Entering 2015, market fundamentals remain similar to how they were a year ago. Globally, growth is slowing. Geopolitically, the landscape is charged. Economically, the US is improving, but slowly. You will recall that our stock market forecast for 2014 called for a below-average year considering these issues. Our expectation was for stocks to return a mid-single digit return, between five and seven percent. In fact, the S&P 500 returned 13.7%, a much stronger year than anticipated. Our forecast for stocks in 2015 is the same as it was a year ago: mid-single digit returns. (more…)

As the year began, our 2014 forecast for US stocks called for sub-par returns. We did not anticipate a losing year, but expected gains in the low-to-mid single digits. Our thinking was that valuation was getting a little stretched coming off of two big years in 2012 and 2013, up almost 50% cumulatively. In addition, we thought a rising interest rate environment would make it more difficult for stocks to continue moving higher.

So far, neither forecast is on track as the US market is up 8.35% through nine months and interest rates have moved lower. But we hold steadfast to our original forecasts. If anything, valuations for stocks have worsened a little. Stocks are not expensive, but they are trading above their long-term valuation (more…)

As we begin the New Year, Maryland investors find themselves in a bit of a quandary: where to invest in 2014. There do not appear to be any clear options. The consensus view on Wall Street is that interest rates will move higher. If correct, that would mean their more safe investments, bonds, are headed for another difficult year. Stocks are up significantly since the financial crisis and appear fully valued. Perhaps the year will not be kind to stocks either. Cash is yielding nothing and unless the Fed has a drastic change of heart, that is not expected to change. So, what’s an investor to do in this environment?

The bond market is probably not the answer as we are most likely headed for another difficult year. The Quantitative Easing program should end in 2014 and the Fed may begin to seriously contemplate increasing the Fed Funds rate. The mere threat of tapering the QE program in 2013 caused a violent reaction as the yield on the 10-year Treasury spiked from 2% in June to 3% in September. The 10-year Treasury began 2013 yielding 1.76%. An upward bias to yields of most maturities longer than 2 years persisted throughout 2013 and many pundits suggest 2014 will likely be no different. Investors are not used to losing money in their bond investments. (more…)

Over the last 30 years, there have been monumental changes to the investment advisory industry in our region. Many great, locally owned firms, like Alex Brown and Mercantile Safe Deposit & Trust, are gone. Others, such as T. Rowe Price and Legg Mason, survived and thrived. Dozens of small money management firms have been created as professionals left larger organizations over the years to start their own. As a result of these movements, the local investment advisory landscape is currently dominated by brokers, Registered Investment Advisors, and banks. RIAs seem to be growing the fastest at the moment, primarily because that business model appeals the most to both clients and practitioners.

The brokerage industry has witnessed mass defections to the RIA model as brokers have struggled with the shrinking compensation levels they have been forced to endure. Most of the compensation to brokers in the past was centered on transaction-based fees and 12b-1 fees from mutual funds. As brokerage firms reduced payouts and attempted to shift clients toward an assetbased fee, many in the industry decided to start their own practice as RIAs. Entire companies were formed to provide platforms for these disenfranchised brokers to start their businesses. (more…)

As Warren Buffet said, “Be fearful when others are greedy and greedy when others are fearful.” Maryland investors do not need a “high-powered” New York investment advisory firm to follow this advice. Our Baltimore-based firm believes so strongly in these words that we’ve placed the quote at the top of the agenda for our weekly investment committee meeting. It’s so easy to get caught up in the emotional side of investing because it is our emotions about money that drive us to invest in the first place. We all love to make money and hate to lose it—greed and fear are the engines of the markets no matter where you live.

There are many reasons why truly successful investors are terrific at what they do. Foremost is their ability to take the emotion out of investing, which allows them to sell closer to peaks and buy nearer the bottom. One doesn’t have to look much further than downtown Baltimore to find famously successful investors—Bill Miller of Legg Mason and Brian Rogers of T. Rowe Price come to mind. (more…)

Baby boomers throughout Maryland are facing a two-pronged assault on their investment portfolios. As we all know, stocks have performed very poorly over the last ten years. Equally as important and probably less obvious is that investment income has been under assault as well. Not only have yields been falling, but during the last recession many companies cut their dividends. It has become very difficult to grow portfolios in the traditional way,and just as difficult to grow investment income. The importance of a growing income stream cannot be overstated, especially as baby boomers begin to retire. Growing investment income is a problem—and that problem in itself is growing. (more…)

Investment Income—The Growing Problem

With bond and money market yields near all-time lows, investors who are trying to generate income feel like they are swimming upstream. Until recently, investors could always count on the bond market to provide them with a steady stream of consistent income. Yields were reasonably competitive, which made it easier for investors to live off of their investment income. The U. S. financial crisis and subsequent recession pushed interest rates to historically low levels.

During this difficult period, however, investors could still manage to find competitive yields, as risk was still rampant. For example, there was a period of time in late 2008 and early 2009 when the consensus view was that municipalities would default on their obligations. Yields spiked to very attractive levels as hedge funds dumped their municipal bonds. Also, corporate bonds maintained high yields throughout the crisis as they were considered very risky. The spread between corporate yields and Treasury yields reached an all-time high.

With the economic recovery, the perceived risk of both corporate and municipal bonds has fallen dramatically. Thus, their yields are now in line with historical levels versus Treasury yields. For the first time in 50 years, many companies’ bonds are yielding less than their common stock. With bond yields at record lows and money market rates near zero, investors are facing the unappealing proposition of replacing their maturing 5% coupon bonds with new bonds yielding 3% or less.

Simply put, after years of growing income streams, investors’ income generated by bonds and money market funds is being systematically reduced. But what can investors do to fix this problem? The answer may lie in the equity market. Diversified stock portfolios can be constructed with yields in excess of 4%. Because of the recent correction combined with companies’ willingness to increase dividends, stock yields have increased. We are not proponents of making a huge asset allocation shift, but are in favor of shifting some money from bonds to high yielding stocks to increase the portfolio’s income. Taking this action may allow investors to swim with the income current instead of against it.

—Dave Stepherson

Value is in the eye of the beholder. I have been in the investment business for 18 years and have met all kinds of different investors—growth, value, momentum and technical. The one common thread among them is that they believe they are purchasing stocks at a good value. Quite simply put, they are buying a stock trading below their estimate of what it is worth. In this sense, all investors are investing for value. But value investing trumps investing for value over long periods of time.

Investing for value and value investing are very different. Value investing is an often-misunderstood investment style. Benjamin Graham and David Dodd are the founding fathers of value investing. Their book Security Analysis is still considered the bible for true value investors and a must-read for all investors. Although value investing has evolved over time, it is based on fundamental analysis used to derive the intrinsic value of a company. This calculated value is compared to the current share price for relative attractiveness. (more…)

Fear and greed drive markets. In Jim’s letter, he explains how we got to where we are so quickly. But to summarize in a word, it was greed. Greed was everywhere, not just on Wall Street, as the media would like you to think. Greed pushed the price of oil to nearly $150 per barrel. Greed convinced speculators to buy homes they intended on flipping. Greed motivated some home-buyers to “fudge” their mortgage applications. Greed convinced mortgage brokers that credit worthiness really did not matter. Greed inspired banks and brokers to securitize these mortgages. And greed produced the over-leveraged balance sheets loaded with these securities.

Now, fear has taken over. Fear forced Bear Stearns into the arms of JP Morgan. Fear brought on the nationalization of Fannie Mae and Freddie Mac. Fear drove AIG, the world’s largest insurer, to the brink of bankruptcy. Fear seized up the credit markets. Fear forced Goldman Sachs and Morgan Stanley to give up their investment banking business models. Fear pummeled stock prices with record force as the volatility index spiked to record levels. Fear is everywhere.

From peak to trough, the stock market has dropped by more than 30% through the first week of October. For investors with a time horizon of anything longer than a year, getting out of the market at this point makes no sense. Most of the pain has been inflicted. Stocks could go lower but clearly a tremendous amount of bad news is already priced into the market. After all of this, a “professional investor” goes on national television and advises people to get out of the market? That should prove to be one of the all-time bad calls ever made. The bigger problem with getting investors out at the bottom is they most likely will not get back in when the market improves. (more…)