Although the stock market finished the first half of the year with double digit growth, we have seen an increase in volatility lately.
The U.S. economy has been showing signs of recovery with increasing housing demand and consumer confidence. The Consumer Confidence Index came in stronger than expected for June (at 81.4 compared with the market expectation of 75.1). However, the recovery has been sluggish with a below-trend GDP growth, rather stagnant purchasing managers index and slowly falling unemployment. Furthermore, corporate profits before tax have slightly fallen (-1.6%) in the first quarter of 2013.
The sluggishness of the recovery aside, the announcement that if the U.S. unemployment rate continues to improve and inflation gets closer to 2%, the Fed will begin tapering stimulus measures has led to investors taking flight. Despite the Fed’s reassurance that the quantitative easing would not be stopped abruptly, most investors expect the pace of the asset purchases to be reduced after September.
As a result, the sell-off in the equity markets was accompanied by a sharp drop in gold prices, both due to the prospect of tapering and the cooling of inflation in the current year. Although gold prices have fallen significantly, we continue to hold the gold stock Eldorado Gold (EGO) in our portfolio as the stock appears very cheap according to our stock-selection model.
We believe that the overall reaction of the equity markets to the Fed announcement was somewhat exaggerated. It seemed like investors were interpreting ‘tapering’ as ‘tightening’. Not surprisingly, the housing stocks (PHM, and LEN) in our portfolio suffered sharp drops after the announcement. We intend to hold these stocks as we expect improvement in the housing market to continue and the rise in long-term interest rates should not be significant enough to offset the positive impact of the general recovery in the economy.
The LEN earnings came in strong in June and its home deliveries increased by 36% compared with 2012. That said, construction activity in the housing sector measured by private housing starts is still less than half of what it used to be back in 2005. Furthermore, the unsold inventory of new homes hit its lowest point on record according to the US Commerce Department statistics. We believe that there is still some upside left in housing stocks and also do not see any urgency for monetary tightening to prevent a housing-market bubble.
The revival in the housing market and rising house prices should improve consumer confidence further – despite the increase in mortgage rates in recent weeks – and should lead to higher consumer spending. We believe that consumer discretionary sectors may particularly benefit from increasing consumer spending.
Contrary to the market view, we are also positive about some banking stocks. The current economic backdrop of low interest rates with record low delinquency/default incidents and strong housing demand should benefit mortgage lenders.
In June, we did not make any changes to our portfolio as our stock-selection decisions are based on a strategy with a longer time horizon. Given the high volatility in the markets last month and the overreaction to the Fed announcement, we believe that was the right strategy to follow.
Going forward, we expect energy stocks to benefit from the optimism with regard to the US economic recovery. This said, in the short-term there may be some pull back in oil prices resulting from some supply-side factors such as the rise in refinery inputs and oil imports. Nevertheless, we expect that in the long-term, the oil price to be pulled up with stronger demand so long as the Chinese economic growth remains resilient.
Certain information contained in this presentation is based upon forward-looking statements, information and opinions, including descriptions of anticipated market changes and expectations of future activity. The manager believes that such statements, information and opinions are based upon reasonable estimates and assumptions. However, forward-looking statements, information and opinions are inherently uncertain and actual events or results may differ materially from those reflected in the forward-looking statements. The investments discussed are held in client accounts as of June 30, 2013. These investments may or may not be currently held in client accounts. The reader should not assume that any investments identified were or will be profitable or that any investment recommendations or investment decisions we make in the future will be profitable.
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