MARKET COMMENTARY

Equity Markets Are Shaken, but Not Broken

Equity Markets Are Shaken, but Not Broken

11.30.2015 - Carin L. Pai

The increased market volatility since late summer has no doubt been unnerving for some investors. However, we see this volatility as a time to reassess the data and determine whether there have been changes to the fundamentals of the financial market. Our view is that the underpinnings of the equity markets are shaken, but not broken. While we believe stocks are generally in the midst of a multi-year period of relatively modest returns, we view bouts of volatility as key opportunities to potentially add quality companies at better prices.

Anticipating What Happens Next

The children’s book, If You Give a Mouse a Cookie, is a fun tale about a mouse whose actions lead to a chain of further actions: when he gets a cookie, the mouse will ask for milk to go with the cookie, and when he gets the milk, then he will need a straw, and so on. Believe it or not, this story has investing elements to it - it is about cause and effect and anticipating what happens next.

In selecting companies and stocks to invest in, we often think about the interconnections of companies to find the next great ideas - or to avoid the bad ones. To draw conclusions between cause and effect, we study the supply chain, or verticals, to anticipate changes in demand for certain products and services. We also analyze the implications of factors such as internal innovation, industry growth and operational improvements.

A Focus on Areas We Believe Can Grow Faster than the Economy

Through our fundamental research, which is designed to help anticipate 'what happens next,' we are finding companies we believe have higher growth potential:

    • Companies that Understand Their Consumers. We believe that consumers are saving a larger percentage of their income in this economic recovery, and lower gasoline prices have not fueled spending in the typical fashion. We find that the most successful consumer companies not only understand what consumers are spending their money on, but how they are spending it. We favor companies with smart digital strategies - ideas that instill customer loyalty and motivate consumers to spend more on every purchase. Our pursuit of these types of companies has led us to a number of restaurants, home improvement companies and retail manufacturers.
    • Effective and Cost-Efficient Health Care. Not too surprisingly, consumers are spending an increasing amount on healthcare, and those that need healthcare are the fastest-growing population. One of our preferred areas within healthcare is the biotechnology industry, which is benefiting from an increase in the pace of drug approvals from the Food and Drug Administration (FDA). Notwithstanding rhetoric on drug pricing control, consumers and healthcare plans are generally willing to pay for effective and safe drugs that cure or treat growing diseases. Additionally, we have taken positions in service providers that are working to make our nation's healthcare system more cost efficient.
    • Higher Productivity through Technology, and Cyber Security. Many businesses are intent on cutting expenses and increasing productivity, which is driving strong growth among software companies that deliver their products over the Internet. Web-based software offers many advantages over legacy, on-site software, including lower up-front costs and ease of product updates. And, with increasing amounts of data transmitted over the Cloud (web), internet security is a critical spend for many enterprises and small businesses.

The Effects of Key Economic Trends Mean Company Selection Is Critical

The economic slowdown in the emerging markets has led to a decline in many sectors and industries, particularly in the demand for commodities. We remain neutral to cautious on energy, industrials and materials as these sectors will likely continue to be impacted by this slowdown, compounded by a strengthening US dollar.

We are also cautious on stocks that are sensitive to interest rates, such as utilities, on the view that the Fed will likely begin to raise rates in the near future from abnormally low levels. Importantly, years of low interest rates have led companies to quietly re-lever their balance sheets, with total US corporate debt levels rising above pre-crisis levels. In an economy that is growing slowly, we believe that those companies that have overly relied on low rates and financial engineering will begin to experience margin erosion due to potentially higher wages as well as higher funding costs, as the Fed most likely begins to raise rates. We therefore believe that company selection within and across sectors is even more critical.

This communication is intended solely to provide general information. The information and opinions stated are as of November 20, 2015, and may change without notice. The information and opinions do not represent a complete analysis of every material fact regarding any market, industry, sector or security. Statements of fact have been obtained from sources deemed reliable, but no representation is made as to their completeness or accuracy. The opinions expressed are not intended as individual investment, tax or estate planning advice or as a recommendation of any particular security, strategy or investment product. Please consult your personal advisor to determine whether this information may be appropriate for you. This information is provided solely for insight into our general management philosophy and process. Historical performance does not guarantee future results and results may differ over future time periods.

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