Wall Street’s not so scary Halloween stories

October 23, 2017 – DJIA = 23,328 – S&P 500 = 2,575 – Nasdaq = 6,629
“It was the witching time of night…”[i]

October has a history of being a frightening month. Shorter days means more darkness together with a chill in the air. Of course, Halloween is accompanied by tales of ghosts, goblins, demonic developments and the release of B-rated horror movies. And scariest of all, Congress is in session.

Of course the financial markets also have a history of paranormal Octobers. The 1929 and 1987 crashes occurred in October as well as the Panic of 1907. In addition to these historic events, October has had other seminal market tribulations such as Long Term Capital Management’s implosion (technically this was a September event but had October fallout) and 2008’s drop after Lehman Brothers failed which helped start the financial crisis.

Despite this maniacal reputation, 2017’s October has been a continuation of the pleasant and steady move higher that has dominated the year. In fact, this year might become the “calmest” on record. Ryan Detrick, Senior Market Strategist at LPL Financial Research, suggests one way to determine volatility (or lack of it) is by measuring the absolute value of the average daily change. Mr. Detrick uses the S&P 500 and calculates this daily change at 0.30% so far in 2017. This is the second lowest reading with 1964 coming in at 0.26%.[ii]

The chart above shows this measurement dating back to 1928. It is interesting that there were three consecutive years of this type of low volatility in the mid-1960s. We can’t rule out the possibility that we are beginning another similar stretch. Another common belief is that when volatility returns it will signal the start of a bear market. Please note the low number registered in 1995. This was followed by much higher volatility readings in conjunction with the bull market of the late 1990s.

The serene capital markets in the face of the current headlines is similar to a perplexing mystery penned by Edgar Allan Poe. There is a great deal of irony that the markets are experiencing one of the least volatile years in the face of cultural division, protests, terrorism, political polarity, and widespread social tension.

Not only are the markets curiously calm, they are trading at all-time highs. The S&P 500 closed at a record high every day last week. Thursday was the 30th anniversary of the 1987 stock market crash where the Dow Jones Industrial Average lost over 20% in one day. Stocks marked this by staging a 2017 type crash – plunging a painful one-half of one percent – before rallying back and closing higher on the day.

The S&P 500 has now recorded 61 record highs in 2017 which is the third most behind 1928 and 1964. And there are two months remaining for this year. Below is a chart showing the yearly number of record closes for the S&P 500.[iii]

While the streak of daily records for the S&P 500 is impressive, there is more to this story. Jason Goepfert, the head of Sentiment Trader, points out that the S&P has 6 weekly record closes in a row and 7 consecutive monthly record closes. As Mr. Goepfert points out, this is 18 record closes across daily, weekly and monthly time frames. He goes to say that this is the most in history and that other periods that had a comparable series of records did not mark major stock market tops.[iv]

It is interesting that the S&P 500’s accent has happened despite battling some intimidating zombies. Bellwether stocks such as AT&T, Disney, Exxon-Mobile, General Electric, IBM, Target, and Wells Fargo are not participating and, in fact, are all lower year-to-date. These blue chip, dividend paying stocks were last year’s darlings but have become “the walking dead”. It’s remarkable that the averages have performed so well despite this drag. Here are the major indexes year-to-date numbers at the close of last week.


Dow Jones Industrial Average 18.0%
S&P 500 15.0%
Nasdaq Composite 23.1%
Russell 2000 11.2%

Indices are unmanaged, do not incur fees or expenses, and cannot be invested into directly. These returns do not include dividend.

Inquiring minds want to know why the financial markets are doing so well when the world seems to be crumbling around us. The answer has nothing to with Mr. Market playing a cruel game of Trick or Treat but rather fundamental improvements together with Wall Street’s masterful marketing.

First, corporate earnings have been strong and are projected to keep growing. This has been the trend for 2017 and it has continued in the 3rd quarter. 63% of the companies that have reported so far have beaten consensus earnings estimates. Stocks trade at lofty valuations but investors currently appear to be willing to pay higher multiples as long as the bottom line keeps growing.

The popularity of passive investing and the use of index ETFs and mutual funds also contribute to the tranquil environment. Passive investing involves buying exchange traded funds (ETFs) or mutual funds that track an index. Investors seek to invest in various asset classes via these funds. For example, SPY is the SPDR S&P 500 Trust and it tracks the S&P 500 index. AGG is the iShares Barclays Aggregate Bond Fund that track the Barclays Aggregate Bond Index which is a broad bond market index.

Capital flows into passive investment strategies have been astounding. BlackRock is the sponsor of the iShares family of ETFs. They recently reported inflows of $96 billion in the third quarter. This brought the year’s total to $264 billion which easily exceeds last year’s inflow of $202 billion.[v]

Vanguard Group, the leader in index mutual funds, has seen inflows of $291 billion in the first nine months of 2017. This is below last year’s influx of $323 billion but will likely be surpassed by the end of the year.[vi]

BlackRock and Vanguard are not the only organizations offering these approaches. There are many other significant investment firms with similar options. But just counting these two firms, a remarkable total of over $1 trillion of investment capital has been gathered in the past two years. We would guess that the majority of these dollars were directed to a passive indexed strategy.

This means that as soon as the dollars get in the ETF or mutual fund, they are invested. There is no discussion over timing and no holding for a better price – the money immediately buys more of the holdings of the index it is mirroring. $1 trillion of indiscriminate buying could be a major force behind the stock market’s steady move higher despite an unsettling news flow.

This develops into a self-feeding cyclical phenomenon and Wall Street is very happy to help promote. The more capital that flows into these funds the better the market performs and the better the market performs the more capital it attracts. So if it’s low cost, index strategies that investors want for their IRAs and 401k’s, the financial industry are more than happy to meet the need with all kind overlapping index products. “Low cost investing for the long term” is a pretty easy sell. We’re sure somewhere in the fine print it mentions that stocks can go down.

The scarier part of this situation is that passive investing is so widespread. It seems everyone is doing it which is eerily similar to some other periods of popular investing fads. Portfolio insurance was a popular strategy in 1987. It was supposed control losses by hedging through stock futures contracts. It ended up contributing to the 1987 Crash.

More recently, tech stocks in the late 1990s were can’t miss as the internet was changing the world. The internet did change the world but somewhere along the way the markets realized that not every dot com company was going to be successful. Stocks crashed again. We won’t go into the money lost on condo speculation in the 2000s.

With the current landscape, the real horror story will be when the markets start to weaken and everyone wants out at the same time. It could be a sudden and dramatic trip lower and once again investors will be wondering what went wrong. Of course, the timing of such an event is the difficult question. For now, that’s enough of fearsome tales of investment ghosts and goblins – it’s time for Halloween candy.

[i] “The Legend of Sleepy Hollow”, Washington Irving
[ii] LPL Financial Research, October 22, 2017
[iii] The Bespoke Report, October 20, 2017
[iv] Sentiment Trader, October 21, 2017
[v] Almost Daily Grants, October 16, 2017
[vi] Ibid

Jeffrey J. Kerr, CFA

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

2017 2nd Qtr.Kildare Asset Mgt-Kerr Financial Group client review letter

Not only did June mark the end of 2017’s second quarter, it was also the eighth anniversary of the end of the Great Recession. This recovery has had plenty of detractors so may it surprise many that this has become the third longest economic expansion since World War II. Only the dot-com boom (10 years – 1991 to 2001) and the 1960’s (9 years – 1961 to 1969) are longer. To put this into further perspective, the average post war expansion is 58.4 months (just shy of 5 years) according to the National Bureau of Economic Research.

When measuring by strength, however, this expansion is not as impressive. Normally an economy that has been expanding for so long would show both above average and accelerating growth. This is not the case for the post-2009 recovery which has a compounded annual growth rate of 2.1%, well below the 3.6% rate of the 1990’s and the 2.8 % of the 2000’s.

Of course, the causes for this below average growth is the subject of intense debate. Much of this deliberation revolves around the impact of the Federal Reserve and monetary policy. Both have played important roles in trying to stimulate the economy as well as stabilize the markets. And both have been controversial in their execution and their effect.

The severity of the financial crisis, according to our central bankers, called for drastic and aggressive measures. The Fed has used “unconventional” to describe their methods which included ‘operation twist’, ‘QE’ (quantitative easing), ‘QE1’, ‘QE2’, and ‘QE infinity’. In contrast to the fancy terminology, the strategy has been simple. It has three basic components – reduce interest rates, print money, and use that newly created money to buy bonds in the open market.

Fed critics believe that these policies and strategies have distorted the markets. Interest rates are unnaturally suppressed which distorts market prices and discounting calculations. Further, some think that the economic recovery would have been much stronger absent central bank meddling.

The magnitude of these programs is illustrated in this chart. The blue line represents the assets owned by the Federal Reserve which consist of securities such as bonds. Prior to the financial crisis, the Fed’s balance sheet normally ranged between $700 million to $900 million.

The blue line spikes at the beginning of the crisis. And after this initial jump, the Fed’s holdings steadily climb until 2014. For the past couple of years, the balance sheet has been steady at approximately $4.5 trillion or more than quadruple the typical balance before the financial crisis.

This shows how dramatic the QE programs were. And while the economic impact of this monetary policy is unclear, the chart shows that the stock market, as measured by the S&P 500 (red line), has benefited. This leads to the question of what happens when the Fed starts to reverse these programs. In June, Janet Yellen and Mario Draghi both introduced the idea that their central banks will start shrinking their balance sheets.

This could increase stock market risk. Alex J. Pollock, senior fellow at the R Street Institute, wrote in June, “The Fed’s problem is now simple and obvious: once you have gotten into positions so big relative to the market and moved the market up, how do you get out without sending the market down? The Fed is expending a lot of rhetorical energy on this problem.”

Of course, the hope is that the economy is strong enough to continue to expand during a gradual reduction of monetary policy help. However, markets have gotten accustomed to central bank involvement and any change could be a headwind. The Fed and ECB’s goal (and challenge) is to gradually remove the elixir without disrupting the markets. The risk is that the addiction is greater than it appears.

Returning to 2017’s second quarter, the stock market advanced further. The gains were less than the first quarter but still respectable. Here is a break down for the major averages for the second quarter and year-to-date.

2nd Qtr 2017

Dow Jones Industrial Average +3.32% +8.03%
S&P 500 +2.56% +8.24%
Nasdaq Composite +3.86% +14.07%
Russell 2000 +2.12% +4.29%

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.

2nd Qtr 2017
+2.72% +5.83%

There were a few notable developments within your portfolio. First, Hurco Companies, Inc. had a good quarter. Its stock rose 10% with the majority of the move happening in June after the company reported earnings. Hurco is a machine tool manufacturer. They produce high end machines with proprietary software and sell them globally with typically over 50% of sales to Europe. The company has a strong balance with no long-term debt.

Hurco has made two acquisitions during the past few years that expands their product offering into other sectors of the market. From the company’s recent results, it looks like they are gaining some acceptance. Annual revenues exceed $200 million and for the past three quarters, for the first time, they have received over $60 million of orders in each quarter.

Hurco is a small company with a limited amount of shares outstanding. Further, they don’t communicate with Wall Street well. Management does not do earnings conference calls nor investment presentations. I speak to Hurco’s chief financial officer (Sonja McClelland) regularly and have encouraged her begin doing earnings conference calls to broaden investor awareness. Whether that happens, if the company continues to grow, Wall Street will find it.

Layne Christensen, which has had some successful recent quarters, and Ares Management, LP (alternative asset manager) were small drags on performance. Both stocks were flat to down slightly. Ares has been especially frustrating as it traded above $22 in the first quarter and closed the second quarter at $18.00. We are still receiving a good yield with a dividend of 6% (assuming a $20 cost basis) and the company has been growing assets and developing new sources for future growth. I think both positions will contribute to performance over time.

On the morning of the last day of the quarter, we received good news that another position was being acquired. Parkway, Inc., a real estate investment trust (REIT) which owns offices in Houston, announced that they were being bought by Canada’s Pension Plan Investment Board. As you may recall, Fortress Investment Group announced in the first quarter that they were being taken over which moved the stock much higher and helped first quarter performance.

Parkway was a late 2016 spin out from Cousins Properties, a much larger nationwide REIT. Cousins’ desire to unload the Houston properties was understandable given the trouble that oil and gas companies have encounter during the past few years.

Despite the challenges, Parkway was attractive because of a cheap valuation which priced in a lot of the negatives. Furthermore, management had a history of re-building real estate companies and there was significant potential over time.

In February, Parkway announced that it sold 49% of one of its properties to a joint venture that included the Canadian Pension Plan Investment Board. They obviously liked the situation and saw value in the whole company. The acquisition is valued at $23.05 per share which is a one-time $4 dividend and $19.05 in cash. The deal is expected to close in the fourth quarter.

Looking to the second half of 2017, the markets will deal with issues such the federal government’s debt ceiling, tax reform, geopolitical tensions, and domestic social acrimony. Add to this the possibility that the Federal Reserve and other global central banks may be cutting back on monetary stimulus.

On the bullish side, corporate earnings are growing and business sentiment is optimistic. And internationally, both developed and emerging markets are expanding. As long as none of the challenges gets out of hand or some other event upsets the global economy, further growth is expected. I will continue to monitor the events looking for opportunities while managing risk.

Thank you for your business and continued confidence. Please contact me with any questions.

Jeffrey J. Kerr, CFA

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

If history repeats itself, and the unexpected always happens, how incapable must Man be of learning from experience

October 2, 2017 – DJIA = 22,405 – S&P 500 = 2519 – Nasdaq = 6,495

“If history repeats itself, and the unexpected always happens, how incapable must Man be of learning from experience.”[i]

Investing is hard. Madison Avenue, however, wants us to believe otherwise as TV ads for brokerage and financial advisory firms make it appear so easy. They portray clients who can only squeeze 15 minutes out of their hectic schedules for their finances yet have everything running smoothly. Or other ads where analysis and winning investment decisions are as simple as hitting a button. Contrary to this fantasy, the real world of money management is much more complicated and challenging.

It is especially difficult when deeply set historical trends inexplicably change. In other words, when the markets don’t do what they are supposed to do. We turn to September as an example of Mr. Market’s confounding ways.

Transporting ourselves back one month to end of August, we find Hurricane Harvey devastating Texas, North Korea firing missiles over Japan, the country trying to understand Charlottesville, the Republicans failing to repeal the ACA, and, of course, Tweets from President Trump. It was an uncertain and worrisome time.

As to the capital markets, caution and risk avoidance would be logical strategies given this landscape. A further nerve-wracking piece of the equation was the fact that were entering a potentially tumultuous time of the year – September and October.

Most are aware of that the two stock market crashes happened in October and the month has witnessed some other nasty air pockets. And as bad as Octobers have been, September is worse. It is the only month that averages a loss for the past 100 years!! The table below breaks down the Dow’s average performance by month for the past 100, 50, and 20 years.[ii] September’s average for the past 100 years is -1.09% – the only month that shows a loss for this time period.

To further illustrate this point, here is a graph that shows the results of $100 invested in the S&P 500 for each of the months going back to 1967 (50 years).[iii] The “Septembers” are the thick red line and are clearly the worst performing month. In fact the $100 invested exclusively in September is only worth $71 in 2017. The next worst month is August which has a value of $98.

So given this history combined with the background of social unrest, geopolitical tensions, and the unknown damage from Hurricane Harvey, who in their right mind would want anything to do with the stock market. Clearly, it would be an easy decision to sell everything and prepare for another sad September.

Instead, the stock market does the unexpected and moves higher. The Dow and S&P 500 increased by over 2% and the small caps (as measured by the Russell 2000) jumped over 6% in September. The Nasdaq Composite, which has been 2017’s leader, paused and was down less than ½%. September’s peculiarity is further proven by the Jets winning 2 games and finishing the month with a 2 – 2 record. Indeed, a curious month. Here are the year-to-date numbers for the major averages.


Dow Jones Industrial Average +13.4%
S&P 500 +12.5%
Nasdaq Composite +20.7%
Russell 2000 +9.9%

Indices are unmanaged, do not incur fees or expenses, and cannot be invested into directly. These returns do not include dividend.

This apparent irrational investor behavior could be explained by optimism concerning the strengthening economy and tax reform. Last week the Commerce Department reported that GDP (gross domestic product) for the 2nd quarter grew at 3.1% which was above forecasts.

Of course, this is backward looking as it is a 2nd quarter number and we just finished the 3rd quarter. However, there are some indications that the growth will continue. The ISM Manufacturing report for September came in at 60.8. This was the first monthly reading at 60 or higher since February 2011 and the highest number since May 2004. The survey dates back to 1948 (formally it was called the Purchasing Managers Index) and only 13.9% of the results have exceeded 60.[iv] September’s number confirms economic optimism.

The Trump Administration released the outline of their tax reform proposal last week. Setting aside its virtues and flaws, reducing corporate taxes is a positive as far as the stock market is concerned. A reduction of corporate taxes obviously translates into larger profits but might result in increased capital investment which will have an exponential economic benefit. That’s what the markets are forecasting.

Returning to our table and chart above, a look forward to 2017’s 4th quarter might add to the bulls’ healthy confidence. October, November, and December all average positive returns for the past 100, 50 and 20 years. Looking at the chart for the past 50 years, November and December are in the top 4 months of performance. Of course, just as September didn’t follow its historical trend, there is no assurance that 2017 doesn’t have a disappointing end of the year.

Considering that the negative news flow can’t stop the stocks market, investors are asking, “Is there anything that can?” That’s actually a $3 trillion question as the Fed announced their intention to start reducing their balance sheet. Recall that as part of their quantitative easing programs, our central bank bought bonds in the market with money they fabricated with the push of a computer key. Their total holdings now exceed $3 trillion dollars (this was around $750 million before the financial crisis).

Fed Chairwoman Janet Yellen announced that the Fed will begin this process in October. To start with, the mechanics of the balance sheet reduction will be that the Fed will stop buying bonds. This will obviously reduce liquidity as dollars stay at the Fed as their portfolio matures. This could result in higher interest rates as bond prices move lower in order to attract buyers. Higher interest rates, if it happens, could be a complication to higher stock prices.

Not only did the equity markets survive scary September, they surprised everyone and moved higher. And getting past September puts us into a historically bullish time of the year. To be sure, there is no guarantee that the markets don’t begin react to North Korea, Russia, the intense social unrest, or some other unforeseen event. However, the markets’ strength in 2017 has been impressive and should be respected until it’s broken. Nevertheless, it’s always wise to keep in mind that Mr. Market can be very, very fickle especially when you least expect it.

[i] George Bernard Shaw, 1902
[ii] The Bespoke Report, September 1, 2017
[iv] Bespoke Investment Group, October 2, 2017

Jeffrey J. Kerr, CFA

Kerr Financial Group
Kildare Asset Management
130 Riverside Drive
Binghamton, NY 13905

“I’m Caught in a Crossfire That I Don’t Understand”

September 18, 2017-DJIA = 22,268-S&P 500 = 2,500 – Nasdaq = 6,448

“I’m Caught in a Crossfire That I Don’t Understand”[ii]

Headlines deteriorate, capital markets appreciate. It is a perplexing mystery that has many confused and incredulous. Issues such as North Korea, Charlottesville, social protests, political discord, terrorism, and natural disasters dominate the headlines. Everyone is aware of them and naturally assume the financial markets should be a tumultuous mess. Yet, markets maintain a calm levitation.

Last week the Dow Jones Industrial Average closed at all-time highs for 4 consecutive days including Friday. The S&P 500 also closed the week at a record high while the Nasdaq reached a record earlier in the week and closed slightly below that level. Even more remarkable is the fact that this is happening in September which is one of the historically weakest months.

Here are the major averages’ performance at the close of last week.


Dow Jones Industrial Average +12.7%
S&P 500 +11.7%
Nasdaq Composite +19.8%
Russell 2000 +5.5%

A partial explanation for the markets’ strength is that numerous negatives provide a wall of worry for prices to advance. In other words, there is so much bad news and it is so widely known that a lot of that risk is priced into current levels. As mentioned, a logical investor, given this news landscape, has probably already distanced him or herself from risk assets.
Another important support for record stock prices is corporate earnings growth. S&P 500 earnings have been quietly and materially expanding. For 2017’s 2nd quarter, profits grew at a double digit rate with the year-over year growth over 12%. Additionally, S&P 500 revenues have grown more than 5%. We’re not sure investors who are focused on the myriad of negative headlines appreciate this development.

Part of the story of earnings growth is foreign exchange related. The U.S. dollar has fallen in comparison to other currencies and is having one of its worst years ever. The chart below shows the value of the dollar in 2017 compared to every year going back to 1995.[iii] It is kind of a messy chart but the red line clearly shows this year’s performance. The irony of the beaten up greenback is that a Trump Presidency was supposed to be accompanied by a stronger U.S. dollar.

The weaker dollar has boosted earnings of large, international companies. The value of foreign sales in euros or yen, for example, translate into higher numbers in U.S. dollars because the euros and yen ‘purchase’ more dollars as they are ‘converted’ for accounting purposes.

Given this financial tailwind, as expected, stocks with significant international sales have greatly outperformed those that have largely domestic customers. Borrowing another chart from Bespoke, this illustrates the difference in the stocks’ gains.[iv] The blue line is S&P 500 companies with greater than 50% of their revenues from international markets and the red line are stocks that have 90% or more of their revenues from the U.S. As you can see, the “domestic’ stocks are up a little more than one-third the gain of their “international” siblings.

This also partially explains the underperformance by the Russell 2000. This index is primarily smaller businesses with domestic customers. On the other hand, larger companies that have global markets, including technology, are included in the S&P 500 and Nasdaq.

Another ‘under the headlines’ reason for the stock market’s record level is the prospect of tax reform. President Trump committed to revamping and reducing the corporate tax burden as part of his campaign. Within dysfunctional Washington, this issue has moved higher on the to-do list and is gaining some momentum.
It is unlikely that anything gets completed in 2017, however, there is a growing chance that something is done in 2018. A new tax law reducing corporate rates will have a major benefit to company bottom lines. The likelihood of something happening on this front is moving stocks higher now.
In addition to growing profits, reducing taxes could easily increase investment back into the business in the form of capital expenditures. This could have an exponential benefit as investing in their company will have a far reaching economic impact. The stock market is discounting this as well.
While the financial markets seem to be oblivious to the bombardment of negative news, it might the case of investors focused in the wrong area. It seems that we are overlooking some important economic positives. Specifically, corporate earnings are healthy and could become a lot stronger if tax reform becomes a reality. Of course, relying on Washington is a risky proposition. However, all parties realize the importance of these market expectations and will ultimately work with the opposition to accomplish something meaningful. And as we wait, we hope that the news flow improves because it’s pretty discouraging right now.

[i] Grant’s Interest Rate Observer, September, 2017
[ii] Bruce Springsteen, 1978
[iii] Bespoke Investment Group, September 8, 2017
[iv] Ibid

Jeffrey J. Kerr, CFA

Kerr Financial Group
Kildare Asset Management
130 Riverside Drive
Binghamton, NY 13905

“The Smiles Are Returning To the Faces”[i]

The level at which any security trades is part fundamental valuation, part supply/demand, and part assumption regarding future events.  These conjectures concerning upcoming developments can be fickle especially as headlines impact investors’ attitude.  In fact, Wall Street’s reaction to the news is often more telling than the news itself.  In other words, when traders are bullish, good news is good and bad news is good.  Of course, in a bearish backdrop, all news is lousy.


The current mentality is that all news is good.  And to be sure, there have been some rays of sunshine that optimists can point to.  Housing has improved, there are no U.S. troops in Syria (yet), and Congress took August off.  The bad news, however, has been visible.  Whether Mr. Market is viewing all bad reports as good because it leads to more quantitative easing or is just overlooking anything negative, we think it is dangerous to believe that all problems can easily be solved by loose monetary policy.

[i]George Harrison

A recent example of Wall Street’s rose colored glasses was the markets’ reaction to the August employment data.  The report’s headline numbers were pretty good with the unemployment rate falling to 7.3% (the lowest in 5 years) and an estimated 169,000 jobs created in the month.  That brought the six month average job growth to 180,330.  Unfortunately, this is below the 200,000 target that some policy makers have set.[i]


Disconcertingly, adjustments to July and June’s data showed softer employment growth.  The estimated number of jobs added in July was reduced from 164,000 to 104,000 while June’s payroll gain was lowered by 16,000.[ii]  Some strategists emphasize the size and direction of the revisions as a sign of the job market’s, and the economy’s, health.  They are dismayed by these adjustments.


Further the decline in the unemployment rate was caused by a bigger drop in the overall labor force rather than job growth.  The number of workers employed fell by 115,000 while the overall labor force declined by 312,000.  This caused the labor participation rate (the number of people either working or looking for work as a share of the working-age population) to drop to 63.2%.  This is the lowest level of participation since 1978 or 35 years ago.[iii]


This soggy job market is clearly a drag on the economy.  Not only do consumers have less income, there are fewer and fewer workers supporting an increasing number receiving government benefits.  Perhaps QE is not all that it’s supposed to be.


Stocks immediately fell after the report but steadily clawed their way back throughout the day and finished little changed.  In the glass is half full view, the bad jobs data supported the Wall Street belief that that the Fed will not “taper” their $85 billion monthly bond purchases which have supported risk assets such as stocks.


After a monthly fall in August, equities have rebounded in September and, at the end of last week, have climbed back to approach 2013’s highs.  Here are the year-to-date performances for the major indexes.



Dow Jones Industrial Average  +17.3%
S&P 500                                    +15.2%         
Nasdaq Composite                    +23.3%

Russell 2000                              +24.1%


Indices are unmanaged, do not incur fees or expenses, and cannot be invested into directly. These returns do not include dividends


While there are some other noticeable blemishes (last week we had lower than expected consumer sentiment and retail sales reports), it is not affecting investor cheerfulness.  45% of the respondents to the AAII survey were bullish (the long term average is below 40%).[v]  This type of reading is often viewed as a contrary indicator (high bullish readings are bearish).


“It Seems Like Years Since it’s Been Here”[vi]


Another concern is the current high level of margin debt.  Margin is debt that is financed with investment securities used as collateral.  The amount of borrowings being financed has returned to levels that coincided with some not so pleasant times for the capital markets.  As shown in the nearby chart, the previous times that margin debt was at the current levels were March, 2000 and July 2007.[vii]  In case readers need a reminder, both dates were followed by material drops in the stock market.


Another troublesome observation is the return of market leadership by exciting, revolutionary companies.  Upstart organizations that change the playing field are a constant part of a dynamic economy.  The United States has experienced this creative destruction regularly.  The automobile industry in the early part of the 20th century was followed by radio and then TV.  More recent, of course, are computers, internet, and cell phones in the information technology area.  In addition, medicine has experienced incredible bio-tech advancements, robots are becoming more prevalent, and energy sources are being discovered and recovered from heretofore unheard of areas.


As stated above, current investment prices discount future revenues and profits.  And some of the companies offering new products and services seem to have unlimited potential.  The debate over what to pay for this prospective success is being fought in the current stock prices.


We offer some examples.  Tesla Motors, the manufacturer of electric cars, carries a $22 billion valuation in the stock market while their trailing 12 month (TTM) sales barely exceed $400 million.  To be sure, $3.50 per gallon of unleaded allows for alternatively powered vehicles.  However, in our opinion, a price-to-sales multiple of 55 times discounts some significant growth.


Yelp describes their business as “an online urban city guide that helps people find places to eat, shop, drink, relax, and play based on the informed opinions of a community of locals in the know”.[viii]  Investors must have a pretty high outlook for this business because the stock’s worth in the markets exceeds $2.5 billion.  We are not sure exactly how Yelp generates revenues but they are less than $150 million.  Another bothersome detail for Tesla and Yelp is that they are both losing money.


Even the most primitive Luddite knows what Facebook is.  While many will assign “failed IPO” to this social media leader, it has undoubtedly changed the way we communicate.  The stock has returned to favored status recently.  Mark Zuckerberg’s venture carries an $84 billion market capitalization as it generates $5 billion in sales.  One distinction from Tesla and Yelp, is that Facebook has a bottom line.  At a price in the mid-$40’s, the price-to-earnings is 190.


Energy exploration in shale formations is dramatically changing our economy.  Cheaper energy is driving a manufacturing renaissance in the U.S.  New plants are being built throughout the mid-west and south.  Furthermore, the abundant natural gas is being targeted as an eventual American export.  Many areas of the world are currently importing liquefied natural gas as an important energy source (Japan and Europe are two large importers).


Cheniere Energy is in the process of building one of the first exporting facility in the U.S.  If all goes as planned, it will be operational sometime in 2015.  Wall Street can not contain their excitement.  The stock trades at a market capitalization over $7.5 billion despite only $260 million in sales and substantial red ink on the bottom line.


Returning to the overall landscape, the stock market has had many reasons which could spark a decline.  While August was lower, it was shallow in comparison to 2013’s move.  Investors returned from the Labor Day weekend and bid prices higher.  There appears to be little to worry about.  Of course this is much different from autumn 2012 when worries over the election, Europe, and the fiscal cliff caused investor angst and pessimism.


A year ago we advised clients that a lot of bad news was priced into the markets.  It turned out to be somewhat correct despite a nasty selloff after the election.  With the current environment so cheerful, we fear there is little risk associated with the future outlook for the economy.  We hope for continued expansion but fear the markets’ expectations.



[i] Wsj.com, September 6, 2013

[ii] ibid.

[iii] Bloomberg Business Week, September 6, 2013

[iv] The Wall Street Journal, September 14, 2013

[v] aaii.com

[vi] George Harrison

[vii] BOA/Merrill Lynch Global research.

[viii] Yahoo.com






This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. The Dow Jones Industrial Average is a price-weighted index of 30 actively traded blue-chip stocks. The NASDAQ Composite Index is an unmanaged, market-weighted index of all over-the-counter common stocks traded on the National Association of Securities Dealers Automated Quotation System. The Standard & Poor’s 500 (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in general. The Russell 2000 Index is an unmanaged market-capitalization weighted index measuring the performance of the 2,000 smallest U.S. companies, on a market capitalization basis, in the Russell 3000 index. It is not possible to invest directly in an index. Investing involves risks, including the risk of principal loss. Additional risks are associated with international investing, such as currency fluctuations, political and economic instability and differences in accounting standards. All information is believed to be from reliable sources; however we make no representation as to its completeness or accuracy. All economic and performance data is historical and not indicative of future results. Market indices discussed are unmanaged. Investors cannot invest in unmanaged indices. If assistance is needed, the reader is advised to engage the services of a competent professional.

Past performance does not guarantee future results

“There Shall be Disaster After Disaster, Rumor After Rumor”

September 5, 2017 – DJIA = 21,987- S&P 500 = 2,476 – Nasdaq = 6,435

“There Shall be Disaster After Disaster, Rumor After Rumor”[i]

Contrary to what you might expect, the above is not a recent CNN headline describing the Trump administration. Rather it was written around 600 B.C. by the profit Ezekiel, who was exiled to Babylon. He was describing his vision of the unthinkable decline and ruin of Jerusalem which ultimately took place. It was an accurate description of what took place 2,000 years ago and, remarkably, today’s current events.

While it seems that we are undergoing a modern fulfillment of Ezekiel’s prophecy, it is amazing that this has had no impact on the capital markets. The stock market is within a few percentage points of all-time highs, bond yields have fallen, and the dollar has been drifting lower.

The stock markets below the surface view, however, is less tranquil. The Dow Jones Transportation Average peaked out in July and as of August 24th had given up all of 2017’s gains (it bounced higher last week).

Smaller cap stocks have also been moving lower. The Russell 2000, S&P Smallcap 600 and S&P Midcap 400 declined in August and all three indexes are lower for the 3rd quarter. The Russell, as measured from the July high to the August low, fell 6.4% in 4 weeks.

Even within the S&P 500 (large cap index), there’s some blemishes as the smallest of these large companies are lagging. When the index is broken into deciles by market cap size, incredibly the 10th decile (the smallest market cap of the 500 stocks) is down 2.11% year-to-date. Contrasting this with the entire S&P 500’s 10% year-to-date gain, the under-performance is shocking.

Of course, the S&P 500 has FANG which has pushed the index. FANG is the anacronym for current stock market darlings Facebook, Apple and Amazon, Netflix, and Google. And as the index is weighted by market cap, the larger companies have a bigger influence. With Facebook, Apple, Amazon, and Google (Alphabet) all in the top 10 market values, they have been especially influential as these stocks are materially higher for the year.

Also, the trend toward passive investing has a self-fulfilling aspect as the S&P 500 is a popular way to gain equity exposure in this approach. And when money goes into the index it buys more Apple, Amazon, Google, etc.

Here are the year-to-date numbers for the major indexes. Note the disparity between the Russell and the Nasdaq. Is this a sign that the broader market is weakening and the bigger stocks will follow? Or is this an opportunity for contrarian investors to enter the small cap market?


Dow Jones Industrial Average +11.3%
S&P 500 +10.6%
Nasdaq Composite +19.5%
Russell 2000 +4.2%

The Nasdaq’s 2017 gains are noteworthy and, as expected, this has pushed the size of the technology sector to 23.5% of the S&P 500. It would be even greater if Amazon was considered a tech stock. It might be natural to assume that technology’s popularity has pushed the sector’s valuation to unreasonable levels. Surprisingly, this is not the case. The current P/E based on trailing earnings is around 23. As the chart below shows, this is slightly above the average of the past 20 years.[ii]

Another important stock market trend for 2017 is the significant lagging of value stocks as compared to growth stocks. Below is another Bespoke chart illustrating this difference.[iii] While this only accounts for stocks within the S&P 500, the spread is not typically this wide. As mentioned with the disparity of large cap vs. small cap, there will be a time when value investing outperforms growth.

The capital markets are facing many economic, political, and societal crosscurrents. And they are doing it at a historically troubling time of the year as September and October can be volatile months for the markets. That the markets have not suffered any significant setbacks given developments such as Charlottesville, North Korea, a possible U.S. federal government shutdown, and Hurricane Harvey is confounding. Maybe it’s a sign of underlying strength or it could be a delayed reaction with forthcoming pain.

Regardless of what the financial markets do, our thoughts and prayers are with those impacted by Harvey and those who will be hurt by Irma.

[i] Ezekiel, chapter 7, verse 26
[ii] The Bespoke Report, September 1, 2017
[iii] Ibid

Jeffrey J. Kerr, CFA

Kerr Financial Group
Kildare Asset Management
130 Riverside Drive
Binghamton, NY 13905

“Yes It’s Been Quite a Summer, Rent-a-cars and West Bound Trains”[i]

Ideally summertime offers chances for getting away to relax.  This typically involves leaving the day-to-day stresses behind and enjoying some nice weather perhaps in the mountains or at the beach.  2015’s summer, however, hasn’t allowed much downtime as the headlines have been both significant and active.
This shouldn’t be a surprise as any year that includes Hillary Clinton and Donald Trump in a presidential campaign will be memorable.  The developments and sound bites from Camp Clinton and Trump should make the next few months interesting.  But there are some other astonishing events playing out – the ongoing saga over whether Greece remains in the European Union or finally departs.  And then what it means to the European financial system.
Additionally, there is the battle over the Iranian Nuclear Deal, Puerto Rico telling creditors it may or may not pay them mañana, and the Fed both deciding when to raise interest rates and then deciding how to let the markets know.  And finally, China choosing to devaluate their currency, the renminbi, against the U.S. dollar, relations with Cuba and, of course, Bruce Jenner.
Certainly there are many other important developments and ranking the list in order of importance is a challenge. We think that near the top of everyone’s lists should be monetary policy and the Federal Reserve.  Specifically, when the Fed will raise interest rates and what it means for the economy and capital markets.
[i] Jimmy Buffett, 1974
“I’m Tore Down, I’m Almost Level With the Ground”[i]
As we know, interest rates are low.  But, within a historical context, it is astonishing how low they are.  In many cases, they have NEVER been at these levels – and “NEVER” involves 500 years in some instances!!  The Dutch government bond markets dates back to 1517.  The lowest yield levels were hit earlier this year when the yield on their 10-year bond touched 0.45%.  The Bank of England was formed in 1694 and the “base lending rate” was established in 1705.  The current rate of 0.5% is the lowest ever.  Landmark lows in other sovereign markets include France (dating back 1746), Italy (1807), Germany (1807), Spain (1821) and Japan (1870).  As Michael Hartnett, chief investment strategist at Bank of America/Merrill Lynch, points out “There have been depressions, wars, earthquakes, famines, all sorts of stuff, yet interest rates have never been lower”[ii]
Shifting from history to looking forward, it seems that the only thing the financial media talking heads are concerned with is when the Federal Reserve will increase interest rates.  The hyperbole surrounding this decision would make reasonable men and women conclude that the future of the human race depends on what the Fed does.  Sadly, perhaps this is not hysteria but reality.
To be sure, our monetary policymakers have followed their current strategy with the well intentioned goals of preventing another crisis as well as restore the economy to growth.  However, their strategies of zero interest rates, asset purchases, and other stimulative efforts aren’t guaranteed to accomplish their objectives.  In fact repressing interest rates distorts the value of any financial asset because of the artificial interest rate used to discount future cash flows.  As Jim Grant describes it, “With one hand, the Fed is manipulating interest rates, therefore the value of myriad financial claims tied to interest rates.  With the other hand, it’s trying to impose safety and soundness from on high.  Left hand and right hand are working at cross-purposes”.[iii]
Beyond the capital markets, record low interest rates are an economic obstacle rather than the intended contributor.  Charles Gave from GaveKal Research describes the issues, “As a rule, entrepreneurs have zero confidence in prices fixed by the authorities, which can change overnight on a politician’s whim (as anyone who invested in Spanish solar power learned to their cost). They also know that very low interest rates bring forward future demand, and they worry what will happen when there is no longer any future demand to bring forward. In response, they stop investing in order to maximize the cash on their books or to buy back their own shares. Meanwhile consumers, knowing that businesses want to reduce their wage bills and afraid they will lose their jobs, begin to save as much as they can. The result is a collapse in the velocity of money, and declines both in economic activity and in prices.”[iv]
Despite good intentions, perhaps manipulating interest rates and capital flows is not providing the desired outcome.  Growth has been much lower than previous economic recoveries and wage growth has been elusive.  This deviation from the planned outcome risks a reduced confidence in central banks which could cause further market volatility.
Last week the Dow Jones Industrial Average fell 1,000 (5.82%) including a 500 point plunge on Friday.  It was the largest weekly point drop for the Dow since 2008 and Friday’s loss was the worst in four years.  The Dow is now down 10.3% from its record high set on May 19th and this is the first time the index has experienced a 10% correction since 2011.  There is nothing significant about the 10% threshold (other than it’s a round number) but it does show that stocks have steadily climbed in recent years.
Here are the year-to-date numbers for the major averages.                              2015YTD[v]                                     Dow Jones Industrial Average  -7.7% 
S&P 500                                   -4.3%
Nasdaq Composite                   -0.6%
Russell 2000                            -4.6%                           
Indices are unmanaged, do not incur fees or expenses, and cannot be invested into directly. These returns do not include dividends
Some other notable market developments include crude oil declining to $40.00 per barrel (down 33.7% YTD) and the yield on the 10-year Treasury note falling to 2.05%.  Gold rose 4% last week closing the week at $1,160 per ounce.
Emerging markets experienced much of last week’s pain as China reported some soggy economic data increasing worries of slowing growth.  The purchasing managers’ indexes fell to a 6 ½ year low and imports fell 8% in July.  This pressured all emerging markets.
While the slumping stock market grabbed everyone’s attention, real news was happening in the foreign exchange markets.  China, Vietnam, and Kazakhstan devalued their currencies against the dollar.  It would be easy to shrug the shoulders and mutter ‘Vietnam and Kazakhstan don’t matter’.  This was probably a common reaction to Thailand’s baht devaluation which started the 1997-1998 Asian Crisis.
“I’d Like to Get You on a Slow Boat to China”[vi]
Regarding China’s devaluation, there are several theories behind this decision.  China had pegged the value of the renminbi to the U.S. dollar so as the greenback strengthened vs. other currencies over the past year, so did the renminbi.  This placed China at a slight disadvantage from a global competitive perspective.
Many believe the move was an effort to increase the chances of being included in the IMF’s Special Drawing Right.  This SDR is a basket of global currencies but is not used for foreign exchange or trade.  It is largely a symbolic IMF gadget.  However, inclusion, which will be decided in a November decision, is important to the Chinese government.  A pegged renminbi would be harder to get IMF approval as it would be viewed as the same as the U.S. dollar.  So China views breaking this tie to the dollar as a necessary step in the renminbi’s evolution.
Another factor influencing this move is the fact that China wants to expand their capital markets to have a bigger global presence.  Free trading markets are an important component of that equation.  Unhinging this peg to the dollar sends a message to the international community that China is serious about moving to a market based system (at least in some areas).
After last week, the financial markets will struggle with whether these devaluations and slowing emerging market economies will result in recessions in the developed countries.  Or the cheaper energy costs will continue to lower cost structures and drive further global growth.
Some are proclaiming that last week will be like October 2014 when U.S. stocks fell 7% in the first half of the month only to fully recover in the second half of the month.  After that, they resumed the pattern from the past couple of years namely a gradual and steady advance.
The ursine side of the debate points to the damage to the global economies and stock markets.  While last October turned out to be a “V” bottom, there are many other dynamics in 2015 that make a repeat unlikely.  The U.S. will be raising interest rates, many economies have too little growth and too much debt, and the stronger dollar hurts major U.S. companies.
As summer winds down, we realize that it has been an eventful year.  And it has not all been bad – we have a triple crown winner in horse racing (first in 37 years), the U.S. women’s world cup team won the gold medal, Serena Williams winning 2015’s first 3 major tournaments in tennis (the U.S open forthcoming), and the New York Mets are in first place.  We hope that some of this good news flows into the capital markets and calms things down.  A little chance to catch our breath would be helpful.  The remaining four months of 2015 should be very interesting.

[i] Carbert Music, Inc. 1961
[ii] Bank of America/Merrill Lynch, “The Longest Picture”, February 22, 2015
[iii] Grant’s Interest Rate Observer, March 20, 2015
[iv] GaveKal Research “Five Corners”, July 15, 2015
[v] The Wall Street Journal, August 22-23, 2015
[vi] Frank Loesser, 1948

SERENITY NOW!! (Insanity later)[i]

July 24, 2017 – DJIA = 21,580 – S&P 500 = 2,472 – Nasdaq = 6,387
SERENITY NOW!! (Insanity later)[i]
For something that comprises so much emotion, the stock market has amazingly ignored the passionate yet venomous division in the United States.  In the midst of name calling, violence, protests, and a prevailing sense of hatred of those with opposing views, the stock market climbs higher.  With the acrimony and polarity so elevated, why hasn’t this impacted the markets?
And not only have stock prices risen in the face of societal deterioration, they have done it in a remarkably smooth and steady manner.  The S&P 500’s largest pullback this year is a hardly noticeable 2.8%.  We all know that there have been times where the markets approach that level within a day! And not only is this incredible given the current landscape, it is historic.  This is the smallest intra-year correction since 1995 and the second smallest dating back to the Great Depression.[ii]
This stock market serenity has gotten so widespread the U.S. seems to be exporting it as international stock markets are experiencing a similar tranquility.  As measured by the MSCI EAFE (Europe/Asia/Far East), the MSCI EM (emerging markets), and the Nikkei 225 (Japan), global bourses are near record low levels of volatility.  Traditionally, emerging markets are one of the riskiest assets classes with high levels of uncertainty.  Yet so far in 2017, the MSCI EM has only undergone a mere 3% pullback.  Contrast this to 1995’s 13% correction which was one of the least volatile years in history for emerging markets.[iii]
In 1995 the Nikkei 225 fell 26.4% from peak to trough.  While this is not the lowest annual pull back for this index, it is among the smallest.  Yet so far in 2017 the spread is a miniscule 6.5%.
Below is a graph showing variance for the S&P 500, the MSCI EAFE, the MSCI EM, and the Nikkei 225 since 1990.  The red circle on the right is 2017.  As measured by these four indexes, this is an astonishingly calm year within the backdrop of chaos.[iv]
There is no definitive reason for this quiet price action.  Until recently, central banks were keeping short term rates low and this has likely contributed.  Also, it is helpful that economies have been growing at a slow but steady pace. Indexing and passive investing has played a role as investors have been buying ETFs which index the market and its various sectors.  These funds buy their underlying components as they receive inflows without concern for valuation or timing.
Whatever the cause, the stock market’s peaceful price action will end and volatility will return – someday.  As shown in the graph, there is a cyclical component to this and there’s no reason to think things have been permanently altered.  Whenever market volatility returns there will be much wailing and gnashing of teeth as investors will not be expecting it.  In the meantime, the steady move higher continues and, as mentioned, the major indexes reached records last week.  Here are the year-to-date returns as of the end of last week.
                                                                                       2017 YTD
Dow Jones Industrial Average                                          +9.2%
S&P 500                                                                            +10.4%
Nasdaq Composite                                                            +18.7%
Russell 2000                                                                     +5.8%
Indices are unmanaged, do not incur fees or expenses, and cannot be invested into directly. These returns do not include dividend. 

Looking at the fixed income market, short term rates have move noticeably higher.  First the 3-month Treasury bill’s yield closed 1.17% last week and this was actually higher than the longer dated 6-month T-bill which closed at 1.10%.  Moving further out, the yield curve returns to its normal upward sloping direction with the 2-year Treasury note at 1.36%, the 10-year Treasury note at 2.24% and the 30-year Treasury bond at 2.81%.  An interesting (and easy) place to park some short-term liquidity might be 6-month CD’s which were yielding 1.35% – 1.40% last week.
Foreign exchange is another market that is offering some unexpected developments.  At the beginning of 2017, the common forecasts were for a stronger U.S. dollar based on the “Make America Great Again” theme.  Increased domestic manufacturing, increased exports, and restrictions on imports were part of the landscape that would drive the dollar higher.  Instead, as measured by the Wall Street Journal Dollar Index, the greenback has fallen 7.25% against a basket of currencies in 2017.
This translates into unexpected stock market leadership.  Companies with high domestic revenues, which would typically benefit from a stronger U.S. dollar, were supposed to lead the markets.  And companies with a more international customer base were supposed to be hurt.  However, with the weaker dollar, technology (with big international sales) has benefited.  Apple, for example, has approximately 60% of their revenues from foreign markets.  Dow Chemical also has over 60% international revenues and the stock has done well.
Once again, this points out how the markets move against conventional wisdom.  In the fixed income market, the yield curve has flattened rather than the predicted steepening.  And again, the U.S. dollar has weakened instead of rallying which switched the stock market leaders.
Where can we currently look for similar predictions to be wrong?  There appears to be two industries that are widely expected to have problems.  One is retail.  Everyone (including Amazon) expects Amazon to ultimately supply all of our purchases and that there won’t be a need for anyone else.  To be sure, some retailers will continue to be challenged and some will fail.  On the other hand, many will survive and trade at very cheap valuations.
Energy is another washed out sector.  As the oil and natural gas markets seem to be well supplied, energy stocks have been laggards. The obvious problem is that the success of these businesses is largely a function of the commodity price.  However, despite the growing popularity of electric cars and more renewable supplies, global hydrocarbons demand is predicted to grow.  As with the retailing sector, there are some investment bargains in the energy stocks.
One of the biggest investment mysteries of 2017 is the markets’ disregard of the widespread social acrimony.  Typically, such chaos and strife would be reason for at least caution, if not widespread selling.  So far it has not happened.  We don’t expect the division and polarity to subside anytime soon.  This means that investors should keep watching how the markets react to new developments. If the indexes begin to lose momentum, it could be a sign that the serenity is switching to the insanity.  In the meantime, deep breaths everyone.

[i] Seinfeld, October 9, 1997
[ii] LPLresearch.com, July 25, 2017
[iii] Ibid
[iv] Ibid
Jeffrey J. Kerr, CFA

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

2017 1st qtr Kildare Asset Mgt-Kerr Financial Group client review letter


As I have mentioned in previous letters, prices in the capital markets are highly correlated with corporate earnings which are a function of economic strength.  And while this didn’t change in the first quarter of 2017, there was another dominating influence – politics.
We know that investors began discounting the prospects for business friendlier policies and stimulus programs the day after the election.    Naturally, this continued into and after the inauguration as excitement and optimism climbed higher.  The expectations of reduced regulations, tax reform, and infrastructure spending powered stock prices and interest rates higher.
The stock market edged higher at the beginning of January and churned sideways until the inauguration.  After the ceremony, the rally resumed and there was a steady climb throughout February.  There was another surge higher to new record levels after President Trump’s State of the Union speech at the beginning March.  In the final month of the quarter, stocks encountered a little turbulence after the failed attempt to repeal and replace the Affordable Care Act.  However, stocks rallied into the end of
the month but remained below the records reached in early March.
Here are the returns for the major averages for 2017’s first quarter.
                                                                                         2017 Q1
Dow Jones Industrial Average                                        +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.

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  Q1                                                                                                          +3.03%

Similar to markets having an oversized impact from politics, your account was influenced by one position – Fortress Investment Group.  Fortress (symbol = FIG) is an investment management company that operate hedge funds, private equity funds, and credit funds.  They manage over $70 billion of assets which makes them one of the largest publicly traded companies in this sector.
Fortress charges a fee for managing investments for their clients.  In addition, they can earn incentives and bonuses if performance reaches certain thresholds.  Their clients include institutions such as pension funds, endowments, and foundations, as well as high net worth individuals.  FIG’s largest expense is compensation and benefits for their staff which includes executives, portfolio managers, analysts and traders.
I was first attracted to Fortress Investment Group because I believed it was an undervalued security that offered an attractive yield.  The company has a very strong balance sheet as well as a history of consistent profitability.  It has underappreciated assets and I thought that there was a
good chance that the business would continue to grow.
Concerning the dividend, the amount the company has paid varies based on its net income.  Fortress often set a stable dividend payment for the year based on its projections and then paid a special dividend after they determined their actual results.  The ‘normalized’ yield was approximately 6% with the ‘special’ dividend usually adding another 5% – 9%.
While this sounds like it was an easy and straightforward investment idea, there many legitimate reasons that Fortress was priced so cheaply.  First, FIG is a limited partnership.  Financial reporting for partnerships is different and, as a consequence, the analysis has some added steps as compared to the analysis of corporations.  For example, in addition to net income, investors should consider such calculations as distributable earnings and net economic income.  These metrics can be different from net earnings and may present a much different picture than typical analysis.  These analytical complications can dampen investor interest.
Secondly, the alternative asset management industry (hedge fund, private equity, etc.) has been under intense pressure from clients.  The appeal of these investment managers is the potential to outperform the benchmark averages while controlling risk.  However, during the past several years, most hedge funds have underperformed the stock market averages and clients have become frustrated.  Many have asked for their capital back including the high profiled decision by the California Public Employees Retirement System (CalPERS) to withdraw all money from hedge funds.  As a result of this and similar institutional decisions, many hedge funds have closed.
Lastly, hedge funds and private equity funds are facing a potentially massive shift in the form of tax reform.  As a limited partnership structure, these organizations enjoy some tax advantages.  Specifically, some of the income from incentives and bonuses, which can be very material, are not taxable or, at worst, tax deferred.  There have been efforts during the past several years to change the tax code and eliminate this benefit.  So far, it remains in place.  Eliminating this provision would significantly change the industry’s profitability and make these businesses less attractive.  And with tax reform again in the news, the prospect of future scrutiny is a heavy weight on publicly traded investment partnerships.
Coming into 2017, Fortress had been in a narrow trading range for an extended period.  It finally broke above the $5.50 level on high volume at the end of January.  This price action was a strongly positive sign and, as a result, I added to the position.  In the middle of February, Softbank Group offered to buy Fortress for $8.08 per share.
While there has been some minor debate whether this was the proper valuation (some have suggested that FIG is worth more than $8), the deal should close in the third quarter.  While I think Fortress’s share price would have moved higher over time, this gives us the opportunity to stay in the same church but move to a different pew.
Blackstone Group and Ares Management are two investment management companies similar to Fortress and are being added to your account.  Blackstone (symbol = BX) was a recent featured recommendation in Barron’s.  Further this has been a position in long time clients’ account since the end of the financial crisis.  BX’s dividend strategy is similar to Fortress’s as they pay a variable amount based on the quarterly bottom line.  Blackstone’s current yield is 6.6% (based trailing twelve months).  While they face the same challenges listed above, they are positioned to capitalize on opportunities throughout the financial markets.
Ares (symbol = ARES) is another investment management company that has good long term potential despite the industry challenges.  They have numerous fee generating funds (a new one was added in the first quarter) as well as a pipeline of additional opportunities.  The current dividend yield is 4.75%.  I think the dividend payments have a good chance to grow over the next few years.
The capital markets had a busy first quarter.  Things such as a Federal Reserve interest rate increase and the European political campaigns were overshadowed by a new administration in Washington.  This brought both excitement and anxiety.  Some were optimistic about the change of direction while others were despondent by the disrupted status quo.
While this divide could easily grow as the year continues, the markets have digested it so far.  Of course, past reactions are not guaranteed to remain the same and the markets could change its sentiment if the craziness increases.  It promises to be an interesting year.
Regardless how events development, I will continue to look for opportunities as well as monitor current positions.  With the markets digesting the anticipated crosscurrents of 2017, there will surely be some favorable circumstances to take advantage of.  Thank you for your continued support and please call with any questions.

Jeffrey J. Kerr, CFA

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

And I could tell the wise men from the fools

June 26, 2017 – DJIA = 21,394 – S&P 500 = 2,428 – Nasdaq = 6,265
“And I could tell the wise men from the fools”[i]
Going into the Memorial Day weekend, the S&P 500 was up 7.89% YTD.  A nice 5-month stretch.  But for those keeping score at home, there’s more to this story as not all stocks deserved a long weekend.
The 5 largest stocks in the index (Apple, Facebook, Amazon, Microsoft, and Google/Alphabet) were responsible for about 40% of this number.  In other words, without these “Fab Five”, the S&P 500 would have advanced a more modest 4.6%.  As a result of their stock prices’ success, our five horsemen have grown to become 14% of the index’s value which exceeds $20 trillion.
That these are premier companies is indisputable.  That their collective financial results should drive such a disproportionate stock market gain is a bull market.  Regardless of the level of logic involved, the fact is that the FAAMG stocks are leading this bull run.  And we must remember that perception is reality in the stock market – it may not make sense but market’s price is the market’s price.  (As a point of clarification, the more commonly used stock market acronym is FANG which includes Netflix at Microsoft’s expense and the “A” accounting for both Apple and Amazon).
Stock market trends eventually end and it may be happening to this one.  On June 9th, a day like most, these investor favorites were leading the indexes to new record levels.  Then suddenly, out of nowhere, the favorites fell.  Apple, Amazon, Facebook, and Google all fell over 3% that day.  Netflix dropped 4.7% and Nvidia dove 6.5%.
The Nasdaq Composite retreated 1.8% from the previous close and 2.1% from the morning highs.  The Nasdaq 100 (the 100 largest of the Composite) fell 2.44%.  The weakness was primarily in technology as the Russell and Dow Jones Industrial Average (both less technology weighted) advanced that day while the S&P 500 was flat.
Interestingly, there was no definable event or cause for this tech wreck.  Some attributed the reason to a Goldman Sachs report that was released that morning which suggested these stocks had increased “mean-reversion risk”[ii]  In other words, these stocks had gotten extended from the rest of the markets in both performance and valuation.  In addition to this Goldman Sachs news, there were rumors that short sellers were targeting some of the names.
Despite this sell off, technology remains the best performing sector for 2017 by a wide margin.  One of the main reasons is that these companies are showing the most growth in an economy struggling to find a higher gear.  Here are the year-to-date returns for the major averages through last Friday.
                                                                                     2017 YTD
Dow Jones Industrial Average                                       +8.3%
S&P 500                                                                         +8.9%
Nasdaq Composite                                                         +16.4%
Russell 2000                                                                  +4.2%
Indices are unmanaged, do not incur fees or expenses, and cannot be invested into directly. These returns do not include dividend.
It is noteworthy that many of the targets of the June 9th carnage remain below the levels from that day.  For some of these stocks it may have been an “emperor’s new clothes” moment and marked a longer-term inflection point.
Companies like Apple, Amazon and Google are transformative.  They have developed products that changed consumers lives, and as a result, have a high level of customer loyal.  However, all tech stocks are not equal especially when it comes to valuation.
For example, Apple trades at a price-to-earnings ratio of 16.8 and 11.4 times its enterprise value-to-EBITDA.  (The enterprise value to EBITDA ratio compares the value of the company’s stock and net debt to cash flows from operations).  Both numbers are reasonable for a premier organization like Apple.
Google and Microsoft trade at slightly higher valuations.  Google’s P/E is 31 and its EV-EBITDA is 18.  Mr. Softy’s P/E is 22 while its EV-EBITDA is 14.
Turning to the other high-profile market leaders, Amazon’s valuation is rich.  It trades 183 times trailing twelve months earnings and 36 times EV-EBITDA.  In addition to this nosebleed price, the retailing powerhouse is getting into the grocery business by buying Whole Foods.  While grocery industry has a notorious reputation as being a miserable business, Jeff Bezos has proved many doubters wrong as he changed the retail industry.  Maybe he can do it again in this low-margin, cut throat business.  It will be interesting to see what happens.
Netflix’s credit rating is junk (single B) and its stock carries a 197 P/E and a EV-EBITDA multiple of 12.  Apparently, Mr. Market is willing to overlook such details as long as they keep growing revenues at 30% per year and the stock price keeps moving up.
The June 9th reversal in the stock market’s technology leaders should be noted.  It might be nothing more than another dip that gets bought with no lasting impact.  Or it could be an important declaration that these stocks are overpriced and a correction is needed.  Just as it took a child to pronounce the obvious in “The Emperor’s New Clothes”, the Goldman Sachs observation might embolden the bears – what few that are left.
Jeffrey J. Kerr, CFA
Kerr Financial Group
Kildare Asset Management
130 Riverside Drive
Binghamton, NY 13905
[i] The Emperor’s New Clothes, Hans Christian Andersen, 1837
[ii] Barron’s, June 10, 2017