BAM Quarterly Letter – Spring 2016

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April 26, 2016

Dear Clients & Friends,

2016 began with significant turbulence in the financial markets. The S&P 500 Index opened the year at 2,044, however continued concerns over the health of the Chinese and European economies, falling oil prices, and the strong dollar drove the index down to a 2016 low of 1,829 by February 11th. This 10.50% drop in the first six weeks of the year tested the fortitude of both long-term investors and short-term traders. The financial press kept everyone on edge with sensational reporting about the pending collapse of the stock market with one CNBC headline stating “The Fed won’t be able to save stocks”, and a Wall Street Journal report indicating “Recession Risk Rising”. 

Analyzing the situation more thoroughly, the decline in the U.S. stock market from June 1, 2015 through February 11, 2016 corresponded with a period of declining corporate profits. Profits for S&P 500 companies peaked in the 3rd quarter of 2014 and then weakened through the 4th quarter of 2015. The decline in profits can be directly tied to the strength of the U.S. dollar (a strong dollar makes goods we produce and export more expensive and less salable in foreign countries) and the rapid drop in oil prices (profits of companies involved in energy production and related businesses declined in tandem with oil prices).

The decline in corporate earnings is a clear indication that the strong dollar and low oil prices played a powerful roll in slowing the economy. Preliminary estimates for 1st quarter 2016 Gross Domestic Product (GDP) will not be reported until April 28th, however early indications are the economy grew very slowly, or possibly even contracted, during the period. Counterintuitively the S&P 500 began moving upward from its February 11th low of 1,829 advancing to 2,092 on April 22nd, an increase of 14.38%. Why would the market go up by 14.38% with bad news presumably pending?

The stock market appears to be anticipating an earnings recovery. While S&P 500 earnings are expected to be lower in the 1st quarter of 2016 than they were for the same period of 2015, earnings are expected to increase over the next several quarters, with calendar year 2016 projected to be about 11% higher than calendar year 2015. The initial impact of lower oil prices was clearly a decline in profits, but longer term consumers have more to spend on other goods and services. Indications are consumers are beginning to spend the windfall they are receiving from lower gas prices. The expectation of higher profits resulting from more consumer spending, along with oil prices moving up from their lows, has led to our most recent stock market recovery.

In our last quarterly letter, we indicated conditions that typically lead to a bear market (20% or more decline) did not exist. As we write this letter, bear market causes are still not on the horizon. We are not in recession, commodity prices are low, the Federal Reserve is not aggressively increasing interest rates, and we do not have extreme valuations in the stock market. That being said, bear markets can happen at any time for unanticipated or even unknown reasons.
We try to point out as often as possible that timing the market with any degree of accuracy has proven to be impossible and the best strategy for long-term investing success is to buy a diversified portfolio of both stocks and bonds and hold them through the turbulence the market subjects us to year in and year out. It is tempting to look at the sharp decline and subsequent recovery that has occurred so far in 2016 and dream about “what could have been” had we sold on January 1st and bought on February 11th. As we wake-up from this dream, I am pleased to say our clients benefited from our advice by resisting the temptation to time the market and sticking to our long-term strategy, which generated solid positive returns during the 1st quarter despite the turbulence.

As always, if you have any questions or concerns please call. We wish you continued success and happiness.

Very truly yours,

Berkson Asset Management, Inc.
Registered Investment Advisor

Steven M. Berkson, CPA\PFS, CFP®, MBT

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