The second quarter of the year was remarkably like the first as both equities and fixed income pushed modestly higher in the face of relatively weak domestic macro data and a slightly less accommodating Fed. The market seems to be continuing to climb the proverbial “wall of worry” as apparently bad news is pushed aside and good news quickly leads to new bids.
We are intrigued by two potential explanations for the low volatility, low volume, yet impressively consistent upward momentum in the equity markets: One explanation is that increased use of ETF’s is driving ever increasing correlation between individual securities and asset classes. This trend favors passive management over “stock picking,” –a trend we view as antithetical to our conviction that individual company performance eventually will drive price.
A second explanation is the growing trend toward debt financed equity buybacks. The end of June presented an impressive example of the benefit management teams are realizing by financing buy backs via, low-rate, long-term debt. Monsanto (MON), a leading supplier of agricultural products and technology, announced a 10bb dollar debt financed buyback. On the day of the announcement the stock was up 8% in a flat market. We have seen similar transactions from a broad range of public companies including IBM and Apple. These corporate buyers are often unconcerned with valuation and are more focused on the accretive nature of the transactions to earnings.
Both of these trends are likely contributors to the recent steady advance of the equity markets. While we prefer the advance be attributable to more traditional organic growth in revenue and earnings neither of these trends is likely to dissipate in the near-term. However, given this advance may be more technical than fundamental, we continue to take profits in names where our valuation targets have been achieved, while remaining vigilant in finding good entry points for putting cash to work.
New this month, I am proud to announce a routine investor call to be hosted by the SCM Portfolio Management Team. These calls will provide clients an opportunity to hear the firm’s current views on the economy and markets, and give clients a chance to pose questions to the Portfolio Managers. We plan to host this call on the 4th Friday of each month. Email firstname.lastname@example.org to RSVP.
As we head towards the dog days of summer we once again want to reiterate our appreciation for the opportunity to serve you.
As always feel free to reach out with any questions you may have.