Let Me Hear Your Balalaikas Ringing Out Come and Keep Your Comrade Warm

April 17, 2017 – DJIA = 20,453 – S&P 500 = 2,328 – Nasdaq = 5,805
“Let Me Hear Your Balalaikas Ringing Out Come and Keep Your Comrade Warm”[i]
The history of Russia spans over 1,100 years.  As expected with anything that has this longevity, it’s not been a smooth journey.  They have been responsible for historic cultural advancements in art, literature, architecture, and science.  Unfortunately, the lows include revolution, conquest, corruption, oppression, world wars, and cold wars.
Surrounding the U.S. presidential election, Russia became the target of the Democrats’ disdain as they were blamed for Hillary Clinton’s defeat.  The election was close in many key states so anything that swayed votes influenced the outcome.  However, without giving a pass to Boris and Natasha, there are many other scapegoats with several being internal.
Of course, more recently, the list of Russian detractors includes Team Trump which was originally criticized for allegedly being aligned with Moscow.  After Nikki Haley’s United Nations tongue lashing and President Trump’s decision to bomb Syria, it’s safe to assume there are not any White House dinner invitations addressed to Vladimir Putin.  Or vis-a-versa.
Global tensions have risen which is causing some unexpected coalitions.  President Trump has back-peddled a bit on the campaign rhetoric concerning China.  Given Chinese influence over North Korea, issues such currency manipulation and trade imbalances were not on the agenda when Chinese President Xi recently met with Mr. Trump.
Unexpectedly, headlines about Syria, Russia, North Korea, ISIS, and other geopolitical problems have not derailed the stock market.  Admittedly, the major averages have pulled back from the records reached at the beginning of March.  But most would have anticipated much lower prices after the news of bombs in the Middle East together with the unstable Kim Jong-un testing nuclear missiles.  Instead, the 2017 version of the U.S markets take this news in stride.  Whether this is whistling past the graveyard is unknown.  Here are where the major indexes are year-to-date.
                                                                                  2017 YTD
Dow Jones Industrial Average                                    +3.5%
S&P 500                                                                      +4.0%
Nasdaq Composite                                                      +7.8%
Russell 2000                                                                -0.9%
Indices are unmanaged, do not incur fees or expenses, and cannot be invested into directly. These returns do not include dividend.
A couple of noteworthy nuggets from the current market landscape.  We draw your attention to the numbers above to highlight that the Russell 2000 finished last week lower for 2017.  As a reminder, the Russell 2000 was the best performing index in 2016 and was especially strong after the election.
On the other hand, the Nasdaq is the strongest of the major indexes through the first 3 ½ months.  Returning to 2016, this was the weakest of the bunch after the election as investors were convinced that Trump’s immigration restrictions would be an obstacle to technology related businesses.
Combining these two reversals, this could represent a rotation from small caps (Russell 2000) to technology (Nasdaq).   It could also be a correction of the solid 2016 gains for the Russell.  Once again, this reminds us that past performance is no assurance of future results.
A common commandment at the start of 2017 was that interest rates would be moving higher.  Indeed, the 10-year Treasury yield, which closed 2016 at 2.43%, rose to 2.61% in March.  Since then, however, bond yields have fallen.  The 10-year finished last week back at 2.23%.
This surprising rally for the bond market (lower yields = higher bond prices) is partially caused by the lowering of 1st quarter GDP estimates, delays in tax reform and regulation cutbacks, and lower inflation. And let’s not forget that the U.S. Treasury market is viewed as a safe haven.  With bombs falling and international tensions high, it makes sense that some global capital flows to U.S. government debt.
Another explanation might be that this move lower in bond yields is a function of how one sided the market had become.  After the election, investors believed that the economic growth would pick-up driven by reduced regulations and increased infrastructure spending.  These additional fiscal programs would be theoretically financed by higher government deficits.  Higher yields would be required to entice buyers of these newly issued bonds.
The result was a crowded investment.  Markets are the summation of investor opinions.  If everyone believes that rates were going higher, prices reflect this. If the market becomes too one-sided, in this case everyone bearish bonds, there are fewer and fewer sellers.  Once the sellers exhaust themselves, the market has to move the other way in order to regain balance.
A final point on the fixed income market.  At the same time that longer term interest rates are falling (10- year and 30-year bonds), the Federal Reserve is raising the short maturity rates (federal funds).  This flattening of the yield curve is often a sign of a sluggish economy.  This is case, however, it might be the necessary rebalancing of the bond market which includes the punishing of the bond bears.
The capital markets have had a lot to digest recently.  And there more on the way – French elections this weekend, British elections in early June, first quarter earnings, and the steady stream of presidential tweets.  Of course, the geopolitical landscape can throw in a knuckleball any time.

It is a bullish sign that the global markets have navigated the recent cross currents without a more prominent pullback.  Nevertheless, this remains a highly-valued market facing a lot of uncertainties.  This skinny margin of safety won’t be problem as long the economy expands, the Fed doesn’t raise interest rates too fast, France stays in the EU, the fleet of U.S. aircraft carriers can cover all international calamities, Congress accomplishes something, Amazon becomes the only retailer left, and the New York Jets don’t do anything too stupid in next week’s NFL draft.  That’s not too much to ask for!

Jeffrey J. Kerr, CFA
Kerr Financial Group
Kildare Asset Management
130 Riverside Drive
Binghamton, NY 13905

[i] Lennon-McCartney, 1969

016 4th qtr-year end Kildare Asset Mgt-Kerr Financial Group client review letter

Vladimir Lenin, founder of the Russian Communist party, said, “There are decades where nothing happens; and there are weeks when decades happen”[i].  There were a lot of weeks in 2016 where decades happened.  The year contained a number of historic events that changed the direction of societies, political systems and economic structures.  While a lot of these events surrounded a rise of populism, their impact flowed to the financial markets.
The year began with the markets in turmoil over worries surrounding China.  The concerns were that a large devaluation of the Chinese currency would lead to a deflationary shock that would cripple the global economy.  This led to the worst start of a year for U.S. stocks.  The major averages lost 10% – 15% in the first six weeks of 2016.
China did not devalue the renminbi and markets stabilized.  Amazingly, U.S. stocks fully recovered their losses and by April they were up for the year.  For the next couple of months, the markets traded in a range as they debated the Federal Reserve’s next interest rate increase and awaited the Brexit vote in June.
As we know, the United Kingdom unexpectedly voted to leave the European Union.  Once again, global markets were chaotic and stocks plunged.  The U.S. stock market dropped over 5% in three trading days.  And once again, prices recovered regaining the losses in the next three days
The exclamation mark for this incredible year was the U.S. presidential election.  Once again there was an astounding change in the markets’ point of view.  In the weeks before the election the U.S. stock market dropped whenever Donald Trump gained in the polls.  And as Hillary Clinton fell behind on election night, U.S. stock futures tumbled with the Dow Jones Industrial Average futures plunging over 800 points.  Then the markets, without obvious reason, reversed course and have not looked back.
Here’s the final tally on the major U.S. stock indexes for 2016.  I’ve also included the returns after the election as they were a significant part of the year’s numbers.
                                                               2016        Election to year end
Dow Jones Industrial Average               +13.4%              +7.8%
S&P 500                                                 +9.5%                +4.6%
Nasdaq Composite                                 +7.5%                +3.6%
Russell 2000                                          +19.5%              +13.5%
Indices are unmanaged, do not incur fees or expenses, and cannot be invested into directly. These returns do not include dividend.

Using a size weighted average, here is how the average Kildare Asset Management-Kerr Financial Group client’s account performed. This is calculated after all fees and expenses.

2016            Election to year end

                                                           +16.42%                +4.97%
There were several holdings that contributed to the 2016 performance.  As was covered in the 2nd and 3rd quarter reviews, positions in closed end mutual funds that focused on high yield corporate bonds and corporate loans.  Throughout the year these funds appreciated in price which was a bonus to the real reason for their purchase – 6% to 8% dividend yields.
Layne Christensen (symbol LAYN) has been a long term holding that moved higher in the second half of the year.  The company is a global water management organization that provides solutions for water, mineral, and energy resources.  The company has had problems involving underperforming divisions as well as pressure from the energy sector when commodity prices fell.  Last year they achieved progress in some of the initiatives to improve efficiencies.
Layne’s stock price in late June was less than $7 per share.  It ended the year over $11 or 50% higher than late second quarter.  If management can continue to make improvements, I think the stock price could see further gains in 2017.
Avianca Holdings (AVH) is another position that contributed to 2016’s gains.  AVH is a leading Latin American airline based in Columbia.  It has one the broadest flight coverages throughout Central and South American together with flights to major U.S. cities.
AVH was undervalued by most financial measures.  While airlines typically trade at discounts to market multiples, Avianca seemed to be mispriced.  Part of the problem was that some of their debt was issued in U.S. dollars.  As the dollar rose in 2015 and 2016, AVH had to pay more in interest as measured in Colombian pesos.  While the company was profitable and fuel expense was declining, the market didn’t like its capital structure.
Outside of the financials, Avianca’s route network appeared to be an asset that would be difficult to reconstruct.  To this point, rumors developed during 2016 that the company could be a takeover candidate.  In December, some U.S. airlines starting having discussions with AVH about acquiring the company or forming a partnership.  The stock rose above $10 per share.  It began the year around $4 but had risen into the $6’s by mid-year.  Avianca is currently in talks with United however the structure (partnership vs. acquisition) is unclear.  Depending on the direction of the discussions, we may move out of the position in 2017.
2016 will long be remembered as its many everts were historic.  Further what happened last year will continue to impact future years on many levels – societal, political, economic, and international relations.  As these pertain to the capital markets, I will remain watchful for opportunities while focusing on managing risk.
Jeffrey J. Kerr, CFA

Kerr Financial Group
Kildare Asset Management
168 Water Street
Binghamton, NY 13905

March Madness – April Absurdity. “Curiouser and Curiouser”

April 3, 2017 – DJIA = 20,663 – S&P 500 = 2,362 – Nasdaq = 5,911
March Madness – April Absurdity
The term “March Madness” is typically associated with the men’s college basketball tournament that happens this time of the year.  The exciting games and inevitable upsets attract widespread interest and viewership.  Of course, March Madness can be used to describe other events that happened during the month such as the weather, the markets and the search for Tom Brady’s Super Bowl jersey.
Of course, this year the madness of the NCAA basketball tournament cannot come close to the madness in Washington.  President Trump is discovering that the campaign was a walk in the park compared to being President.  He is criticized for Congress’s failure to repeal Obamacare.  He is scrutinized over wiretapping claims and is questioned on his relationship with Vladimir Putin and the Russians.  Of course, his brash unconventional approach invites detractors.
The wackiness of Washington isn’t exclusive to the executive branch.  Congress’s dysfunctional behavior moves within and across party lines.  And we must not forget the fourth branch of government – the press.  Their job of covering our political leaders has not been exactly objective.  Clearly, we will need more synonyms for ‘madness’ to form alliterations for the other months – April Asininity, May Mindlessness, etc.
This lunacy has had surprisingly little negative impact on the stock market.  Normally such acrimony and uncertainty are headwinds for higher stocks prices, but investors seem to be focused on other factors (or ignoring it).  Stocks just finished their 6th consecutive positive quarter.  There were solid gains for all the major averages.
                                                                          2017 YTD
Dow Jones Industrial                                             +4.6%
S&P 500                                                                 +5.5%
Nasdaq Composite                                                 +9.8%
Russell 2000                                                           +2.1%
Indices are unmanaged, do not incur fees or expenses, and cannot be invested into directly. These returns do not include dividend.
Despite the stocks markets’ recent rally, not all investors are reaping the rewards.  Last week’s American Association of Individual Investors (AAII) survey showed that more respondents were pessimistic than optimistic.  There were 37.4% bears vs. only 30.2% bulls.  This is remarkable on several levels.  First, bulls normally outnumber bears.  Next considering that stocks reached record levels in the beginning of March, we would expect a lot more excitement than the gloominess that those numbers suggest.  Lastly, both figures have deteriorated since the beginning of the year as bullish sentiment stood at 46% in January while the ursine camp was down at 25%.
Away from Wall Street, people are cheerful (this shouldn’t be surprising!).  Last week’s Conference Board’s Consumer Confidence survey jumped to 125.6 from 114.8 in February.  This is the highest reading in 16 years. Naturally, a smiling consumer is good for the economy.
Another part of the survey indicated that consumers have higher expectations for increased income.  Of course, these two are joined.  One of the reasons for a higher confidence level is the belief that you going to see more in your paycheck.
The contrast of a sanguine consumer and gloomy investor is an interesting economic backdrop.  Why the conflict?  Are the consumers’ views a result of being on the frontline of commerce and things are pretty good?  Workers are feeling upbeat about both their current conditions as well as their future and they respond accordingly.
Returning to the grumpy investors.  Are they overly influenced by headlines that are casting the new administration as a modern-day Marx Brothers?  Or does he or she view stocks prices as a little high and getting ahead of the fundamentals?  This latter point does not explain why the pessimism has been increasing while stocks have been rising.  Usually higher prices generate more excitement and enthusiasm rather a river of tears.
The fixed income markets offer another puzzling development.  The Federal Reserve fulfilled their earlier smoke signals by hiking the federal funds rate in March.  And everyone knows that interest rates will be rising.  But for some peculiar reason, interest rates have gone down during the past several weeks.  The 10-year Treasury note’s yield reached 2.6% in mid-March.  This rate closed last week at 2.39%.  The 30-year Treasury bond had a similar drop as it fell from 3.20% to 3.01% at the end of the month.
These moves may seem minor but, for several reasons, they are noteworthy.  First, the bond market is supposed to be less volatile.  Fixed income is regarded as ‘safer’ than equities and is theoretically used to reduce portfolio risk.  We’re not sure a 5% move in two weeks defines stable.  Secondly, interest rates are expected by everyone to be moving up.  That they are doing the opposite calls into question market forecasts and suggests that something else in underfoot.  That there might be unknown market influences logically increases risks.
As we transition from March Madness to April Absurdity, the markets are digesting some large conflicting signals.  While equities have corrected in the last couple of weeks, they remain resilient.  Perhaps this is an example of Wall Street climbing a wall of worry.  The summation of the current market milieu is that it is not an opportune time to increase risk.  Yet, there is no guarantee that the markets provide better entry points for investing capital.   As Alice observed, “Curiouser and curiouser”.
Jeffrey J. Kerr, CFA
Kerr Financial Group
Kildare Asset Management
130 Riverside Drive
Binghamton, NY 13901