Is the glass half full or half empty?

After six months of significant volatility — both down and up — global stock market indexes have reached new highs and the bull market that began in 2009 appears to be alive and well. Investor enthusiasm and confidence, which was at a low point just last October, has also been reinvigorated and all that appeared to be dark and stormy now appears bright. However, not a great deal has changed since October when stock indexes were 15% below current levels. So why has the market recovered? Or perhaps a better question would be “why was it down so much in October?” Obviously, in the short term — days and weeks — markets are driven by psychology, most of which a prudent, longer term investor should ignore. However, our team and our research suggest that global stock markets are in transition. Though the bull market is not geriatric, it is aging, and investors would be wise to manage risk.

Global bull markets are in their best shape when all economic sectors are participating and all stock prices are rising. However, something strange has happened over the past six months. The materials sector (steel, copper, gold, etc.) and the energy sector (oil) are in what we call bear markets — down more than 20% or in this case each down 35% to 50% from their highs. Fortunately, given our Active Risk Management process, we sold both your material and energy stocks prior to most of the significant declines. From our viewpoint, neither of these sectors will likely recover anytime soon — for good reason. These sectors are dependent on healthy global economic growth and, slowly but surely, that is diminishing. This is most prevalent in the developing parts of the world — think China, Brazil, Russia (eck!). Can the global economic expansion continue without the energy and material sectors? …Maybe. We don’t want to “rain on the parade,” but from a historical perspective, a decline in these sectors has been a precursor to global economic recessions and significant stock declines — in almost all sectors. Given that our interests are aligned with yours in growing and preserving your assets, we are continually looking at the glass as half full — as well as half empty!

In the spirit of the glass being half full, an aging bull market can provide some of the best returns of the whole cycle, often in a narrower group of sectors and stocks. Given that we are in the sixth year of this bull market, it is quite possible that it may continue for one or two more years – years we certainly do not want you to miss. This phase of the bull market cycle is usually when we do our best work. As you know, your portfolio is not an index fund and we can pick and choose which sectors and stocks to own (healthcare and technology) and which to avoid (materials and energy), which can give our investment style a “leg up” versus a more passive approach. In addition, the use of risk management tools assists us in avoiding catastrophic losses in sectors that begin to perform poorly. This is an exciting part of the cycle to be a stock investor and we will be working diligently on your behalf to manage your return and risk.

On a subject as important as the stock market, the bond market continues to offer little value in terms of yield. A five year treasury remains less than 1.5% annually and the Federal Reserve, try as they may, have been unable to raise rates to prop these yields up. Given the dysfunctional global expansion, this is unlikely to change in the next six months. As you know, over the last few years we have been partial to what we call our “bond alternatives”: high quality utility stocks, preferred shares, Master Limited Partnerships and real estate investment trusts (REITs) – all which provide 3-6% dividends – similar to what the bond market provided in the “old days.” We believe this strategy has worked like a charm. If and when rates rise in earnest, we will be more than happy to buy you bonds. We are just not there yet.

All of us hope that you are doing well. If you have experienced any significant changes in your finances or would like to review your portfolio please let us know. Thank you for your confidence in our team and our investment process.

Sincerely,

Your Team at Main Street Research