Jerry Jordan Commentary | Fourth Quarter 2009 Investment Outlook
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The equity markets continued to surge globally in the third quarter and, unlike the second quarter, experienced almost little volatility. The S&P 500 Index rose during nine weeks of the quarter, and the down weeks witnessed only shallow declines as investors broadly reacted to the realization that the recession appears to have ended. The global markets also advanced nicely, but, interestingly, the Asian markets began to underperform as more developed markets, such as the United Kingdom and Germany, produced stellar returns. The beginning of the global exodus from defensive cash positions appears to be well under way.
We were pleased with our portfolio results during the stock market advance, benefiting from sharp recoveries in energy, industrial, financial, and technology sectors. As the stock market ended the quarter in a significant overbought condition, we have reduced exposure in some of our extended holdings in anticipation of opportunistic entry points later in the fourth quarter. Our intermediate outlook for equities remains positive as economic momentum improves and monetary conditions remain highly stimulative. But we expect the rate of advance to moderate meaningfully as valuations in many markets have approached neutral levels.
The Economy & Interest Rates
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“What is significant about widespread global economic improvement is that it is occurring in the wake of one the most violent and abrupt declines in industrial production in economic history.” |
On September 15 Federal Reverse Chairman Ben Bernanke declared that the recession was likely over, as the effects of enormous monetary and fiscal intervention worldwide have created a very visible impact on the credit and capital markets. With the help of central bank guarantees and cash infusions, banks and financial institutions have been able to raise record amounts of capital and have returned to a position where they can again lend money to help grow the economy. The fiscal stimulus efforts, such as the cash-for-clunkers program, have jump-started auto production from abysmal levels and buoyed retail sales. Industrial production everywhere appears to be improving. The housing markets have been stabilizing and have risen in some areas. As of September 30, 2009, the S&P 500 Index has rallied 62% from its March 9 lows and is up 17% year to date. Clearly, things have gotten better.
What is significant about widespread global economic improvement is that it is occurring in the wake of one the most violent and abrupt declines in industrial production in economic history. Because of increased leverage in the economy and the acute global interdependency of markets, the collapse of the credit system last year forced factory floors everywhere to drastically reduce production. Companies cut costs and employees at record speed. Fortunately, global central bankers were largely unified in their correct strategy approach of unprecedented monetary intervention. So the credit market’s “cardiac arrest” has been averted, where do we go from here?
We believe that the U.S. and global economies should experience substantial improvement over the next several quarters, at a minimum, because: 1) this historically happens after very sharp contractions; 2) the stock market’s enormous rally appears to be essentially forecasting the improvement; 3) low interest rates are punishing savers and rewarding borrowers; and 4) after many months of severe global contraction, there is a lot of pent-up demand.
While China and much of Asia rocketed out of the economic quagmire earlier than the rest of the world, and the Chinese stock market bottomed earlier and rallied more than most markets, it is quite noteworthy that the Chinese stock market was actually down in the third quarter, after having doubled from its October 2008 low. China has aggressively “restocked” its economy with its stimulus plan, which was visible in significant purchases of raw materials in the last six months. However, there is some anecdotal evidence this process is somewhat complete, with the result that sequentially economic momentum in China may be flattening. While this may be the case and might explain the radical recent underperformance of Chinese equities, there is very little evidence to support the premise that Chinese growth will slow sharply in the months ahead. The Chinese economy merely needs to absorb this inventory, which may explain why commodity prices have been flat or down for the last few months.
Even if the Chinese economy decelerates for a few months from the torrid growth earlier this year (7.8% GDP in the second quarter), the rest of the industrialized world has only recently experienced industrial reacceleration and other economic improvement. U.S. industrial production had its first up-tick in July and August and remains down 10.8% year over year. Similar trends have been apparent in many other developed economies. The restocking of inventories associated with moving industrial production back to more normal levels in the industrialized world is thus only beginning. Therefore, we expect economic activity to quicken in the months ahead and commodities to rise, as global demand improves.
The risks to our economic outlook appear largely in the potential for higher levels of inflation to ignite from all the monetary stimulus. While prices of commodities have had big rallies from their lows, there is little evidence of inflationary pressure at this time, and the output gap remains wide. Also, somewhat concerning is that loan growth continues to be very weak and money supply has been contracting recently, but the economic recovery is still very young and these data points should improve sharply in the next nine to 12 months.
Regarding interest rates, it is interesting that long-term Treasury bonds rallied in the third quarter, after their big decline in the first half of the year, which reflects that the economy is still weak and inflation is quiescent. Corporate bonds rallied sharply on the improving perception of credit risk. We believe that Treasury rates should eventually begin to rise again if the U.S. economy’s improvement becomes more visible and sustainable.
The Stock Market
We have been very bullish during the last six months and have benefited from the sharp bullish advance this year, especially from the March lows. While we remain bullish at present and expect the stock market to push higher in the months ahead, the sheer magnitude of the huge advance in the last six months has rendered the risk reward in owning equities less favorable. Thus we have reduced exposure in some extended positions and will seek to be more tactically opportunistic in the months ahead, as the possibility of a correction has increased.
Our overweight positions in our favorite themes have been justified over the past few months, as many of our holdings exhibited strong absolute and relative performance in the third quarter. Economic data continued to surprise to the upside, confirming our bullish thesis for energy and raw materials. However, we believe the most likely outcome in the near term will be a moderation in some of the high frequency economic data that can influence stock prices in those groups. In August the ISM New Orders Index reached 64.9%, the highest level since December 2004, and, statistically, further gains from here will be difficult. While GDP and industrial production levels will likely continue to increase, leading indicators such as new orders could decelerate once low inventory levels are replenished.
As noted above, China’s inventory restocking period is likely behind it. Commodity prices may come under some pressure as China reduces imports and works through its reserves. While there may be a transition back towards demand being led by the recovery in OECD (Organisation for Economic Co-operation and Development) countries, the changeover could lead to some volatility in prices. Energy and raw materials remain among our favorite ideas over the next 12 to 24 months, but we’ve reduced some extended positions. Also, while we have decreased exposure to base metals, we have added to investments in precious metals, particularly in gold miners. Our expectation for higher gold prices is based not necessarily on further U.S. dollar weakness, but the continued excess printing of money by governments worldwide.
We have increased exposure to health care, as we anticipate some group rotation by investors into less economically sensitive sectors. While there has been some concern about the impact of a new health care bill on health care companies’ profitability, the new regulations will likely have little to no negative impact on the fundamentals of our holdings. In fact, the Obama administration’s policies may benefit some health care segments, such as companies that provide the technology behind the implementation of electronic medical records (where we have initiated new positions). Many other growth-oriented health care stocks are cheaper on a relative basis than they were in the first half of the year, and they remain at attractive absolute valuations. We have continued to focus on companies with strong intellectual property, including ones specializing in biotechnology and diagnostic equipment.
During the third quarter we eliminated our financial holdings, as we expect loan losses and high provision levels to remain an earnings headwind for the industry. We used those proceeds to increase our holdings in select technology stocks, particularly ones based in China. Many of these companies are selling at P/E valuation discounts to the U.S. and Shanghai market averages, have more cash than debt, and have been growing revenues well in excess of 20% annually. As investors search for strong secular growth (which is becoming harder to find in a slow-growth economy), these stocks could see significant multiple expansion. The industries in which we have initiated or added to positions include online gaming, online advertising, software, and pollution control.
The views in this newsletter were those of the Fund manager as September 30, 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.
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