Seeking Diamonds in the Rough

Tom Connolly’s Equity Market Forecast

for the upcoming week beginning April 18, 2016

With Market Questions and Answers

 

Summary Comments:

This week’s write-up will be relatively brief given the time required to complete my 2015 Federal and State tax filings.  A fuller version will be back next week.

Equities continue to lack appeal for me.  The tug of war between wanting to own great companies and the price of choosing to act on that desire dominates my view of the market.  At the current multiples of earnings and cash flow, the market is very expensive based on historic comparisons.  This would be justified if we were experiencing significant growth and growth opportunities, but that robust environment is just not evidenced in the economic results to date.

As I walk through the streets of Manhattan I am struck by the expanding number of retail outlets that have closed and for which the space is available for lease.  When I inquire of others that live outside of Manhattan as to their observations in regard to retail, I hear the same observation.  When looking at the residential real estate market in New York, it is clear the bloom is off the rose this Spring.  Properties are not moving, volume and price are down.  The professional service firms appear to be slowing in their growth as we see more and more financial and advisory firms reducing their workforces.  Regulations, cost of doing business, and the tax and health care cost burdens are taking a toll.  I not only see this in my readings, conversations, and walks about town, but I am experiencing it first-hand in my own cost of living (as I work on my tax return, presently my tax bill for 2015 looks like it will be close to 40% of income).  The cost burdens that continue to expand, many targeted to fund transfer payments in the United States, are not adding productivity, but are expanding the drain of capital away from expansionary economic undertakings.  With this as the backdrop, I scratch my head at a market that sees the S&P 500 trading at 24X current earnings and at 17.7X forecast earnings.  At a cash flow multiple of 18.3X forecasted 2016 results, and with 2016 and 2017 forecasted cash flow growth below the historic growth rates of the past.  The returns on investment do not justify the prudent deployment of capital in the current environment. 

Based on an assessment of United States reported economic data, my models show negative results for Economic indicators, Interest rate indicators, Market value indicators, and FX indicators.  The only positive is the money indicator, and that has been positive for so long.  The data is telling us that the stimulative impact of money was present for a time, but now lacks positive value generation. The lack of economic growth indicates diminishing returns. 

Finally, from a technical perspective the market behavior is positively endorsing the holding of stocks.  I scratch my head here, but cannot ignore the support of higher flows into advancing stocks.  My concern for a headfake is real, but maybe, just maybe, the market is telling us that better economic results are in our future.  I wait with bated breath.

Given this perspective, I am studying all of the tea leaves in search of hard facts, hoping to find diamonds in the rough.  They seem very hard to come by.   The portfolio and market performance report for the YTD period ending on April 15, 2016 is as follows:

 

YTD Connolly portfolio gain as of April 15, 2016 equals        +5.78%

S&P 500 Index YTD gain as of April 15, 2016 equals              +1.80%

NASDAQ Index YTD loss as of April 15, 2016 equals              -1.38%

 

Portfolio composition as of April 15, 2016 is as follows:

  • Cash                   51.1%
  • Equities             34.9%
  • Gold                    12.2%
  • Fixed Income      1.8%

 

Have a great week!

Tom

Author: Thomas Connolly

Tom possesses a rich and diverse background that includes deep investing experience, senior corporate executive positions, and roles as a Regional Managing Partner and Global Industry Leader within Ernst & Young. He has advised executives on some of the largest acquisitions and dispositions in the Media and Entertainment industry, including clients such as Comcast, Citibank, Sony, Dalian Wanda and Publicis. Tom is a Certified Public Accountant with a Masters Degree from Columbia University. His skills are further accompanied by a personal passion for the study of economic trends and evolving market dynamics.

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