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
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