Summer Client Investment Letter {Part I.}

This week we are going to be running in serial form our latest investment letter to clients.  Here is part I.

Market Review

Equity markets around the globe have basically run in place this year.  The S&P 500 {the most widely measured US equity index} gained about .25% during the last six months.  International stocks gained between 2-6% only to give most of that back owing to the triple trifecta of the ongoing crisis in Greece, issues of Puerto Rican debt and an equity meltdown in China.  Typical asset allocation strategies returned less than 1.0% in the first half of the year.  US markets have been locked into a tight trading range this year. This is reflective of an indecisive market.  US economic developments have been generally upbeat, especially when you factor in a 1^st quarter slow down that was partly energy related and also had much to do with the miserable winter weather that blanketed much of the northern half of the country.  On the other side of the coin cuts to earnings, especially in energy related industries, has made the market’s valuation look more expensive, hence the troubles stocks have seen in gaining traction this year. 

Earnings growth ex-energy is expected to be around 2.2% this quarter.  Our 12-month forward earnings estimate is between $124-125 on the S&P 500 with a mid-point 124.50.  That has the index currently trading with a high 16’s price to earnings ratio, a dividend yield of around 2% and an earnings yield of around 6%.  Historically this has been seen as expensive and as mentioned above is likely one of the reasons prices have been range bound.  However, we are still in an era of historically low interest rates with even long term government bonds trading under 3%.  That is an interest rate environment where probability suggests stock prices at a minimum can be sustained.  I’ve spent many years in this business where stock prices traded at PE levels between 14-15 and interest rates were substantially higher than what we see now.  In that context stock valuations may not be as elevated as first appears.

Our Cone of Probability for year-end 2015 is 2100-2200 on the S&P 500 and for 2150-2250 12 months forward.  That represents potential gains in the 3-7% range, not including dividends.  The Cone of Probability is our current assessment of the price range within which we think stocks have the potential to trade during a described period, in this case out to June 30 calendar year 2016.  It is a probabilistic assessment based on many inputs.  Some of these are: earnings estimates, and whether those estimates are rising or falling, dividend yield, earnings yield and the current yield on the US 10 year treasury.   We use this solely for analytical purposes.  It will fluctuate with market conditions and changes to the data inputs.  Index prices can and have traded in the past outside of its range. 

{Tomorrow we'll discuss some of the headwinds the market currently faces.}

*Long ETFs related to the S&P 500 in client and personal accounts although positions can change at any time.