Recent tensions in the Mideast have fueled an increase in volatility across financial markets. Stock prices have declined in every global region and oil prices have risen significantly. Many investors fear that this may persist for an extended period of time. While we agree that the tensions in the Mideast may not be resolved quickly, and that oil prices may remain elevated for some time to come, economic data points and stock market fundamentals suggest that stock prices should trend upward again once this temporary correction is completed.

Our forecast for global economic growth remains positive and recent events have not changed these leading indicators. Though unemployment and debt levels remain higher than normal, we believe that US and other developed country growth will continue at a 3-4% pace, while economies in the developing world will continue to experience faster growth. These growth rates should lead to higher corporate profit growth, particularly in certain sectors of the global economy such as industrial, technology, energy and the materials sectors – all of which you currently hold in your portfolio. Our forecast for growing economies and higher corporate profits should, after a temporary correction, lift stocks throughout this year.

Stock market fundamentals also suggest that this recent decline in prices is more likely an overdue correction. Stock prices based on almost every measure are still very reasonably priced. For example, the Morgan Stanley World Index is trading at a price to earnings multiple of 14.5 based on this year’s earnings. This price to earnings multiple would need to approach 20 – in conjunction with a number of other “red flags” – for us to be concerned that markets are overvalued. Since September, stock prices have advanced almost 20% without a “normal” correction. This is abnormal and suggests that we have been overdue for a pull back.

These recent events have caused interest rates to decline in the short term. However, we continue to forecast higher interest rates throughout this year, once this recent volatility subsides. This should allow us to continue to find much better values in the bond market and increase the overall yield of your bond portfolio.

Though the tensions in the Middle East have created violence and volatility in the short term, these changes have important long term effects on extending democracy and are very supportive of free markets – both very positive for global economic growth and stock markets.

Given the Great Recession of 2008-9 and its effect on destabilizing economies and markets, we have entered a new – if somewhat strange – era for financial markets. This makes our forecasting more challenging. Therefore, we continue to use risk management tools on your portfolio. These include your portfolio’s allocation to stocks, sector management and the use of carefully placed stop loss orders. Keep in mind that we do not put stop losses on all of your stocks, just those that would be very vulnerable to an economic recession.

We hope this note finds you well. If you have any questions, please feel free to contact us at your earliest convenience.

Sincerely,

James E. Demmert
Managing Partner