Download Too Much, Too Many - Goelzer Investment Management

January 2016
Too Much, Too Many
“A world with
too much of too many
things unfortunately
did not lead to
too much return
for investors this
past year.”
J. Andrew Concannon, CFA
Chief Investment Officer
[email protected]
317 264- 2600
www.goelzerinc.com
Since the start of the industrial revolution, people have worked to become proficient at
mining, manufacturing, financing, and selling all types of goods. It became evident
this past year that our proficiency has led, at least temporarily, to too much
production. As a result, much of the world now has too much of too many things.
This current condition of too much and too many can be seen in several markets. The
most commonly discussed is the oversupply of oil as shown in Figure 1. In response
to a sharp rise in oil prices early in the last decade, oil companies invested heavily in
new production which has led to too much oil being produced. A similar situation has
occurred in the metals mining industry. In an effort to supply what once appeared to
be endless growing demand from China, companies opened too many new mines and
created a glut of industrial metals. And the desire to supply goods to a growing middle
class in emerging market countries, along with higher factory productivity, has led to
too much manufacturing capacity. This is evident by factory utilization rates in the
mid-seventy percent range in both the U.S. and China.
Another example of the too-much-too-many condition can be found in the retail sector
where endless pressure to grow sales, combined with the ease of online shopping, has
led to too many retail stores. Highlighting this problem was a recent report stating
that more Americans shopped online than in stores over the Black Friday weekend.
Our final example of too much, too many is money itself. Most people do not feel as
though they have too much money, but the world as a whole is awash in it. Central
bankers desiring to inflate their economies have created more money than can be
absorbed. In the U.S. this has led to banks holding more than $2.5 trillion in reserve
deposits at the Federal Reserve throughout most of 2015. This is mostly money for
which the banks cannot find qualified borrowers.
FIGURE 1
Worldwide Liquid Fuels
Daily Production Less Consumption
(millions of barrels)
2.5
2.0
1.5
1.0
0.5
0.0
-0.5
-1.0
-1.5
Q3 2015
Q1 2015
Q3 2014
Q1 2014
Q3 2013
Q1 2013
Q3 2012
Q1 2012
Q3 2011
Q1 2011
Q3 2010
Q1 2010
Source: U. S. Energy Information Administration
A world with too much of too many things unfortunately
did not lead to too much return for investors this past
year. Instead returns for most asset classes were modest
to negative. The problem for stock investors was that
surpluses led to lower prices which in turn led to lower
earnings for the businesses affected. And for bond
investors, because interest rates are the price for money,
excess money in the economy meant a continuation of
low rates.
Commodity traders have a saying that you should buy
surplus and sell scarcity. This is just another way of
saying that you should buy when prices are low and sell
when prices are high. Given enough time, this will prove
to be good advice, as the world grows to absorb the
surplus. But this will not occur soon enough to avoid
more financial losses for industries that are producing
too much.
History serves as a valuable guide for predicting
long-term outcomes, but it gives little insight as to
timing. That is why diversification and having a
long-term horizon are so important to successful
investing. Speaking of the long-term, below are our
thoughts on the longer-term outlook for the U.S. stock
and bond markets
U.S. Bonds
Improvement in the long-term outlook for bond returns
depends on higher interest rates. A first step in that
direction came in December when the Federal Reserve
raised the federal funds rate by one quarter of a
percent. The current target federal funds rate of
0.25% to 0.50% is still well below the Federal
Reserve’s normalized target rate of 2.0% (equal to its
inflation target), so its bias leans toward additional
rate increases. Future rate increases, however, will
depend on the economy’s strength and are by no
means guaranteed.
We remain defensive in our bond portfolio strategy by
favoring shorter maturities relative to benchmarks.
Yields on longer-maturity investment grade bonds,
which are little changed versus a year ago, provide
insufficient compensation for the amount of
interest-rate risk attached. As shown in Figure 2, the
yield on the 10-year U.S. Treasury bond is currently
less than half the long-term average. Rather than
reaching for yield by extending maturities, we prefer to
obtain what limited yield is available through
reasonable credit exposure.
FIGURE 2
U.S. Stocks
The slight price drop in the S&P 500® Index over the
past year combined with both higher dividends and trend
earnings improves our 10-year return outlook for the
index. We currently forecast an annualized rate of return
between 5.3% and 7.5% for the next ten years versus
our forecasted range of 4.3% to 6.5% at the end of
2014.1 The improved outlook remains below the
long-term 10% annual return average for the index, but
it is well above yields available on investment grade
bonds, thereby compensating investors for the added
volatility of owning stocks. We continue to be neutral on
equity exposure relative to long-term targets.
U.S. 10-Year Treasury Bond Yield
18.0
16.0
14.0
12.0
10.0
8.0
Average
6.0
4.0
2.0
0.0
The information provided in this material should not be considered as a recommendation to buy, sell or hold any particular security. This report includes candid statements and observations
regarding investment strategies, individual securities, and economic and market conditions; however, there is no guarantee that these statements, opinions or forecasts will prove to be
correct. Actual results may differ materially from those we anticipate. The views and strategies described in the piece may not be suitable to all readers and are subject to change without
notice. You should not place undue reliance on forward-looking statements, which are current as of the date of this report. The information is not intended to provide and should not be relied
on for accounting, legal, and tax advice or investment recommendations. Investing in stocks involves risk, including loss of principal. Past performance is not a guarantee of future results.
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www.goelzerinc.com
2015
1
A change to how we incorporate dividend growth in our forecasting model has raised the 10-year forecasts produced by the model. By way of comparison, our
previous model predicted a 10-year annual rate of return of 3.9% to 5.9% at the end of 2014.)
2010
2005
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1995
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1985
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1975
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1965
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1955
Source: Bloomberg