Quarterly Update: Now is the Time to Ask Why

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October 6, 2015

Mike Kauffelt, Chief Investment Officer

As I am sure most of you have noticed, over the past six weeks, the stock markets have had a difficult time. In the third quarter of this year, every major stock index in the US and internationally had a negative return. This pullback in stock performance has been attributed to slower growth in China, slower growth in Europe and fear that the very modest growth in the US may stall. A strong dollar has also caused some concerns since US companies that sell products overseas are subject to a double whammy. First, they are selling fewer items overseas due to the aforementioned slowdowns. Second, they are netting less in profit when those foreign sales are translated back into US dollars. These concerns are all legitimate, but we think the further out you look, things will begin to improve, economically speaking.

If you are a long-term investor, a key question to always ask yourself is why you own any investment (stocks, bonds, mutual funds, etc.). The answer should not be to increase in value every day. No investment in the capital markets increases every day with no setbacks. The answer should be more complex; it involves increasing value (more so with stocks) and preserving value (more so with bonds) while working in harmony with all your other investments and objectives. By knowing why you own something, it can go a long way in helping you decide what to do when your investment is suffering a setback.

At the core, you own stocks to own part of the cash flows of good businesses in good economies. If the economy presents a setback that you think is temporary (and most of them are), that could create an opportunity to buy more of those growing assets at a lower price. Investors should not blindly buy every dip in the stock market, but many successful investors buy most of them. Based on what we know now and with consideration of the reasons given for the current slowdown, we think the economy will be self-correcting in the near future (first half of 2016).

The China slowdown is real. However, the overreaction to their natural migration from less dependency on manufacturing to increased dependency on service businesses (just as the US and Europe did over the past decades) is a natural bump in the road. They have huge foreign reserves (savings) to offset any slowdown and they also have the ability to lower interest rates. They are practically the only large nation that has not done so in the past few years. Importantly, the US should not be pulled into a recession by China’s slowdown. Sales to China (exports) are only 1% of our GDP (total economy). The continuing offset of very low energy prices (increasing our domestic sales) will more than make up for sales lost to China. Europe will remain weak, but that is priced into their stocks and they remain cheap on a relative basis. The strong US dollar has hurt US stock earnings this year, but as we head into 2016, the quarterly and annual results should reflect that and create better earnings comparisons going forward.

We are not rebalancing our portfolios yet. We expect more volatility (up and down swings) to continue to impact current stock markets. Yet, given the year-to-date sell off in areas like emerging markets stocks (down 15%) and sectors of energy (with MLP stocks down 30%) along with traditional US large-cap stocks (with the S&P 500 down 6.7%), we are getting closer to pulling the trigger. When we look at why we own stocks (to grow) and why we own bonds (to preserve value), we see that over the past two months, bonds have done their job. Stocks have not done their job in the short term. It may soon be time to take some bond money and reinvest it in stocks at lower prices. We continue to watch this current correction, viewing it more as an opportunity than a long-term problem. If our view changes, you will be the first to know! Enjoy the colors of fall.

Mike Kauffelt

Chief Investment Officer

Bill Few Associates, Inc.

Data Sources: JP Morgan, The Wall Street Journal

p.s.  I am just curious… For those who read my quarterly update from 6/30/15, how many times did you look at your account values in the past 90 days? You can send me your anonymous replies by regular mail in an unmarked envelope. Thanks! Mike

Contact Michael K. Kauffelt, II, CFA

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Pittsburgh, PA 15237
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