Following the explosive upward action in equities that capped off a healthy 2014 for long positioned investors, the first quarter was burdened by three albatrosses. A large portion of the country, particularly the Northeast was socked by repeated snowstorms and extreme winter weather that kept shoppers at home and construction activity frozen. On the West Coast, longshoremen, dissatisfied with an average salary of $147,000 per year and Cadillac medical benefits, battled management in a slowdown/strike that cost retailers at least $7BB in lost sales and countless $ billions for farmers whose exports were delayed or cancelled. Meanwhile, the business media, lacking solid news, over- hyped the importance of an anticipated Federal Reserve Bank overnight interest rate hike beyond rationality. While the valuation of equities and the forward motion of the economy are to a significant degree negatively affected by sharp or large increases in interest rates, the small and incremental measures contemplated by the Janet Yellen chaired Federal Reserve Board are hardly something that would take our current healthy economy into a recession. I suspect those who panic at the thought of an interest rate increase are younger, less experienced investors, recalling the models taught in Macro Economics textbooks. Those of us who lived through the years of the Paul Volker Federal Reserve, recall mortgages at 15% and treasury bonds at 16%, so it’s difficult to get worked up about mortgage rates rising to perhaps .25 to .75 basis points over the next 12 months.

Both equity and bond indices were little changed for the quarter, and the same can be said for most of our managed accounts, although a fractional amount of forward momentum was the rule for most. As the quarter closed, some worry about a strong US dollar hurting earnings for US exporters. This is likely a valid concern, but reduced earnings expectations abroad should, in my opinion, be offset by steadily rising domestic demand as consumers enjoy lower gasoline and fuel prices and industrial construction expands (the US is an attractive destination for companies who want to enjoy cheap fuel and petrochemicals). Although a 10% correction is certainly a possibility as we enter a seasonally weak period for equities, my principal concern is lack of truly undervalued equities and the challenge of finding decent yields on fixed income instruments. Thus, we retain about 10% in cash Client portfolios.

Your portfolio is populated with securities that attempt to capture both cyclical and secular themes and, while I address some “Big Picture” subjects here, we remain bottom up investors. What we bought this past quarter for many accounts includes:

Activities during the First Quarter 2015

  1. Closing our long position in Priceline, held by more risk-tolerant accounts, resulted in a significant loss near 20%.
  2. Closing our long position in PNC Bank with a modest one year gain of 8%.
  3. Closing our position in US Bank with a significant gain over a three year holding period.
  4. Adding to international exposure via funds.
  5. Adding New York Community Bank (NYCB) with a yield of 6% and a reliable loan portfolio backed by low turnover, rent controlled apartment buildings.
  6. Adding Goodyear Tire (GT), a familiar name that benefits from increased driving propelled by low gasoline prices and from higher margins due to low rubber and plastics prices. Goodyear is a stock that should pop upward once import duties are imposed on Chinese tire dumping in the first half of 2015.
  7. Adding MasterCard (MA), purchased just at the close of 2014 in the belief that rising employment and falling energy prices would drive increased consumer spending. So far this anticipated surge has proven to be a disappointment. The stock is essentially unchanged from its purchase price. For some of the reasons enumerated above, consumer spending has been more tepid than anticipated. However, I continue to believe MA to be analogous to a toll road, as it is an essential part of the infrastructure for US and international commerce in a generally expanding economy.
  8. As available, we picked at new offerings of high yielding preferred stocks primarily for clients who rely on their portfolios for income.

Stepping back and considering your holdings for purposes of this report, I can say that I like what you own. As you know, we are not “traders”, but want to be long term owners of businesses with superior characteristics: something of a moat, high returns on equity, high free cash flow and capable management. While able to react when there have clearly been changed circumstances (exiting exploration and production oil companies), my tendency is to hold on to solid names even during periods of doubt (energy pipelines were trimmed, but we retain core holdings in Enterprise Products and Kinder Morgan.)

We try to remain ever aware of demographic trends that create opportunities to profit our clients. One of those trends is our steadily aging population. Age brings rising demand for medical services and pharmaceuticals. In the wake of passage of the Affordable Care Act, we decided the playing field was becoming treacherous, given political uncertainty and possible distortions to the marketplace by the increased role of government, deep disagreement between the two main political parties, and the ever present threat of judicial action. So this is one of the sectors we trust to third party managers. Both vehicles we’ve selected for our clients have done well in the past quarter and since inception. The Healthcare Select SPDR exchange traded fund (XLV) jumped 6% while T. Rowe Price Health Sciences fund added a spectacular 15%.

Speaking of demographics, I believe we are entering an era when Millennials (people born between 1980 and 2000, 85,000,000 strong, will be seeking home ownership as they reach their late ‘20’s and early ‘30’s, often forming families. We’ll probably nibble at a homebuilding stock soon. I do not think that if mortgage interest rates on a 30 year fixed loans rise to 5.00% or 5.25% that home buying will be stopped in its tracks (recall that mortgage Wizards still offer shorter term paper at lower interest rates.) Besides, while the Fed may raise overnight borrowing rates, strong demand for longer dated U.S. Treasuries, by pension funds and foreign investors should keep mortgage rates suppressed.

Rising rates, and rising demand for loans, both characteristic of the late stage of an economic recovery means that the banking sector is tempting me to increase exposure to that sector. Then there is the ongoing tale of Apple computer. The firm’s highly successful introduction of a larger format iPhone (6 and 6s) has been greeted with enthusiasm, leading the company to snatch the crown of top smart phone sales back from Samsung, for the time being. The stock responded accordingly, perhaps getting ahead of itself, although by most measures it is far from overvalued. (As an example, Apple trades at 6 times book value while another beloved, “hip” company, Tesla, trades at 26 times book.) Still, I’m a bit concerned that Apple Pay does not seem to have taken off as a popular application and personally, I just don’t get why anyone would buy an Apple Watch (but…I said that about the iPad, and now I own one, 5 years after its introduction!) It is clear, however, from visiting Apple stores, that the company’s products are being increasingly adopted across a broad demographic spectrum, notably retirees. This is an amazing feat. As a “value” investor, I am uncomfortable owning such a widely loved company. However, indications are that Apple is going to announce a significant increase in its dividend or stock buyback program sometime this month, which could boost the stock back to and perhaps above its recent high of $133/share (closed at $124.43 on March 31).

I recently stumbled across our Trusted Advisor newsletter from March/April 2009, which we no longer publish, as “blogging” is our approach today. March 2009, in hindsight, was when the US stock markets plumbed their bear market depths. In hindsight, this turned out to be “the bottom” of the cycle, but neither we nor anyone else (who is candid) realized it at the time. However, we did wave the banner for bond buying, and were in the midst of acquiring some high quality issues for client portfolios, often with yields in the 9% plus range (e.g. General Electric). Tax free muni bonds were available for 6% and these were packed into taxable portfolios. These yields are unheard of today, at least for high quality debt instruments. Last year, I described our bond holdings as the “Wind Beneath our Wings” for much of the past few years. In March 2009, I expressed doubt that we would have a sustained equity rally (wrong), but we held on to quality names through the Panic and our clients were able to return to the pre-crash portfolio values and we were able to recover our clients’ pre-crash wealth within 1 year. By comparison, it took the S&P 500 Index an additional 20 months to achieve the same feat. That six year old newsletter is a reminder that the #1 job at Trusted Financial is to minimize the damage from inevitable market cycles, while being willing to take reasonable risks when others are paralyzed and passing up bargains.

Today I am again cautious on U.S. stocks, finding it difficult to locate screaming bargains. Yet, I suspect we will be expanding our holding of stocks in Europe and Japan, two markets that appear undervalued. I believe we are in a bull market that has some years to run. But all bull markets have corrections. We’ll be looking for bargains wherever and whenever they can be had.