Jerry Jordan Commentary | Second Quarter 2010 Investment Outlook
Back to Q210 Newsletter »
When we exited 2009, a year which witnessed some of the biggest equity gains in history, we expected a return of volatility and significant sector rotation, followed by further gains. The stock market did indeed suffer a sharp correction in the second half of January, with the S&P 500 declining 9% from its highs. While the decline was sharp, it ended quickly after two weeks, and the market resumed a steady advance before the S&P 500 finished the quarter up 6%. But rotation did not occur, as the consumer discretionary and technology sectors continued to lead the advance. Commodity and late cycle sectors continued to lag relatively, as they did in the Fourth Quarter. Emerging markets also lagged relative to the U.S. and other developed market bourses, with a notable decline in the Chinese market of 5%, as measured by the Shanghai SE A Share Index.
Given this market backdrop, our positions lagged materially, after having performed so well last year. Energy stocks and Chinese growth stocks, two areas we particularly favored, performed poorly on a relative basis. Most of our investment themes we believe are long-cycle growth stories, whereas stocks that have benefited strongly from short term stimulus, such as retailers, continued to outperform. We expect that the market will return to the longer cycle themes, as long as the economy continues to recover and confidence builds.
We remain cautiously bullish on the stock market, and believe it should eventually end the year higher. Near term, however, we feel some caution is warranted given the big advances experienced in the last twelve months and the fact that the level of general optimism is reaching high levels. Many stocks that have led in the advance in the last six months now have neutral valuations at best, and very high earnings expectations.
The Economy and Interest Rates
| |
“The economic recovery is proceeding largely as we expected, with sharp percentage GDP gains that are mostly a function of activity returning to more normal levels” |
The economic recovery is proceeding largely as we expected, with sharp percentage GDP gains that are mostly a function of activity returning to more normal levels after the extreme declines in 2008 and early 2009. Retail sales and durable goods orders are rebounding, and vehicle sales are rising meaningfully. Even the housing market has stabilized and prices are showing modest improvement. Internationally, Europe has been surprisingly weak, but is improving, while emerging economies, led by China, are showing vigorous growth. And global trade has increased sharply, with global exports surging at a 21% annual rate, led by stunning recoveries in Japan and in other Asian exporters.
We expect the economy to keep improving throughout the year, as confidence rebuilds. There is a lot of room for improvement, as U.S. consumer confidence remains near multi-decade lows. Despite the sharp recoveries of stock prices, the shrunken equity value of residential real estate and consumer debt de-leveraging continues to depress sentiment. And money supply growth has been surprisingly weak, along with bank loan activity. These are areas that we expect to improve and may lead the next leg of recovery.
The short-term interest rate picture in the US remains on hold, as the Federal Reserve Bank kept the federal funds rate near zero, despite the almost 6% gain in GDP in the Fourth Quarter. But long-term interest rates have started to rise again, particularly in the wake of recent weak U.S. Treasury auctions and faster economic growth. We believe that the Federal Reserve should not begin to tighten until the end of the year, as it may be reluctant to tighten before it can assess the impact of the expiration of some of the credit market relief programs that expired at the end of the First Quarter.
Even though we expect 10 year interest rates to continue rise modestly, we do not feel that it will derail the economy or the stock market, except for a temporary setbacks, at which point interest rate pressures should moderate. Right now a lot of stimulus is still being thrown at the economy, and some interest rate adjustments should soon be appropriate.
The Stock Market
Our outlook on the stock market remains cautiously optimistic, following last year’s huge gains. We believe that both the economy and equity prices may improve as the year progresses. While corporate profits have been stellar in the Fourth Quarter, and could remain so through the First Half, we believe that expectations may have gotten too optimistic in the wake of equity gains. This is especially true given the inability and reluctance of businesses and consumers to employ leverage in the current environment.
The technical momentum of the stock market remains very strong, as evidenced by the rising Advance/Decline Line, the high number of stocks above their moving averages, the high number of new highs, and very few new lows.
But the stock market is very overbought, as evidenced by the very high year-over-year rate of change, which is at levels that has generally provoked a period of volatile consolidation, notwithstanding potential further gains. Most investor sentiment measures show signs of complacency, and there has been a surge of ETF (exchange-traded funds) buying in recent weeks, which may reflect a lot of short covering. Additionally, if interest rates continue to rise in the long-end of the curve, this could also exert short-term pressure on stocks. In conclusion, we believe that the risk/reward in pressing the bet on top-performing stocks is not favorable at the moment. In fact, when a period of volatility resumes, we think there is the potential for significant rotation into what we consider "longer-themed growth stocks", which we will discuss in our Strategy section below.
Strategy
We continue to invest in industries and sub-sectors that we think may likely benefit from secular trends that we see developing over the next several years, if not the better part of the decade. While many companies (especially within the consumer discretionary sector) have seen sales recover to pre-crisis levels, we believe out-performance from here will require secular growth. In our opinion, our equity holdings have longer-term growth opportunities that should drive earnings momentum well ahead of the S&P500, while many have P/E valuations below the market multiple.
Recently we have increased exposure in the media, telecom, and value-oriented retail industries. Our holdings in these sectors offer earnings growth potential that could surpass S&P500 earnings projections in coming years, as new revenue streams come online, expense cuts drive operating leverage, and high cash levels are used to repurchase shares. We believe we are witnessing the beginning of a sea change within media, where companies will increasingly charge for access to their content (especially online), and/or use advertising to better monetize their assets. One recent example was announced by Viacom in early March, when it removed "The Daily Show" and "The Colbert Report" videos from the free site. Instead, Viacom will host the content on a company-owned website (Comedycentral.com), where they’ll receive all related advertising revenues. Also, select telecom operators should see significant cash flow improvement as capital expenditures are wound down from extremely high levels in the past five years, allowing for potentially higher dividends, share repurchases, and shareholder returns. Finally, we expect consumers to continue to trade down and stay with lower-priced retailers (especially in the lower and middle classes), as ongoing debt de-leveraging should weigh on discretionary income for years to come. Our holdings in value-oriented retailers are well-positioned to possibly benefit from these trends and outgrow their peers.
We remain bullish on the long-term trends in agriculture, as worldwide production should struggle to keep up with demand growth in coming years. Emerging market population growth and food substitutions for fuel (i.e., corn-based ethanol) will continue to suppress inventory levels. Without extremely favorable weather conditions (as seen in 2009), production shortfalls may become much more common as 2010 progresses and especially into 2011. Our investments, including fertilizer producers, machinery manufacturers, and grain processors, should benefit from farmers’ attempts to improve yields. Our portfolios also include several packaged-food companies, which we expect to benefit from higher grain prices by actively hedging raw materials exposure and raising their own prices, which should allow for margin expansion.
Our energy-related investments (in producers and service companies) have underperformed oil prices recently, partially due to the weakness in natural gas. We expect natural gas prices to stabilize in coming months as we head into the shoulder season (with less hydroelectric output and increased gas switching), which should improve the relative performance of our holdings. Demand growth for oil products has accelerated in the last two months, which should continue as the economy recovers further, supporting higher oil prices and increased expenditures in exploration/production activities. Also, earnings estimate revisions for the oil services industry have recently started to inflect positively relative to other sectors, which should portend a resumption of strong performance.
Healthcare is another area of focus with potentially attractive long-term growth characteristics, particularly after the passage of the Health Care Reform Bill. 32 million additional individuals will have access to healthcare insurance by the end of the decade, which may drive higher prescription, diagnostic test, and screening volumes. Based on this, we anticipate most of our holdings could substantially appreciate in the near-term, even before the benefits of the Reform Bill.
While our portfolios are positioned somewhat defensively, we expect to have an opportunity to regain relative momentum in the months ahead after the stock market experiences a consolidation process.
The views in this newsletter were those of the Fund manager as March 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.
Please click here for the Fund's top ten holdings as of March 31, 2010. Fund holdings and sector allocations are subject to change at any time and should not be considered recommendations to buy or sell any security.
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. The Shanghai A-Share Stock Price Index is a capitalization-weighted index. The index tracks the daily price performance of all A-shares listed on the Shanghai Stock Exchange that are restricted to local investors and qualified institutional foreign investors. The index was developed with a base value of 100 on December 19, 1990. You cannot invest directly in an index.
The Price to Earnings (P/E) Ratio reflects the multiple of earnings at which a stock sells. Cash flow measures the cash generating capability of a company by adding non-cash charges (e.g. depreciation) and interest expenses to pretax income.
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 Q210 Newsletter »