First Long Island Investors Senior Vice President and Chief Financial Officer of First Long Island Investors Stephen Juchem is Long Island Business News CFO of the Year.
Clients and friends of FLI Investors gathered for a discussion on navigating the Fiscal Cliff in light of the uncertainty ahead and this year’s political election. Robert D. Rosenthal, FLI Chairman & CEO, and Jason Trennert, Chief Investment Strategist of Strategas Research Partners, shared their insights and predictions.
Jason Trennert(right) responds to client’s question about outlook for inflation, the U.S. dollar, gold and energy prices.
Robert D. Rosenthal(left) asks Jason Trennert if Europe and the Euro can stay together in light of the European debt crisis.
HERE ARE SOME OBSERVATIONS FROM THE HIGHLY CHARGED CONVERSATION TO KEEP IN MIND FOR YOUR INVESTMENT PORTFOLIO:
U.S. INTEREST RATES & DEBT
The U.S. Government is using short term debt to run the economy. This is an “extremely dangerous” way to capitalize the economy. US debt has gone from $10.9 trillion to $15.5 trillion in the past three and a half years. Yet, the dollar continues to be the reserve currency.
ASSET ALLOCATION
The only chance for positive real return is equities and the real return from bond funds for the next 5 to 10 years will be negative.
GOLD
Gold may continue to “have an underlying bid for a long time.” It’s not as much of a commodity play, as it is an insurance policy.
ENERGY
Oil production is limited by technology and it’s only a matter of time before a major transport fleet, such as FedEx, converts to natural gas.
THE EUROPEAN DEBT CRISIS
The fiscal authorities in Europe cannot continue to spend money they don’t have. The U.S. is extraordinarily different; it is the only place in the world where people want smaller government—“you will never see a Greek protestor calling for smaller government.”
Hope you will join us at our next event!
Jason Trennert
Managing Partner — Chief Investment Strategist
Jason Trennert is the Managing Partner and Chief Investment Strategist of the Strategas Research Partners. He has been ranked consistently by Institutional Investor magazine as one of the top Strategists on Wall Street. A keen market observer, known for giving “good copy,” he is a regular guest host on CNBC’s “Squawk Box” and “Bloomberg News.” He is the author of the popular investment book, New Markets, New Strategies, published in 2005 by McGraw Hill. Prior to founding Strategas, Mr. Trennert was the Chief Investment Strategist and a Senior Managing Director at International Strategy & Investment (ISI) Group. He has an M.B.A. from the Wharton School at the University of Pennsylvania and B.S. in International Economics from Georgetown University.
“We must build dykes of courage to hold back the floods of fear.”
Martin Luther King, Jr.
Investment Perspective We had an excellent first quarter for our equity based strategies, both defensive and traditional with gains as high as 17% (net) for our best performing strategy. This was accomplished despite widespread investor fears that continued to prevail from last year. For the most part, our strategies outperformed their respective benchmarks, and we believe we accomplished this while taking less risk, using no leverage, * and maintaining the utmost transparency. Our bond portfolios tracked at least as well as their respective benchmarks despite most bonds offering little return and not much value (in our opinion). Our private equity and real asset investments appear to be making progress as well.
Of great importance in being able to accomplish solid results despite ongoing fear, is deploying one’s liquid net worth in a prudent asset allocation. One’s carefully constructed asset allocation among our investment baskets in security; defensive equity; traditional equities; and private investments is the building of our dykes of courage. The floods of fear come daily from the many economic, geopolitical, and political challenges that we face. Our asset allocation seeks to protect us from the emotional decisions that investors often make that tend to hurt their performance.
* Only our Sterling Stamos strategies invest in funds that use leverage.
Our explanation for the first quarter’s significant gains stems from a catch up to reflect last year’s earnings growth, and the somewhat reduced fear emanating from last year’s economic, political and natural disasters. The Japanese earthquake and related events, our budget debacle and subsequent credit downgrade, predictions of a Lehman-like financial meltdown in Europe,
and a projected double- dip recession were digested/dealt with/or just didn’t happen. Of course some challenges including structural and growing deficits, unacceptable levels of unemployment and anemic domestic growth need to be addressed with reasonable fiscal policy. But that will have to wait until after the election given the selfish nature of our politicians.
We at FLI believe that the economy is somewhat better than many pundits believe based on the financial strength of American business and the resilience and prudence of the American consumer. This is in spite of politicians who have chosen to bicker rather than promulgate constructive fiscal policies relating to addressing budget deficits, overdue tax reform, and impending difficulties with Social Security, Medicaid, and Medicare. This paralysis has contributed to a continued level of high unemployment as existing businesses are slow to deploy capital and hire new employees as there remains too much uncertainty. And overzealous government regulation in many industries including energy have hampered growth initiatives and subsequent job growth.
The unfortunate reality is that we face significant uncertainty from both unknown tax and healthcare policy which severely impact the domestic economy. Tax rates for almost all Americans are set to increase the first of the year as payroll taxes go back up and the Bush tax cuts expire. In addition, our new health care law is being challenged by 26 states before the Supreme Court. Their decision will impact virtually all Americans and most businesses. And by the way, imbedded in this new health care law are tax increases on all forms of investment income. The net result could be a huge headwind to the consumer and business depending on what happens at year-end (we believe some compromise will be made lessening the tax blow).
Meanwhile China’s growth is still strong but somewhat slower than recent quarters. Europe’s debt and banking issues are being dealt with but it is in a modest recession (thus far) resulting from austerity and tax increases (there is a lesson here). The good news is that the powers in Europe are looking to avoid a Lehman-like event. So far so good – and even headlines about Greece, Italy, Spain and Portugal don’t really move our markets as much as they had. However, we continue to be concerned that steps taken to this point are still a temporary fix and include anti-growth austerity. This could present issues down the road. Other eopolitical hotspots in the Middle East could bring back volatility, especially efforts to stop Iran’s nuclear undertaking.
The good news is the S&P 500 and other benchmarks are at much higher levels than three years ago, but not record levels. However earnings are higher for companies and we believe share prices therefore are more reasonable. This is especially the case given the historically low interest rates being paid on bonds. Corporate balance sheets are much stronger; however the pace of expected earnings growth has slowed. Dividend growth is robust and our Dividend Growth strategy yield is more than fifty percent greater than the ten year Treasury! Thus we remain comfortable in advising clients to have prudent but reasonable allocations to our defensive and traditional equity strategies. Too much money is in money market funds and bond strategies which we believe will provide negative real returns (after inflation) and will suffer losses if interest rates increase. Skepticism about the market’s gains and ongoing fear continues to cause
this outflow from stocks into bonds and cash. This we believe, as contrarians, is a positive factor.
Commodities are hard to call given the uncertainty of global growth. Gold remains more of an insurance hedge against inflation and global conflict now that financial collapse seems off the table. Real estate, if not overly levered and financed at longer term low interest rates while sporting a good cash on cash return, could be a worthwhile investment (not so easy to find, but we are looking). Private equity also is attractive if you’re willing to endure long periods of illiquidity (you are generally paid for waiting).
The proverbial wall of worry described above should also include high energy costs and a housing market that continues to sputter along (we believe it will get better in the next year). Both particularly hurt the consumer who is still deleveraging. So why do we remain defensively optimistic? The answer is cash, fear, and progress.
The individual and corporate cash on the sidelines, both here and abroad, will ultimately find its way into investment, dividend increases, share buybacks, and acquisition activity. This will bode well for good stocks. The media-driven fear seems to be giving way to the animal instinct of greed. Apple at $600 and paying a dividend, Facebook going public at a hundred billion dollar valuation and old Big Blue (IBM) hitting $200 per share have made those risk takers richer. Given what we believe to be reasonable valuations for both Apple and IBM, even my older relatives would make that risk-on trade. Yet many remain on the sidelines still contemplating an entry point. They will slowly but surely commit as other asset classes provide little or no value and that also will be good for the markets. Despite the legitimate real life concerns that exist, progress is being made by companies in terms of earnings growth, market share gains and product innovation. And even politicians both here and abroad are starting to deal with structural issues that must be solved.
So stay disciplined and nimble by allowing us to work with you on a prudent asset allocation. In the current environment we generally recommend an asset allocation that emphasizes defensive equities, so volatility and fear doesn’t shake you out of the equity markets. In addition, at this juncture we believe that our defensive equity strategies provide better value and yield than most bonds. At the same time you will also have a better chance to make a real return (after inflation) on your core capital. The balance of security (bonds and absolute return) on one side and traditional equities (growth, value and diversified) on the other side of defensive equities should give you a pathway to reasonable long term returns while taking on the level of risk you are comfortable with. Meanwhile you can watch events unfold on our wall of worry with fewer sleepless nights.
You will see from the results in the next section that having been diversified among our allocation baskets of security, defensive equity and traditional equities paid off handsomely this quarter while permitting you to sleep at night. We can’t let fear dictate a policy of accepting below inflation returns.
Best regards,
Robert D. Rosenthal
Chairman and
Chief Executive Officer
Ralph F. Palleschi
President and
Chief Operating Officer
*The forecast provided above is based on the reasonable beliefs of First Long Island Investors, LLC and is not a guarantee of future performance. Actual results may differ materially. Past performance statistics may not be indicative of future results.
Disclaimer: The views expressed are the views of Robert D. Rosenthal and Ralph F. Palleschi through the period ending March 31, 2012, and are subject to change at any time based on market and other conditions. This is not an offer or solicitation for the purchase or sale of any security and should not be construed as such. References to specific securities and issuers are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities.
Content may not be reproduced, distributed or transmitted, in whole or in portion, by any means, without written permission from First Long Island Investors, LLC. Copyright © 2012 by First Long Island Investors, LLC. All rights reserved.
“The economy depends about as much on economists as the weather does on weather forecasters.”
Jean Paul Kauffmann
Investment Perspective
The fourth quarter of 2011 saw equity markets significantly rebound from the sharp downturn experienced in the third quarter. The entire year was a troubling and difficult one for investors as volatility from economic, geopolitical, and natural disasters interfered with rational investing. These factors prevented stock prices from reflecting significantly higher earnings achieved by
many companies in the U.S. and around the world. In fact, there was an unusually high correlation between the stock market performance of companies whose businesses performed well and those that didn’t. Thus higher earnings from better performing companies were cast aside from a valuation standpoint as fear and uncertainty spread by the media dominated investors. Specifically the uncertainty of the European debt crisis, the Arab Spring, and the horrific natural disaster in Japan from an earthquake and tsunami plagued investors on almost a daily basis. Couple this with dysfunction in Washington and an unprecedented downgrade of U.S. debt, and we found ourselves in an ugly environment with outflows from equity markets
and inflows to cash and bonds.
One result from the above factors was the proliferation of dire economic forecasts from many notable economists. Predictions of another Lehman-type financial crisis initiated in Europe, a double-dip recession, and an imminent attack on Iran surfaced on a regular basis adding to the uncertainty and fear of investors. Well, thus far the economists have been wrong to a large extent. The U.S. has not gone into recession, although growth remains painfully slow. Employment has steadily improved, although still leaving millions unemployed and underemployed. Europe continues to kick the can down the road with its efforts to bolster the Euro and the besieged economies of Greece, Italy and Spain. Despite political paralysis, our government is still functioning and we as a nation have survived our first credit downgrade (it was no shock that France and other European countries were downgraded in January). So, as a global economy, we are doing somewhat better than that which was suggested by many economists just six months ago. Well, their predictions made for some interesting reading, although it sometimes bordered on fiction. Economists weren’t able to predict much of what the real economy was. And that is why we focus on the fundamentals and don’t listen to weather forecasters as well.
The confluence of these factors led to a tough year for different strategies. Most equity-based hedge funds did quite poorly with negative results as correlations were too high amongst stocks. Longer duration high quality municipal, treasury, and corporate bonds did reasonably well as did our fixed income portfolios. Most traditional equity strategies suffered modest losses, failing to
achieve a flat benchmark return. Our defensive equity strategy, dividend growth, had a great year achieving a 12% net return. Other of our traditional equity strategies suffered modest losses. Foreign equity strategies did poorly as the international benchmarks declined from ten to twenty percent, falling in sympathy with the angst in Europe and fears of a hard landing in China. Thus it was a difficult investment environment in which our strategies did alright on balance, led by Dividend Growth.
While it is true that many economists got it wrong last year, we remain optimistic but cautious ahead of continued uncertainty. We take solace in knowing that American domiciled businesses (especially large ones) have solid balance sheets with significant amounts of cash. This is a good position to be in and gives these companies the flexibility to possibly raise dividends, buy back
shares, and make opportunistic acquisitions. Interest rates remain incredibly low as mandated by monetary actions taken by the Fed recognizing weaker than desired economic growth, a still declining housing market, and a benign inflation outlook. This will save bond investors for the time being who have extended out too far in maturity, but provides weak yields that in many cases are below the inflation rate. Thus those investors remaining in cash and those holding bonds are getting a negative real return after inflation. Those investors who have stretched maturities to grab yield will be punished if rates start to increase sometime in the future (we believe they will increase in the future).
Equity valuations remain attractive in our opinion. Projected S&P 500 earnings of about $100 for 2012 (a modest growth from 2011) makes the general market seem somewhat undervalued. We believe that, over time, this asset class will generate investor inflows for the first time in years. This could lead to multiple expansion and meaningful appreciation. However, investors should
always be choosy in selecting companies to invest in. We see many companies that are reasonably growing and represent real value in our opinion. Others might not fare as well in this more difficult and slow growing economy. Accordingly, we believe that our defensive equity strategies, including Dividend Growth, are key sound strategies for the current uncertain environment. Our dividend growth strategy should benefit from what we believe will be another year where its dividends should grow by 8% or more. This strategy continues to garner investor interest because of its above average yield and steadily growing income stream. Thus we believe these two defensive equity strategies are ideally suited to prosper in the current uncertain economic and geopolitical environment.
Our traditional equity strategies are also seemingly in a good place given both valuation and significant earnings improvement forecasted for 2012. These strategies will particularly benefit if the European debt crisis has some resolution as this has been a major overhang. In any event, the headlines from Europe no longer generate the panic they did last year, and our domestic banks are actually seeing some lending opportunities in Europe. Valuations are reasonably compelling for traditional equities and while earnings growth on average appears modest, less uncertainty than last year should help these strategies appreciate. We also believe that our seasoned managers have identified those companies that can prosper in the growing global economy as well as those capable of making market share gains.
On balance, we remain cautiously optimistic as the forecasted disasters last year didn’t materialize and the global economy continues to slowly improve. However, given continuing policy uncertainty both domestically and internationally, we believe that asset allocations for our clients should be biased on the defensive side. Defensive equity strategies make sense while fixed income offers unreasonably low returns. We would not add to them at this time unless one is willing to accept a negative real return on an after tax basis for most quality bond offerings. Finally, for those who can withstand illiquidity, private equity also seems attractive given the need for capital in the small to middle market companies where credit is still hard to come by. We remain committed to the strategy of reasonable diversification.
As always, we stand ready to assist you with your asset allocation in these difficult times. Our goal remains preservation of capital with appreciation above the rate of inflation while minimizing risk through greater emphasis of defensive equity strategies and overall diversification. And yes, we know this will help you sleep at night as well. Please call upon us.
Best regards,
Robert D. Rosenthal
Chairman and
Chief Executive Officer
Ralph F. Palleschi
President and
Chief Operating Officer
RDR/lsb
* The forecast provided above is based on the reasonable beliefs of First Long Island Investors, LLC and is not a guarantee of future performance. Actual results may differ materially. Past performance statistics may not be indicative of future results.
Disclaimer: The views expressed are the views of Robert D. Rosenthal and Ralph F. Palleschi through the period ending December 31, 2011, and are subject to change at any time based on market and other conditions. This is not an offer or solicitation for the purchase or sale of any security and should not be construed as such. References to specific securities and issuers are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities.
Content may not be reproduced, distributed or transmitted, in whole or in portion, by any means, without written permission from First Long Island Investors, LLC. Copyright © 2012 by First Long IslandInvestors, LLC. All rights reserved.
Dear (Client):
We wanted to take this opportunity to thank you for investing in our Dividend Growth strategy. You probably have noticed that we had a very good year in 2011 by appreciating 12.0% net of all fees and expenses. (This compares favorably to the S&P 500 which advanced 2.1%.) We appreciate your confidence in our strategy and we are glad to have provided a really good return in what turned out to be a most difficult year for investors.
Recently, many pundits and strategists have pointed out the benefit of investing in higher yielding large companies as if this were a new phenomenon. We believe that this way of investing has rewarded investors over many decades. We also believe that the key to this being a successful way to invest over the long term is to find companies that can grow their dividends virtually every year. That requires a successful business model as well as managements that have it in their DNA to share growing cash flows with their shareholders. This is why we carefully select our portfolio companies to include only those that combine a higher than average dividend with the ability and history to increase dividends on a yearly basis. We are proud to report to you that each of our portfolio companies (27 in all) raised their dividends last year. In some instances, we have companies that have raised their dividends for more than fifty consecutive years!
Based on our reviews of academic studies and our analysis of companies that pay higher and growing dividends, we firmly believe that dividends play a significant role in total appreciation over long periods of time. We believe that many companies that don’t pay dividends (or don’t raise them on a frequent basis) will suffer from less than desirable valuations unless they have unique growth characteristics. Today, with bond yields so low and in some cases less than the annual inflation rate, we believe that large quality companies that pay higher than average dividends with the potential of growing those dividends continue to make great sense as part of an overall asset allocation for any investor. Getting a three to four percent on average growing cash return settles a lot of nerves during periods of great uncertainty.
Diversified investing is still the key to a successful overall investment strategy. We believe that our Dividend Growth strategy of investing should continue to be a meaningful component of your investment plan. This, along with allocations to our security and traditional equity baskets, will help you navigate the uncertainties that exist in our world today with a goal to both preserve and grow your net worth.
Thanks for your continued support!
Best regards,
Robert D. Rosenthal
Chairman and
Chief Executive Officer
*The forecast provided above is based on the reasonable beliefs of First Long Island Investors, LLC and is not a guarantee of future performance. Actual results may differ materially. Past performance statistics may not be indicative of future results.
Disclaimer: The views expressed are the views of Robert D. Rosenthal through the period ending December 31, 2011, and are subject to change at any time based on market and other conditions. This is not an offer or solicitation for the purchase or sale of any security and should not be construed as such. References to specific securities and issuers are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities.
Content may not be reproduced, distributed or transmitted, in whole or in portion, by any means, without written permission from First Long Island Investors, LLC . Copyright © 2012 by First Long Island Investors, LLC. All rights reserved.