03 May

EPIQ Blog: Quarterly Notes

Spring has arrived and the change in season is welcome by many, both literally and metaphorically. Warmer and longer days do wonders for the psyche and the transition seems to also have a positive effect on financial markets. The past 18 months have been challenging for most investors. The broad-based, US-equity averages are essentially flat and bonds, with few exceptions, have had it no better. It seems that only investments with small-return prospects, such as municipal bonds, delivered on expectations.

During the first six weeks of 2016, markets fell precipitously due to global concerns over economic growth prospects and a myriad of other issues including, general discontentment with candidates from both parties for the US Presidency along with other growth concerns facing Europe and China. When momentum takes hold, which we believe it did, market prices move too far causing dislocations. The selloff in risk assets that began to accelerate during the 3rd quarter of 2015, continued right through yearend. However, fundamentals do matter and even though macro-economic conditions have not changed significantly, markets rebounded during the month of March resulting in stocks ending the quarter where they began. Treasuries and other high-quality, long-dated corporate debt out performed their coupon payments as rates fell to near all-time lows.

The exhibit above charts the return of the Russell 3000, a broad based index including both large and small US publicly traded companies. Over the past 18 months, investors have experienced volatility but do not have a lot to show for it with a return of just 2.10% annualized, which is made up almost entirely from dividends.

As we move into the middle of the year, our expectations are muted for both stocks and bonds in the short term.

 

First and foremost, the US and Global economies continue to expand at a slow rate. With issues such as a slowing China, political upheaval in Brazil and immigrant concerns in Europe, to name just a few, the uncertainty surrounding the presidential election seems minor in comparison. However, global markets continue to grow as economies expand in spite of challenges.

We view two critical forces that will continue to have outsized influences in market returns moving forward: (1) accommodative monetary policy from central bankers around the world and (2) technological productivity gains driving more products or services while lowering costs. This is nothing new and societies will continue to benefit from the development and deployment of disruptive new services. There will be winners and losers (think of Uber and taxi drivers/medallion owners) but on the whole, we are better off with these changes.

Factors that have contributed to the success of the United States over the last couple of hundred years have been inexpensive money, cheap energy and affordable labor mixed within a free society that has encouraged entrepreneurship. These values continue to slowly spread around the world with few exceptions and should lead to more efficient allocation of all kinds of resources. The result will be a higher standard of living for more of the world's population which leads to greater global wealth. We are challenged to imagine how the US does not continue to lead in this creation of wealth.

On the monetary front, policy makers, both home and abroad, have clearly stated and acted in a way that will keep money cheap for the foreseeable future. The consequences of raising short-term rates at anything faster than a glacier's pace are simply too high. Although there are many factors, the recent rebound in stock markets are directly tied to the expectations that the FOMC will only raise rates once or twice later in the year instead of four times as indicated in December.

The downside of this policy is that savers will continue to see their purchasing power eroded requiring one to assume risk to earn even a marginal return. At EPIQ, we continue to seek out and invest in companies and other vehicles well positioned within their respective industries that return a portion of their earnings to shareholders. Although growth is scarce for many, the excess capital produced from earnings spent on dividends and share repurchases can be rewarding should future results remain stable. The same philosophy carries over to bond portfolios where we stress prudent credit and structure risk to produce returns derived primarily from stable cash flows.

Where appropriate, we continue to seek out value in private or less-liquid investments where we gain a significant valuation advantage for giving up the liquidity found in public marketable investments.

Thank you for reading to the end.  Please call on us if you would like to continue the conversation.

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