Dear Clients & Friends,
After three months of going sideways, the Dow Jones Industrial Average finally popped above its March 1 closing high on June 1, at 2,430.06, and continued upward toward gradual new highs throughout the month of June. On Wednesday, June 14, the Federal Reserve raised short-term interest rates another quarter-point to a range of 1%-1.25% for federal funds, as was expected. But the real news was buried further down in the post-meeting press release. Starting “this year” the Federal Reserve plans to “gradually reduce” its massive bond holdings accumulated during the Quantitative Easing program between 2008 and 2014. The Federal Reserve will stop reinvesting principal on as much as $6 billion a month of Treasury debt and up to $4 billion a month of mortgage-backed paper as these securities mature. In short, Janet Yellen has officially announced that the Federal Reserve intends, sometime before the end of 2017, to complete its three-year long transition from Quantitative Easing of credit (QE) to Quantitative Tightening (QT), a genuine policy reversal is under way. We do not want to jump to any conclusions because it will probably take several more turns of the credit screws before the economy and the stock market get into any serious trouble. However, history shows that sooner or later, tighter credit will topple the economy into recession and stocks into a bear market.
Risks are mounting for Wall Street’s long-running and rapidly aging bull. Key indicators are looking ahead to a peak in the business cycle, possibly within the next 12-18 months. Investors have not seen a major top in the U.S. stock market for almost 10 years. Many folks have either forgot what such an inflection means or have given up looking for it. Complacency reigns, as indicated by the multi-decade June 9 low in the CBOE Volatility Index (VIX). As we look back at the halfway mark in 2017, the broad stock and bond market trends have performed as we expected up to this point. However, we do not anticipate a similar performance during the second half of 2017.
The Dow’s belated show of strength does not completely erase the caution that we have noted in previous updates. Despite the June highs trifecta of new all-time index highs (DJIA, S&P 500, NASDAQ), we remain cautiously optimistic for 2017. With corporate earnings as perky as they are, there is really just one thing that might hinder stocks from streaking higher over the summer, which is stock valuations. According to a recent chart from FactSet, the Standard and Poor’s 500 is now trading at essentially its highest forward Price-Earnings (P/E) ratio, using the next twelve months’ estimated earnings as the denominator, of the past decade.
It is possible, of course, that enthusiastic investors will choose to look past today’s skybox valuations and bid up share prices even further. However, we feel that we are nearing the end of the market’s recent ebullience and a “market siesta” may well be in store.
During the quarter, we sold stocks that could cause problems in 2018 and trimmed some of our stocks that have significantly appreciated. We sold our entire positions in Du Pont E I De Nemours & Co (DD), Rayonier Inc. (RYN), Verizon Communications (VZ), and Ralph Lauren Corporation (RL). We also trimmed over-weighted positions that have doubled in value such as Phillip Morris International Inc. (PM) and Altria Group Inc. (MO). We also trimmed Federal Express Corporation (FDX) and used the proceeds to purchase United Parcel Service Inc. (UPS). This had the affect of reducing the Equity portion of the portfolios and increasing the Fixed Income portion of the portfolios due to the fact that UPS is an excellent company and has a dividend in excess of 3%.
The additional cash provided us an opportunity to increase the Fixed Income portion of our portfolios. We added Rowe T Price Group Inc. (TROW), a financial services holding company that provides global investment management services through its subsidiaries to investors across the world, Health Trust of America Inc. (HTA), a real estate investment trust that operates medical office buildings in the United States and General Mills Inc. (GIS), a manufacturer and marketer of branded consumer foods sold through retail stores. On the equity side, we added two new positions, Hormel Foods Corporation, (HRL), which engages in the production of a range of meat and food products and Fairfax Financial Holdings (FRFHF), a property and casualty insurance, and reinsurance and investment management company. We feel that these positions will perform well in case of an economic downturn.
As far as our investment strategy is concerned, we continue to maintain our standard two-pronged strategy, which is to maintain a substantial exposure to common stocks (and mutual funds) as long as there is a reasonable prospect for double-digit returns. Furthermore, we will continue to take profits more frequently so that we could gradually increase our weighting in cash as well as the fixed income portion of our portfolios. During the quarter, we continued with our average asset allocation mix of 40%-50% Equity, 40%-50% Fixed Income and 0%-20% cash for most of the portfolios.
We want to thank all of you for giving our firm the opportunity to serve you. We thank you very much for the trust and confidence you have placed in our firm as it is always appreciated. Please contact us should you have any questions or comments. Also, we want to invite you to visit our website at www.farmandinvestments.com for a quick Retirement calculator, our latest firm news, and Market Commentary archives.