Jerry Jordan Commentary | First Quarter 2010 Investment Outlook
Back to Q110 Newsletter »
2009 was a remarkable year for investors across the spectrum of assets and asset classes (with the exception of high-quality government bonds). With the aggressive aid of the global monetary and fiscal authorities, financial assets were reliquified with successive injections of monetary and fiscal stimulus, especially through the newly favored technique of "quantitative easing. " Asset appreciation was enormous for the year, and much more dramatic from the first quarter lows. Commodities and emerging markets did the best, but high-yield bonds and equities in developed markets posted historic recoveries. The worst investments, high-quality government bonds, posted double digit declines as intermediate and long-term interest rates rose.
Our positions experienced significant gains in 2009, both absolutely and relative to benchmarks, notwithstanding the consolidations in many of our holdings in the fourth quarter. In the final quarter, our holdings in energy and other commodity stocks lagged the broad market, despite positive performance of underlying commodity prices (i.e., crude oil advanced over 10% during the quarter).
Our outlook for 2010 is positive, but is tempered by our expectation of substantial volatility during the year. We expect the U.S. and global economies should experience significant economic acceleration during the year, due to continuing stimulus and easy comparisons. But stocks have had enormous advances and valuation levels in many sectors and regions are neutral at best even given our optimistic expectations for profits. Furthermore, we expect interest rate pressure to continue on the long end of the curve, and, eventually, to spread to short-term interest rates, which currently remain near zero.
The Economy and Interest Rates
| |
“As we have done this year, we will look to reduce exposure to our favorite groups if they become overbought, and add to positions if they become oversold, both absolutely and relatively.” |
Given the magnitude of monetary and fiscal stimulus thrown at the global economy, one might observe that the pace of recovery in 2009 was quite modest, notwithstanding China’s strong performance. By year end, industrial production and bank lending in the major developed economies was still hovering near cycle lows, even as the recession officially ended. But importantly these indicators have started to improve, now that confidence is building with the recovery in asset prices. Most noteworthy is that by the middle of the fourth quarter, economic reacceleration became visible across a broad spectrum of indicators including employment, durable goods, trucking surveys, corporate profits, housing activity, and commodity prices.
In an economic recovery cycle it is only natural for visible economic improvement to meaningfully lag the recovery in asset prices. This should be especially true given the shock of the financial crisis last year, and the magnitude of asset declines and the extended balance sheets of many borrowers. Furthermore, most of the U.S. government stimulus spending is scheduled to occur in 2010. Historically, the more dramatic an economic decline is, the more intense the recovery generally is, as a function of sequential comparisons. Therefore, we should expect accelerating economic strength this year in the United States.
Given that the recession has ended and economic momentum is beginning to be visible, it is reasonable that interest rates could start to rise. This is already occurring in the intermediate and long maturities of the fixed-income markets. It is also clear, however, that short rates may remain low for a protracted period, because the Federal Reserve has continued to declare this policy in recognition of the weak underpinnings of the economic recovery. We expect that the recovery in 2010 should be strong enough for the Federal Reserve to begin to raise short rates before year end.
The Stock Market
The recovery of the stock market from its first quarter low was one of the most dramatic gains in U.S. stock market history, with the S&P 500 rising almost 70% in the 10 months following the March bottom. And the advance has been largely uninterrupted, except for the modest corrections witnessed in June, September, and October. And while we anticipate a big recovery in corporate profits in 2010, several factors cause us to expect an increase in market volatility, thereby tempering our enthusiasm.
Sentiment measures for owning equities currently reflect excessive optimism and complacency. For example, the Investors’ Intelligence survey of investment advisors recorded a low level of bearish advisors, on a four-week moving average, not seen since the middle of 1987. Put/Call ratios have reached multiyear lows. The "VIX " Volatility Index has been grinding down at low levels, reflecting the decline in option premiums demanded by investors, which reflect investors’ current high appetite for risk.
The supply/demand data for U.S. equities has been disappointing. We started the year with a "mountain of cash " in cash and cash equivalents. And while this "money mountain " is still huge, according to the ISI Group the amount has declined by over $670 billion since it peaked this year. Equity issuance by companies, especially banks, has reached record levels, over $200 billion. U.S. corporate bond issuance also reached a record. And money has been flowing out of, and not into, equity mutual funds (except in the last weeks of the year).
The internal technical condition of the stock market has remained very good, however, with market breadth (the number of advancing issues less declining issues) continuing to confirm the higher highs of the U.S. equity indices. The number of new highs has also remained robust.
Another major positive for equities is the likelihood for strong corporate profits in 2010. The profits recovery in the second half of 2009 has been steep, and the positive revisions in earnings estimates for 2010 are the highest in many years. Also, S&P operating profits bottomed at a higher recessionary level than might have been expected cyclically, due to the unprecedented decline in selling, general, and administrative costs, as businesses aggressively cut costs in the wake of the financial crisis. Another major positive for the S&P 500 is that roughly half of the index’s revenues are non-U.S. and thus exposed to higher growth foreign economies. Finally, corporate cash levels have improved sharply in the last year.
Therefore, we approach 2010 with the expectation of potentially rewarding opportunities in many equity sectors, but recognize that after the large gains achieved in 2009 that investors will need to deal with the headwinds of an overbought market, excessive optimistic sentiment, and rising interest rates.
Strategy
Because the stock market ended 2009 in an overbought condition, we expect that 2010 will witness increased price volatility and greater sector rotation. Repeatedly in the past few years, industries with strong fundamentals have often experienced prolonged periods of weak relative performance, only to soon return to a leadership position. We expect this market action could continue. As we have done this year, we will look to reduce exposure to our favorite groups if they become overbought, and add to positions if they become oversold, both absolutely and relatively.
Healthcare was one of the best-performing sectors in the fourth quarter, as more details emerged about the healthcare bill and investors realized it should not have a material negative impact on profitability for most companies. This move was in-line with our prior expectations, and we have taken advantage of the recent strength to realize profits and reduce exposure to the group. We are still bullish on the earnings prospects for our remaining holdings, particularly as millions of newly insured individuals should begin to contribute to volume growth. Our healthcare investments are focused on exposure to higher prescription growth, market-leading biotechnology products, and high-tech devices with strong patent protection.
Additionally, we remain underweight in U.S.-based technology companies. While growth has been solid, valuations appear stretched and bullish sentiment toward the group has rarely been higher. We expect our rotational theory to resolve itself negatively for many of the high-focus technology names in the first half of 2010.
Two areas which we have recently added that have underperformed, but appear attractive, are consumer staples and financials. While consumer staples traditionally offer defensive characteristics such as a history of stable growth, many of these investments have low valuations and high dividend yields which could amplify returns. From food manufacturers to low-cost retailers, we have selected companies that we believe can outperform due to expected margin improvements coupled with revenue growth of one to two times gross domestic product (GDP). Large capitalization banks are another industry group that has trailed the market during the past three to six months. We have recently added back a select group of bank stocks, as we expect decreasing loan loss reserves, stronger balance sheets, the removal of equity issuance overhangs, and increased merger and acquisition activity should contribute to stronger performance in the coming year.
We remain bullish on the outlook for commodities, as the effects of global quantitative easing will likely be even more pronounced this year than in 2009. As the lagged effects of expansionary monetary policy work through the economy, growth should accelerate and spare capacities in many commodities may shrink materially. Another factor contributing to economic growth (and commodity demand) should be the long-awaited ramp of stimulus-driven infrastructure spending in the second quarter and beyond. Supply increases will likely trail demand growth, as many producers are hesitant to increase capital expenditures after the economic collapse of 2008. Prices of oil, natural gas, coal, metals, and grains should all benefit from tighter supply-demand balances, as should our holdings in production companies and their equipment/service providers.
Select Chinese growth stocks remain overweight positions in our portfolios. The majority of the companies are consumer-oriented and offer exposure to a burgeoning middle class in China. They offer attractive earnings growth, forward P/E multiples that we think could reach the high single-digits or better, a history of solid cash flows, and high net cash positions. These stocks have been trading at significant discounts to both the U.S. and Shanghai stock markets, and a narrowing of that valuation gap combined with strong earnings growth could lead to considerable outperformance. Our holdings include leading companies in Internet advertising, online gaming, software, and consumer products.
The views in this newsletter were those of the Fund manager as December 31, 2009, and may not reflect his views on the date this report is first published or anytime thereafter. These views are intended to assist shareholders in understanding their investments in the Fund and do not constitute investment advice.
Past performance is not a guarantee of future results.
Before investing you should carefully consider the Jordan Opportunity Fund’s investment objectives, risks, charges and expenses. This and other information is in the prospectus. Please read the prospectus carefully before you invest.
The Fund’s investment parameters are diverse and as such may be subject to different forms of investment risk such as non- diversification risk, concentration risk, small- and medium- sized company risk, interest rate risk, high yield bond and foreign securities risk, and lastly, the Fund may use derivatives such as options to increase its exposure to certain securities. Please see the prospectus for a more detailed discussion of the risks that may be associated with the Fund.
Fund holdings are subject to change at any time and should not be considered recommendations to buy or sell any security.
Current and future portfolio holdings are subject to risk.
The S&P 500 Index is a broad based unmanaged index of 500 stocks, which is widely recognized as representative of the equity market in general. You cannot invest directly in an index.
The Price to Earnings (P/E) Ratio reflects the multiple of earnings at which a stock sells.
The Jordan Opportunity Fund is distributed by Quasar Distributors, LLC.
The VIX is the ticker symbol for the Chicago Board of Options Exchange
Volatility Index, a popular measure of the implied volatility of the S&P
500 Index.
The put-call ratio is a popular tool specifically designed to help
individual investors gauge the overall sentiment (mood) of the market. The
ratio is calculated by dividing the number of traded put options by the
number of traded call options. An increase in traded put options signals
that investors are either starting to speculate that the market will move
lower, or starting to hedge their portfolios in case of a sell-off.
Back to Q110 Newsletter »