In the second quarter of 2014, U.S. equities provided solid returns as evidenced by the 5.23% return in the S&P 500 Index (SPX). The Timberline Dividend & Growth (D&G) portfolio advanced 5.40% (net of fees).
In general, positive equity performance was largely associated with modest but steady earnings growth that the market appears to view as sustainable. While overall sales growth has not been impressive, earnings have been enhanced by many companies that lever technology, engage in process improvement and actively buy back shares.
It is interesting to note that earnings growth came in the wake of the 2.9% GDP contraction during the first quarter, Middle East instability. The GDP decline has been largely dismissed (rightfully so) as a function of extreme weather.Furthermore, a GDP bounce in second quarter looks likely in my opinion. Yet it will only reaffirm the sluggish growth pattern that has been prevalent for some time. The Middle East tension is a serious issue, but domestic economic consequences look to be mitigated by growth in domestic energy reserves. Energy stocks represented the strongest performing portfolio component. Consistent with domestic energy development, pipeline companies Williams (WMB) and Kinder Morgan (KMB) performed well as did energy producers Penn West (PWE) and Chevron (CVX). Technology was the second best performing sector with Apple (AAPL), Cisco (CSCO), and Intel (INTC) posting double digit returns. Negative performers in the second quarter included JP Morgan (JPM), BB&T (BBT), Pfizer (PFE), Paychex (PAYX), DuPont (DD). With the D&G strategy, dividends are an important element of return. During the quarter, dividend growth was nicely evident with 12 portfolio companies announcing increases. Several of the increases emanated from banks that met regulatory capital requirements and were given the green light to raise payouts. The list of all companies raising their dividend consists of Apple (APPL +7.9%), Bank of New York Mellon (BK +13.3%), BB&T Bancorp (BBT +4.4%), Chevron (CVX +7.0%), Johnson & Johnson (+6.1%), JP Morgan (JNJ +5.3%), Microchip Technology (MCHP +0.1%), Peoples United (PBCT +1.5%), Pepsi (PEP +15.4%), PNC Financial (PNC +9.1%), Wells Fargo (WFC +16.7%), and Williams Companies (WMB +5.6% with a 32% preannounced increase for the next quarter). Looking ahead, modest earnings growth appears sustainable in my opinion. It is also nice to have the Fed managing expectations carefully about its future plans to gradually normalize interest rates. However, equity market valuations are slightly above historical levels with signs of investor complacency given the market's low volatility and narrow credit spreads.
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