Counterpoint —
A Commentary of Jurika, Mills & Keifer LLC
Second Quarter: April 2016

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Broken News

A reporter on a major TV news channel recently marveled at all the media attention Donald Trump was getting, all the while giving Donald Trump even more media attention. The irony seemed lost on the reporter.

Donald Trump’s remarkable rise as a political phenomenon would not have been possible without the media’s paparazzi-like fascination with him and 24-hour news coverage of his every move, word and tweet.

Moses and Trump

Moses could literally come back and part the Red Sea, but if Mr. Trump offered to part his red hair, or something equally less remarkable, it would be “Breaking News.” The camera crews would all cut to The Donald. Sorry Moses.

The point of this is not to make a political point, but rather to call out the way the media can both amplify and distort our sense of reality, often giving disproportionate coverage to things that are undeserving, and insufficient coverage to the things that really matter. The world as we see it on TV is often quite different than the world as it really is. Reality Television is far removed from reality and Breaking News is often broken.

This is equally true in the coverage of economic and financial news. The Financial markets, like politics, have turned into spectator sports, replete with celebrity pundits, play-by-play analysis, charts, special effects and even theme music.

The first quarter of this year is a case in point. The financial markets started the year on a sharply negative note, which only got worse into the first half of the quarter. Many reporters noted that it was the worst start to any year on Wall Street in the history of recorded time, if not ever. Egads!

The list of reasons for the decline became extensive, including a global recession, China and other emerging markets, collapsing oil and other commodity prices, a rising dollar, the Federal Reserve and rising interest rates, terrorism, the Zika Virus and the ever present fear of a zombie apocalypse. If you wanted to feel depressed, you just had to turn on the television.

And, as the markets fell, the commentary became evermore dire, suggesting even darker days to come. Investors ran for the exits; sell first, ask questions later. But as is typical, it is always darkest before the dawn and you can’t have a market bottom without the conviction that things will get even worse.

Meanwhile, out in the real world, things were not quite so bleak. In fact, the global economy was doing fine. Not great. But, no recession or impending apocalypse and no reason to sell all your worldly possessions and hide under a rock.

Miraculously, around the middle of February, investors started to realize that the fears and the selling were overdone. The Federal Reserve issued comforting words, economic data came in better than expected, and, financial assets reversed course and began a strong rally higher into the end of the quarter. Asset classes that declined the most, such as small company stocks and Master Limited Partnerships, rose the most in a rather stunning reversal of fortune. Chart I shows the performance of 12 asset classes, including a diversified portfolio, from January 1st through the market bottom on February 11th, and from February 12th through March 31st, as well as the return for the full quarter.

Chart 1
(Click to enlarge)

After all was said and done, the U.S. stock market ended up just a little over 1%. Much ado about nothing.

Which takes us back to the distorting and often damaging role of the media. If you had bought into the negativism and actually taken the advice of many of the commentators and sold your stocks, you would likely have missed the rally back as well as possibly realizing taxable gains on the stocks you sold.

Short-termism:

As Carrie Fisher famously quipped, “The problem with instant gratification is that it takes too long.” With the advance of technology, we can now get almost instantaneous access to news and information. Sometimes, this is invaluable, when vital information is at stake. But there is no automatic correlation between the amount of information you can get, the speed with which you can get it, and the relevance of the information.

Technology now allows us to get portfolio updates on our smart-phones and watches on an almost immediate basis. This seems really cool, convenient and even engaging, but is potentially more of a danger than a benefit for most investors.

The flood of instant information and “breaking news” creates a false sense of drama and leads investors to think that there is more going on with their investments than there really is, and that perhaps they should be doing something when they really shouldn’t. Without proper perspective, it can lead investors to become overly short-term and reactionary in their thinking and actions, to the detriment of their long-term goals and wellbeing.

The relevant time horizon of most investors is measured in decades. The daily, monthly and even quarterly fluctuations of markets are normal and to be expected, and should be of little consequence to a sound long-term investment strategy and an appropriately allocated portfolio.

As interesting and stimulating as it is to get so much instantaneous feedback on our portfolios, successful investing is an inherently patient process. Although stock and bond prices may fluctuate from minute to minute, the underlying intrinsic value of the companies and obligations they reflect does not. The growth of economies, markets, and companies in which most people are invested takes time. The successful investment in that growth takes perseverance and the wisdom to know when to act, and when to let things be.

Investment Outlook:

Things are typically not as bad or as good as they seem on television. We never believed that the economy was falling into a recession nor that China was going to allow its economy to collapse, nor that the Federal Reserve was going to kill the recovery by raising interest rates. We are not even scared of zombies, and they seem far less scary than most of the leading presidential candidates.

We also don’t believe that things are all rosy either. Reality is much more of a mixed bag.

In our view, the global economy is limping along, producing slow and suboptimal economic growth. We think that, at the margin, things are improving, slightly.

The U.S. is doing the best overall, and the rest of the developed world, including Europe and Japan, is also moving slowly forward, boosted in part by massive doses of monetary stimulus. China is also growing, despite headlines to the contrary, but there is a clear demarcation between the manufacturing and export sector and the consumer sector. India also continues to do well. The rest of the emerging economies are struggling, especially resource-based economies like Brazil and Russia.

The U.S. is in a different place than most of the rest of the developed world. The U.S. economy is growing around 2% and we are actually seeing some signs of inflationary pressure in wages, especially with an unemployment rate under 5%. The Federal Reserve is slowly moving to raise interest rates while other Central Banks are moving in the opposite direction.

This divergence between the Federal Reserve and the ECB, Bank of Japan and Chinese Central Bank, should drive interest rates higher in the U.S. and keep upward pressure on the dollar.

Meanwhile, we should start to see some of the benefit of lower energy prices work their way through the U.S. economy and result in higher levels of consumer spending.

The political situation in the U.S. will likely cast a cloud of uncertainty over the financial markets until it is resolved. Over recent years, people have learned to tune out politics and get on with their lives. Today, politics are hard to ignore.

Beyond the actual candidates, the current race and the success of both Trump and Sanders reveals a significant anti-establishment sentiment across a broad swath of voters who are frustrated and want something different, especially if they are presented with easy answers to difficult and complicated problems. Regardless of who ultimately wins, we think that the current sentiments against the establishment, against free trade, and against immigration, will endure into the next presidency and will hinder economic growth.

Europe is growing around 1% and the recovery remains fragile. We think that the European Central Bank (ECB) may have to resort to even more significant and potentially unconventional monetary policy to boost confidence and growth.

As a recent report by BCA Research notes, most forms of extraordinary monetary policy may help to stabilize an economy, but they do not really benefit broad society or engender renewed consumption by putting money in the hands of the average person. Buying troubled debt primarily benefits the holders of that debt, and lowering interest rates primarily benefits those with the means and good credit to borrow.

The terrorist attacks in Paris and Brussels, as well as the wave of refugees from Syria has led to a backlash against immigration, the rise of far right parties, and a move away from European unity. In June, Britain will vote on whether or not to leave the European Union. Current polls show that the U.K. will vote to remain, but it will be close. The more important takeaway is that Europe is currently moving more towards isolationism and disunity than unity, creating an additional headwind to growth.

The developing world is in the early stages of a massive deleveraging cycle. In the wake of the credit crisis, China embarked on a large fiscal spending and stimulus program, and, in the process, created a debt-fueled bubble in demand for commodities, construction equipment, transportation, and other capital goods. It will take years to work through the excesses in debt and industrial capacity and the result will be a long-term headwind for commodities and capital goods.

But the developing world is more than just commodities, factories and cranes. It is also a burgeoning consumer market of billions of people. China alone has a middle class of over 300 million people, larger than the population of the U.S., and if you throw in India, Brazil and the rest of the developing world, you have a massive, diverse and rapidly growing block of consumers who will account for an ever-increasing amount of global consumption.

Investment Strategy:

Putting it all together, we see a world of slow growth, fueled by large forces of innovation, entrepreneurial zeal and heavy doses of monetary policy, and thwarted by dysfunctional politics, geopolitical risks, and a host of other fears and problems, both real and imagined.

Although the outlook for overall asset growth is muted, we do see pockets of value and opportunity. In a world of slow growth, we want to emphasize areas of higher growth, such as technology, healthcare, life sciences, and the growth of the developing economy consumer. We also look for investment strategies that focus on companies and sectors that have been sold-off based on a set of problems and fears that are more than reflected in current prices and represent compelling value.

We would expect higher levels of market volatility to persist, fueled by media sensationalism, the packaging of various securities into baskets that can be bought and sold in mass (aka Exchange Traded Funds or ETFs), and the growing dominance of computerized trading. For long-term investors, this volatility should be expected, ignored, or even embraced, because when investors panic and Wall Street has a sale, it can present a compelling opportunity for a smart shopper.

This past quarter is a case in point. If you went to a tropical Island on January 1st and came back on March 31st, you would not notice much that had changed, other than the weather and the political landscape. Your portfolio values would be largely the same as when you left. If you turned on the TV and freaked out in mid-February and sold your portfolio, you would be down about 10%. Conversely, if you actually put money to work as we did, at the height of the recession that never was, you would be up and slightly ahead of the game.

As always we focus and invest for the long-term, balancing diversified investments focused on areas of long-term growth and innovation with more defensive equity, alternative and bond strategies to mitigate volatility and risk.

We thank you for your ongoing interest and welcome your questions and comments.

Jurika, Mills & Keifer, LLC
April 2016

Important Disclosures

Opinions expressed are those of Jurika, Mills & Keifer, LLC, and are subject to change.

Investments in securities involve the risk of loss. Past performance is no guarantee of future results.

This communication is neither an offer to sell nor the solicitation of an offer to buy a security or advisory services, which can only be made by the appropriate offering document.