THE SUMMER LETTER
Out of clutter, find simplicity. From discord, find harmony. In the middle of difficulty lies opportunity.”
– Albert Einstein
Economic Perspective
There is little doubt the American polity is beset by political discord of the most venomous variety. Yet, with occasional hiccups, the economy continues plodding away at about a 2 percent annual growth rate. An erosion in credit demand generates a few worries. In tandem with bond markets, the Federal Reserve ratchets interest rates gradually higher; in recent semi-annual Congressional testimony Chairwoman Yellen suggested another quarter point rise before year end. Consumer price and wage growth inflation reached Fed targets of 2%. A strong dollar and weak commodity prices keep producer price inflation in check. The economic landscape remains benign; but political event risk here and abroad is pervasive.
The unemployment rate, which hit a 16 year low in May, shows labor markets are tightening. Yet inflation is drifting away from the central bank’s target. Data show housing cost increases slipping to 2.7% from 3.4% as rising inventories of newly built apartments have weakened landlords’ pricing power. Likewise, growing inventories of used cars have weighed on their sale prices. Wage growth approaches 2.5% but the Fed’s favorite gauge of inflation, personal consumption expenditures price index, slipped below 2%. As ever, a cautious Fed awaits more data. Elsewhere, the European Central Bank maintains an accommodative stance on interest rates and bond buying.
Market Thoughts
This earnings season has brought some notable disappointments at Home Depot and Qualcomm but also an overall revival in revenue growth, a hallmark of a continued economic expansion. With the failure of Republican efforts to repeal or revise Obamacare, the health care sector is breathing a sigh of relief and rallying. Hope for the Trump bump from lower corporate taxes, infrastructure spending and health care reform have faded.
Despite the occasional swoon in technology stocks and the persistent decline in energy issues, the market continued to rise through the second quarter. The SPDR S.&P. 500 Trust, an exchange-traded fund that tracks the Standard & Poor’s 500-stock index, returned 3.1 percent for the period, including dividends.
In an effort to navigate the challenging equity markets, we emphasize sectors like: consumer staples (Church & Dwight, Nestle); manufacturers (Hexcel, Parker-Hannifin, Wabtec); medical equipment makers and pharmaceuticals (Bristol-Myers, Celgene, Eli Lilly); entertainment (Disney, Liberty Media); selected technology (Versum, Xylem); insurance (Alleghany, AIG, White Mountains); and, dividend plays like Prologis and Digital Realty (data centers) and Kinder Morgan Inc. (energy pipelines).
We have become more cautious in our views. The economic backdrop provides an O.K. environment for stocks, but there’s not much margin for error.
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Stephen K. Bache, CFA
Sources: Bloomberg Business Week, The Economist, New York Times, The Wall Street Journal, Patrick Leigh Fermor, Between the Woods and the Water
