August 27, 2015

It has been our steadfast belief that normal market forces have been suppressed in recent years as a result of the Federal Reserve’s and other central banks’ extraordinary monetary policies.  It was also our belief (as discussed in our quarterly letter published in July), that market valuations were quite full and investors were mostly complacent.  Recent data and market action over the past week, however, suggest that global economic fundamentals are far from perfect and that global economic activity is not accelerating as was previously hoped.  Extreme price volatility in global stock markets and uncertainty as to when the Federal Reserve will raise interest rates have disconcerted investors.  After several years of a zero interest rate policy and multiple rounds of Quantitative Easing, it appears that the Federal Reserve would like to begin raising interest rates off the zero-bound before the end of the year so that they are in a position to lower rates when the next recession is on the horizon.  Because economic growth is still very moderate, inflation is low and earnings growth has slowed markedly, the market is likely to be choppy as investors evaluate the Fed’s likely course of action and until it also becomes more clear that a tightening of Federal Reserve policy will not harm the economy.  Investors will also remain skittish until they gain confidence that economic and market weakness in foreign markets, most notably China, does not spill over into our economy.

The extreme price movements in major US stock indices these past few trading days deserve a special mention.  The increased popularity of ETFs and other passive investment vehicles among individual and institutional investors alike has resulted in security analysis becoming less relevant in recent years, in our opinion. As the rising tide of passive investment flows has lifted all boats irrespective of fundamental merit, we have the potential for heightened stock market volatility which creates added uncertainty in the current environment due to the technical breakdown of the market.   The good news is that we think we are moving into an environment in which asset prices will once again be  influenced more by economic and individual company fundamentals and less by central bank interventions and passive fund flows.  This should work to our Clients advantage going forward as we continue to apply the same rigorous, fundamentally grounded process we have relied upon to add value to our Clients’ portfolios over the last three decades.

Because the high quality growth stocks in our Clients’ portfolios are reasonably valued on our work, are financially strong and have sound earnings prospects, we believe they are well positioned for what could be a more choppy and volatile environment in the period ahead.