2015 earnings), great balance sheet, and our view that the company has durable competitive advantages. Johnson & Johnson (JNJ) The business of this healthcare leader is performing admirably and their stock has performed well. With the share price up 16% for the year, the valuation is looking full. Because of this, we decided to scale back on position sizes for selected accounts. Microsoft (MSFT) The stock has rallied over 26% for the year and position size in portfolios has grown disproportionately so we took the opportunity to trim back on the position for selected accounts. Like a lot of tech firms, Microsoft is facing a myriad of challenges from the rapidly changing technology landscape. With its strong cash-flow and more than $85 billion in cash on its balance sheet, we believe it has the financial flexibility and resources to remake itself. The valuation looks reasonable to us. United Parcel Services (UPS) The global parcel shipment company s shares recently began trading at over 25 times trailing earnings, therefore we decided to take gains in selected accounts. U.S. Bancorp (USB) The large, highquality domestic bank has continued to perform well and we like the shares long term. However, the size of the position and its valuation were factors that we considered when we decided to trim positions for selected accounts. ADDITIONS Amazon.com (AMZN) The Company is playing a prominent role in the structural shift away from brick-andmortar retail. We think the company s potential is undeniable and believe its valuation is misunderstood. We purchased shares of the company for selected accounts during the quarter. Bank of America (BAC) We believe many of the problems that plagued 3

4 Portfolio Activity Continued the company are behind it. With its low valuation, its expenses in decline, and profitability rebounding, we thought the shares were worthy of purchase during the quarter. Citigroup (C) Like BAC, Citigroup is in the process of recovery after the financial crisis. The balance sheet is shrinking and expenses are falling. We like the improving prospects and valuation, so we purchased shares for selected accounts. Coach Inc. (COH) The luxury handbag maker has stumbled recently as it transitions its business into a lifestyle brand. With the recent stock slump, we are able to accumulate shares of the company at what we consider a bargain price. We like the company s long term potential, particularly in China and other developing markets. General Electric (GE) The diversified manufacturer has positioned itself as a leader in all markets in which it competes. Since the financial crisis, the company has rebuilt its finance arm, improved its capitalization while working to pare its non-core assets. With its global presence and rebuilt capital arm, we believe the company s future looks promising. We continued to purchase shares for selected accounts. International Business Machines (IBM) The stock has underperformed recently due to fears of cloud computing which is shifting the enterprise technology landscape. With the shares trading under 12 times trailing earnings, we think the concerns are more than reflected in the stock price and used the opportunity to build long term positions in this dominant global IT company. McDonald s (MCD) Cyclical and competitive pressures have weighed on McDonald s operating results driving the share price down to what we believe is an attractive level for purchase. We believe the company s brand and scale will allow it to compete well in the evolving $900 billion global quick service restaurant industry. National Oilwell Varco (NOV) This dominant oil drilling equipment supplier s shares were under pressure recently due to the decline in oil prices. We think the current valuation does not reflect the long term earnings potential of the company and used the opportunity to purchase shares for selected accounts. Despite the lower oil prices currently, drilling activity continues to rise and NOV s backlog remains robust. Proctor & Gamble (PG) The global products company is going through some challenges as it tries to right-size its brand mix. We like their portfolio of leading brands that are essential for retailers to drive traffic in their stores. The valuation is attractive in our view and we used the opportunity to buy positions for selected accounts. Visa (V) The mobile electronic payment market continues to evolve due to increased competition, but we believe Visa will flourish due to its powerful network brand. Its shares look reasonably priced to us, so we purchased shares for selected accounts during the quarter. Walmart (WMT) The largest retailer in the world has seen its shares lag over the recent past. In our opinion, this has put the company s valuation at an attractive level and shares were purchased for selected accounts. With $475 billion in annual global sales, Walmart has tremendous scale and pricing power which should drive long term earnings power. 4

5 HCM Is Protecting Your Personally Identifiable Information, Are You? By P.J. Piccone, Director of IT Help Protect Yourself With These Simple Steps: Use strong passwords when accessing accounts online & change them often - Should be at least 8 characters - Should contain upper and lower case letters - Should contain numbers - Should contain symbols Use different passwords for each site, especially personal websites such as Facebook & Limit the type of information you post on social networks - Criminals data mine social networks - Criminals can find your home address, work address, and daily schedule Do not carry your Social Security card with you Update software when patches are available Do not give personal information over the phone while in public areas Check your credit report regularly - These reports are available for free at: Technology provides many ways to make our lives easier; however it has also opened up a variety of ways for cyber-thieves to access our Personally Identifiable Information (PII) and financial data. There have been several recent high profile news stories discussing technology threats including security breaches occurring at major retailers, Home Depot and Target. These security breaches resulted in the theft of sensitive customer information and credit card data. We take the security of your PII very seriously. Currently we have several systems in place to protect your confidential information and access is limited to authorized individuals only. We are pleased to announce the implementation of a new Secure System as the next step in safeguarding your information. This new Secure System will be used to send and receive forms or documents containing any PII, ensuring your information is safe and secure as it travels over the internet. In addition to the system, another option for sending secure communication is through the Vault in our HCM Wealth Management Solutions. If you have not signed up for HCM Wealth Management Solutions, contact your client advisor today. Both of these options are completely free to our clients and only require a few minutes to set up. It is unfortunate there are so many new threats in the world today. It is quick and easy to help protect yourself by following the simple tips provided on the left. Please contact your client advisor or our client service team at 855-To-Horan if you have any questions or to sign up for our HCM Wealth Management Solutions. 5