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Economic and Stock Market Update (1st Quarter 2016)

This is a sample of the letter that I send to all of my management clients on a quarterly basis.

The US economy continues in its rut; a good quarter followed by several slow quarters. The slow growth continued in the fourth quarter with GDP growing at 1.4%. The consumer, aided by strong employment, continues to support the economy. Business spending, especially manufacturing, are holding it back. Manufacturing is very close to recession levels due to the strong dollar and falling exports. Mining and gas and oil production are in a deep recession. Other businesses are not confident enough to open the purse strings and business spending continues to lag.

Economic and Stock Market Update

The good news is that the consumer is getting stronger. Rising employment is a huge part of this. We need real wage growth to accelerate consumer spending at a faster pace, but for now the consumer is improving their balance sheet. This bodes well for the future. Rather than spending, American consumers are paying down debt and increasing savings. This will provide them with the financial resources to continue spending going forward.

Gross Investments is forecasting continued economic growth in the US, which will be at a fast enough pace to pull the rest of the world forward. Rather than sliding into a recession, we believe US growth will accelerate as the stronger consumer induces businesses to increase spending in order to capture the sales growth. Exports and oil production will work out of their recessionary state over time, adding to another potential area of growth.

Asset Allocation

We use this section to review the client’s target asset allocation and compare the actual allocation to the target.

Stock Portfolio Update

The correction was harder than we forecasted. A necessary evil, and very difficult to experience. We seem to have gotten the correction behind us, and now the stock market will be dependent on economic growth and future earnings gains. Expect volatility to stay high, as many risks remain. But, overall, the stock market will follow the economic growth and will move higher in the 8% to 10% range.

We will continue to take advantage of the volatility in accounts with bond allocations by rebalancing as the market allows. By selling equities in a strong market (and moving the proceeds to bonds) and vice-versa in a weak market, we can maintain the accounts proper risk level and add value. For all equity portfolios, we will trade individual equities, cutting our winners and adding to the laggards.

We continue to overweight energy. This hurt our returns in 2015, but early in 2016 energy prices gained and our holdings followed suit. We believe more gains are ahead of us (we are just unsure of the timing). As the economy grows, so will demand for energy, and eventually supply and demand will come inline. The dividend yields on our holdings will buy us time to wait for this to happen.

Our other major theme for the portfolio is technology. In most portfolios, we use a combination of individual tech stocks (Apple, Cisco, Micron and Seagate) and Ivy Science and Technology. The individual stocks are old line firms with earnings, while Ivy adds exposure to the new, faster growing firms. Our financial stocks are not the typical banks and insurance companies. Instead, we are currently invested in hedge fund managers (Blackstone and KKR), an investment manager (AMG), credit card processor (Synchrony) and debt collection (PRA Group (the old Portfolio Recovery)).

News: Stock Portfolio

During the quarter, we experienced record setting earnings from three of our stocks.

  1. Disney: All-time high net income of $2.9 billion in quarter four of 2015. This was driven by Star Wars, which became the number one grossing film of all time.
  2. Southwest Airlines: More than doubled net income ($536 million vs. $190 million). A main driver to this increase was the fuel savings the company experienced from weak oil prices.
  3. American Railcar: Recorded record revenues ($890 million in 2015) and record earnings per share, which was propelled by all segments (especially manufacturing).

In February, Cisco announced the purchase of Jasper Technologies for $1.4 billion. This is an effort to strengthen their position in the “Internet of Things” market. Jasper Technologies specializes in developing cloud platforms.

During the quarter, the SEC was reportedly looking into Boeing’s accounting practices for the 787 Dreamliner and 747 jumbo aircrafts. Boeing uses “program accounting,” which spreads upfront costs of manufacturing over a longer time period. Critics of this accounting method say it smooths earnings and potential losses. The stock traded lower on the day of the announcement, but has recovered since.

A federal jury has ruled against Gilead Sciences in a patent trial against Merck. The jury ordered the payment of $200 million to Merck. (Merck wanted $2 billion.) Gilead will appeal the verdict, and we will monitor the situation moving forward.

We had two companies that raised their dividend during the quarter: Cisco (to $1.04, up 24% year over) and Gilead Sciences (to $1.88, 10%).

Ford paid an additional dividend to investors this quarter, due to a strong year in 2015. The additional dividend was $0.25/share which represented an additional 2% yield (roughly).

We had two stocks that cut their dividend:

  1. ConocoPhillips (to $1.00, or 66%)–due to dramatic oil price drops and a weak balance sheet.
  2. Rio Tinto (up to 48% decrease)–Rio Tinto states that the dividend per share will not drop below $1.10. Weakness in global demand and commodities are the main culprit for the cut.

Bond Market Forecast and Update

The low interest rates continue. The Federal Reserve held rates steady at their last meeting, and until economic growth and inflation pick up, we do not expect higher rates. Watch oil and commodity prices; they will indicate when rates are about to move higher. Until then, we are stuck in this extremely low interest rate environment.

I am looking to add value by adding bonds that offer above market rates. This comes from bidding bonds out for sale, buying CD’s where the bank has to raise money or other special offerings. Even with these efforts, the returns on our new bond purchases will be very low and will remain this way until we see a sizeable increase in interest rates.

Once rates do rise, our ladder will provide cash flow that will allow us to participate in the higher rates without having to sell bonds at a loss. The longer-term bonds in the portfolio will lose money as rates rise, but these bonds are providing the return to the portfolio as we wait.


This section is used to provide the client with account specific returns.

Transactions for the Quarter

Each client would have their transactions detailed in this section.

Please call me if you have any questions on this letter.


Donald R. Gross, Jr., CFA