Registered Investment Advisor | New York Investment Advisory - Rgaia Menu Skip to content Investment Strategy Team Research Fees Commentary FAQ Contact Us My Account | 516.665.1945 We are an independent, fee-only investment management firm providing wealth management and financial planning for individuals, families, non-profit firms, and corporations of all sizes. As a fiduciary, our clients interests are tantamount to our objectives and we are therefore not plagued by conflicts of interests inherent in the asset management business today. Independent and Fee Only Investment Advisors RGA Mission We are students of Benjamin Graham and a value-oriented investment management firm. This means that we seek investments with an identifiable margin of safety, a true underlying value, and a cost lower than the asset's fundamental worth. Low Fee Strategy Value Philosophy We understand the disconnect between true value and cost. We aim to buy only at the most favorable times when others in the investment industry typically sell. In the same way, we typically sell when others are more likely to buy. We move strategically, focusing on possible loss before examining gain. Underlying Value Long Term Focus Minimize turnover; maximize time. Adopting a long-term focus requires the understanding that fewer transactions over an extended time period result in fewer costs. Although we recognize that not everyone has the luxury of unlimited time, and we tailor our investment process to each individual's needs, we also aim to satisfy the long-term goal. Aim Long Term Research Process Too many advisors claim there is One Key, or One Secret, that allows them to buy stocks just as they are ready to go up. Simplicity is appealing, but we've found that magic and investment don't mix. We think the Key to identifying investment opportunities lies in robust, well-rounded analysis, balanced across a variety of metrics. Robust Analysis Minimize Risks When we build a portfolio, we aim to limit risk. That said, understanding investment means accepting risk as an inevitability. In order to limit risk to the entire portfolio, we approach investment with an eye toward reasonable diversification. Portfolio Construction Services When welcoming a new client, we include a methodical and comprehensive report of her existing portfolio. We examine new client accounts systematically and pinpoint the portfolio's baseline. Our report includes... Get Started An Envestnet for the Long Run Elliot Turner was honored to present at the 2016 Value Conferences Wide Moat Investing Summit. He presented IMAX at the inaugural event three years ago followed by eBay/PayPal in 2015. At this fourth annual event, recognized value-investors presented some of their best investment ideas. Elliot presented on Envestnet. We are excited to share his slides here: This entry was posted in 2016 on July 21, 2016 by RGAIA. June 2016 Investment Commentary: Brexit is No Lehman As of last week, the story for this quarter was going to be different. We were going to highlight the more orderly recovery in stocks taking place after a chaotic first quarter. On Wednesday, the 22nd of June, the S P closed within spitting distance of all-time highs. That narrative suddenly evaporated the night of Thursday June 23rd as votes were counted in the United Kingdom on whether to leave or remain in the European Union. In a flash, the British Pound went from its highest level of the year to its lowest level in thirty years: What followed was one of the harshest days of selling in global markets, with our S P falling 3.59% on that Friday, alone. The weekend did little to curb the selling pressure as market commentators wondered aloud whether this was a Lehman moment. Since Lehmans failure marks the most cataclysmic event in financial markets since the Great Depression, we think it is important to address head-on this fearful reprise and bring a dose of reality to the conjecture, as the differences between Lehman and Brexit are far more consequential than any perceived similarities. Mr. Markets PTSD: The invocation of Lehman here strikes us as a case of recency biasa form of post-traumatic stress disorder that the humans who operate markets exhibit in the aftermath of extreme events. The cleanest definition for the recency bias is that it is the phenomenon of a person most easily remembering something that has happened recently, compared to remembering something that may have occurred a while back. [1] Ultimately it is easier to recall recent events, especially when a high level of emotion is involved. Ye the more emotion is involved, the harder it is to cleanly recall a sequence of events with a factual level of detail. This is why every time the markets have had a rough patch since the Great Financial Crisis, some investors wonder whether it will be the next acute phase of troubles. A reality that we often cite in these instances is that it is far safer to fly in an airplane shortly after a crash happens, than just before. This is true because those who are stakeholders in the security of flying are on higher alert for any potential problems in the aftermath of disaster. The same is true in financial markets, with one of the clearest signs today being the very safe capital ratios in the financial sector. If you will recall, the troubles at banks were the transmission mechanism through which problems in markets became a real economic calamity, and while we are never immune from problems in markets, they are far less likely to spread and become really deep when in such good shape. The reason we are calling out the markets recency bias is that a far more apt historical analogy does in fact exists and the set of circumstances around it are very similar to what is happening today. We will visit this example shortly, but it is important to first point out that without question, markets were taken aback and surprised by the vote. Herein lies the one similarity to Lehmanmarket commentators did not expect the powers-that-be to let Lehman fail. Yet, too much of the rhetoric focuses on the binary question of whether the markets were wrong about the Brexit vote? Markets do not think in terms of yes or no. Instead, they handicap likely probabilities, and clearly the expectation was too high that the Remain vote would win. Moreover, we think labeling this a Lehman moment relies on the wrong paradigm for understanding Lehmans failure. On the five year anniversary of Lehmans collapse, we wrote our commentary suggesting that investors beware of mistaking a symptom for the cause.[2] Lehman certainly exacerbated problems, but the key feature of Lehman is that it was caused by really deep, underlying stresses in our financial system. According to the Federal Reserve Bank of New Yorks own internal documents, released nearly three years after Lehmans failure, the Fed essentially says that the bank run began around August 20th, 2008, nearly four full weeks before Lehman filed for bankruptcy.[3] This was the first bank run our country experienced since the Great Depression. Clearly Lehman was not the causal event, it was a symptom. So how does this relate to Brexit? Beyond merely contemplating frightening events, it doesnt relate in the slightest. As discussed earlier, it is far easier to contemplate horrible possibilities than to weight likely ones. Lehman had some obvious and immediate contagion effects. For example, within days of Lehmans bankruptcy, one of the largest utilities in the country was on the brink of filing its own bankruptcy due to counterparty risk with Lehman.[4] Meanwhile, days after the Brexit referendum we remain unsure whether the UK will even exit the EU. From here, there will be no next step until at least October when a new Prime Minister is selected in the UK. Only then will we know if a two year (or longer) process for departure will in fact commence. While the uncertainty is challenging for markets to grapple with, the imminent prospects of financial stresses that could bring down companies and impact how the average American lives their life with regard to spending and investment is essentially non-existent. Importantly, despite the plunge in bank stock share prices since the vote, there are no real signs of stress in financing channels. In fact, credit indicators remain mostly constructive and are far more benign than they were a few short months ago. If Not Lehman, Then What? Recall that the recency bias lends more weight to recent events than to something that happened further back in time. There is truly a historically relevant comparison that we have hardly seen mentioned in the press at all following the Brexit vote. Many of you are probably aware that whereas countries like France, Germany and Italy use the euro as their currency, the United Kingdom uses the Pound. This is so despite all countries being members of the EU. As history would have it, the UK was supposed to be part of the euro currency until what is today referred to as Black Wednesday (Wednesday, September 16, 1992) also known as the day George Soros Broke the Bank of England.[5] This event similarly happened at a crucial juncture on the pathway to European integration. It is worth sharing the aftermath section from Wikipedia here in its entirety:[6] Other ERM countries such as Italy, whose currencies had breached their bands during the day, returned to the system with broadened bands or with adjusted central parities. Even in this relaxed form, ERM-I proved vulnerable, and ten months later the rules were relaxed further to the point of imposing very little constraint on the domestic monetary policies of member states. The effect of the high German interest rates, and high British interest rates, had arguably put Britain into recession as large numbers of businesses failed and the housing market crashed. Some commentators, following Norman Tebbit, took to referring to ERM as an Eternal Recession Mechanism after the UK fell into recession during the early 1990s. Whilst many people in the UK recall Black Wednesday as a national disaster, some conservatives claim that the forced ejection from the ERM was a Golden Wednesday or White Wednesday, the day that paved the way for an economic revival, with the Conservatives handing Tony Blairs New Labour a much stronger economy in 1997 than had existed in 1992 as the new economic policy swiftly devised in the aftermath of Black Wednesday led to re-establishment of economic growth with falling unemployment and inflation (the latter having already begun falling before Black Wednesday). The economic performance after 1992 did little to repair the reputation of the Conservatives. Instead, the governments image had been damaged to the extent that the electorate were more inclined to believe opposition arguments of the time that the economic recovery ought to be credited to external factors, as opposed to good government policies. The Conservatives had recently won the 1992 general election, and the Gallup poll for September showed a 2.5% Conservative lead. By the October poll, following Black Wednesday, their share of the intended vote in the poll had plunged from 43% to 29%, while Labour jumped into a lead which they held almost continuously (except for several brief periods such as during the 2000 Fuel Protests) for the next 14 years, during which time they won three consecutive general elections under the leadership of Tony Blair (who became party leader in 1994 following the death of his predecessor John Smith). Note that speculators quickly went on to attack Italys currency (then the lira) on the assumption that other similarly frustrated and vulnerable countries would be at risk of similarly troubling attacks in currency markets. This history is rhyming today as traders drive down global markets on speculation that yet again, Italy and other weak countries in the EU might host their own referendums to leave the EU, creating a troubling spiral of events. After Black Wednesday, the UK quickly fell into recession and took years to recover. This too will be the UKs economic destiny today, and in our estimation, is the most likely consequencea harsh reality for those in the UK, but not so much for us here in the United States. The S P chart from the beginning of 1992 to that same date one year later paints an interesting picture: The S P had been range-bound for months leading up to Black Wednesday. It dropped 4.3% over the next two weeks (once upon a time markets moved a little slower than they do today); recovered to 52-week highs within two months; and, one year later was up 9.4% from that of Black Wednesday. There is no reason to suspect that the S P move from here on out will be similar. We are merely highlighting the aftermath to show that a traumatic political event out of the UK, with significant economic ramifications need not change the trajectory for the US economy or the US stock market. The biggest consequences today, as they were then, will be local and political, and while there could be some negative ripples that follow-through, we think it is imprudent to position based off of what these ripples might entail. In sum: as of today, it remains unclear when, or even if, the UK will actually leave the EU, it is unlikely that there are any enduring economic consequences for us here in the U.S., and there are no imminent follow-on events that would tell us otherwise. Thank you for your trust and confidence, and for selecting us to be your advisor of choice. Please call us directly to discuss this commentary in more detail we are always happy to address any specific questions you may have. You can reach Jason or Elliot directly at 516-665-1945. Alternatively, weve included our direct dial numbers with our names, below. Warm personal regards, Jason Gilbert, CPA/PFS, CFF, CGMA Managing Director O: (516) 665-1940 M: (917) 536-3066 jason@rgaia.com Elliot Turner, CFA Managing Director O: (516) 665-1942 M: (516) 729-5174 elliot@rgaia.com [1] http://www.davemanuel.com/investor-dictionary/recency-bias/ [2] http://www.rgaia.com/september-2013-investment-commentary-beware-of-mistaking-a-symptom-for-the-cause/ [3] http://www.nytimes.com/2011/04/03/business/03gret.html [4] http://blogs.wsj.com/deals/2008/10/21/constellation-and-then-we-came-to-the-crisis/ [5] https://en.wikipedia.org/wiki/Black_Wednesday and http://www.investopedia.com/ask/answers/08/george-soros-bank-of-england.asp [6] https://en.wikipedia.org/wiki/Black_Wednesday Past performance is not necessarily indicative of future results. The views expressed above are those of RGA Investment Advisors LLC (RGA). These views are subject to change at any time based on market and other conditions, and RGA disclaims any responsibility to update such views. Past performance is no guarantee of future results. No forecasts can be guaranteed. These views may not be relied upon as investment advice. The investment process may change over time. The characteristics set forth above are intended as a general illustration of some of the criteria the team considers in selecting securities for the portfolio. Not all investments meet such criteria. In the event that a recommendation for the purchase or sale of any security is presented herein, RGA shall furnish to any person upon request a tabular presentation of: (i) The total number of shares or other units of the security held by RGA or its investment adviser representatives for its own account or for the account of officers, directors, trustees, partners or affiliates of RGA or for discretionary accounts of RGA or its investment adviser representatives, as maintained for clients. (ii) The price or price range at which the securities listed. This entry was posted in 2016, Commentary on June 29, 2016 by RGAIA. May 2016 Investment Commentary: Get Your Heavy Duty Staple Remover Ready On August 25, 2014 the S P crossed 2000 for the first time. We are nearly two-years past that milestone (now 21 months), yet the S P continues to wrestle with the round-number level. In essence, very little has happened in the broader markets over this time. Yet, on the sector level the story is very different. Below is a table showing the performance and delta in the P/E ratio for each of the GICS Sectors, the S P 500 and the Russell 2000 since the markets first move above 2000: A few points stand out right away: Energys P/E has risen substantially despite a 30+% drop in price. This is due to the collapse in energy shares and underlying earnings of the companies who operate in energy. Since the P/E we included here excludes extraordinary one-time items (charges against earnings that are non-recurring in nature), it is clear that markets are pricing in some kind of cyclical improvement for energy. After Energy, Consumer Staples and Utilities are the only other sectors for which P/E ratios have risen since the S P first crossed 2000. This is not because earnings growth has been robust in either sector. In fact, with staples, nearly the entire 16.34% return since 8/25/14 can be attributed to the change in its P/E and not to growth. This is a result of the sectors historically robust and sustainable dividends being used as bond proxies in this era of low interest rates. Health care and Consumer Discretionary each had their multiples contract while earning double-digit price returns. Both sectors benefited from robust earnings growth; however, the multiple contraction indicates that the markets anticipated this healthy growth and priced at least some of it in. The S Ps multiple expanded by nearly 8% despite generating less than a 5% return. In other words, for this time period, all of the markets return and then some can be explained by multiple expansion rather than growth. We went through the sectoral components of growth in our September 2015 Commentary which further explains how and why this has happened.[1] The Russell 2000 has had a huge amount of multiple compression. The Russell 2000 has been essentially flat (down less than 1%) since the S P first crossed 2000, yet its multiple has dropped by an extreme 31%. What this means is that earnings at the Russell 2000 companies have grown tremendously while price has gone nowhere. One reason for looking at the sectors in this way is to highlight how many moving parts there are when we talk about the market. There are significant divergences these days and unique drivers behind the action in market subcomponents. This leads to confusion and indecision. Confusion and indecision often result in sideways, volatile price action. As a result, it is no surprise that the time period encompassing this discussion has been sideways and volatile. What exactly can we learn from the price action in Consumer Staples and Utilities? Only one simple fact has mattered as far as valuations go for these two sectors: On August 25, 2014, the 10-year yield was at 2.39%; it ended May at 1.84%. Over this time, the dividend yield for Staples went from 2.71% to 2.61%, while the Utilities yield went from 3.69% to 3.54%. Below are the P/E ratios for these two sectors charted since 1990: The top of the chart shows the Staples sector, while the bottom is Utilities. Aside for the dot.com bubble period, Staples have never been as richly valued. Meanwhile, Utilities are as expensive as ever. Of the four best performing sectors (Discretionary, Staples, Healthcare, Utilities), two experienced multiple contraction, while two experienced multiple expansion. We have often discussed the markets multiple as the sentient component of valuation for how it embodies the character and emotion of market participants more so than any other single variable. The multiple is essentially how we measure Mr. Markets mood. We can use some fundamental tools to determine a range of appropriate multiples based on several scenarios in an effort to triangulate what fair value for an index or security should be. What we can never do (nor will we do) is attempt to predict where a multiple will be any time in the future. One of the simplest things we can say is that typically (and there are fair exceptions), a rising multiple indicates improving fundamentals, while a falling multiple indicates deteriorating fundamentals. With this heuristic, it would be fair to assume that Staples and Utilities had a much better forward outlook today than they did in the Summer of 2014, while the outlook for Healthcare and Discretionary deteriorated. There is an element of truth to this with respect to Healthcare and Discretionary; however, the opposite is actually the case with Staples and Utilities. In some respects, key components of these sectors are as fundamentally challenged as they ever have been and the truth behind these challenges is even more evident today than it was two summers ago. In the market practitioners lexicon, when something in the market is boring and justifying of a low multiple, people call it a utility. These properties have become synonymous with the Utilities sector for a reason: it has slow growth, with predictably boring fundamentals and a historically high yield (i.e. low valuation). Financials are often labeled todays utilities and we can see pretty clearly that they have been near the low-end of the markets P/E for this entire digestive period. In the market practitioners lexicon, growth has been synonymous with high multiples. Meanwhile, today, one of the sectors with the worst growth profile (Staples) has the highest multiple of any sector. By the end of this year, three of the five platforms we highlighted in our January commentary will have lower P/Es than the Staples, despite their robust growth rates.[2] By the end of 2017, all will have lower P/Es. That could change with our stocks moving higher, Staples moving lower, or a little bit of both. Clearly by virtue of our positions we expect our stocks to move up irrespective of market or sector action. In the meantime, we will continue to search for opportunities in some of the more unloved sectors of the market like Healthcare and Financials, where multiples have either contracted substantially or already were much lower than average. The strength of Utility and Staples sectors are part of the fallout from the Financial Crisis. While yield alone explains the multiple expansion here, the Financial Crisis itself has created a misguided sense of buy whats safe in the retail investment world. This credo has become agnostic to pricing and valuation. As Howard Marks once said, when everyone believes something embodies no risk, they usually bid it up to the point where its enormously risky.[3] Marks is telling us here that at a certain point, price itself becomes the risk. When people become price-agnostic in a given area, smart investors should run the other way every time. Moments ago we said we would refrain from making predictions about market multiples. Right now we will make a prediction, albeit with a twist. We are not sure when exactly this will happen, but we are confident that Staples will lose their place as the markets most richly valued area with limited likelihood of ever recouping that status. Thank you for your trust and confidence, and for selecting us to be your advisor of choice. Please call us directly to discuss this commentary in more detail we are always happy to address any specific questions you may have. You can reach Jason or Elliot directly at 516-665-1945. Alternatively, weve included our direct dial numbers with our names, below. Warm personal regards, Jason Gilbert, CPA/PFS, CFF, CGMA Managing Director O: (516) 665-1940 M: (917) 536-3066 jason@rgaia.com Elliot Turner, CFA Managing Director O: (516) 665-1942 M: (516) 729-5174 elliot@rgaia.com [1] http://www.rgaia.com/a-liquidation-move/ [2] http://www.rgaia.com/robust-networks-for-the-long-term/ [3] https://www.oaktreecapital.com/docs/default-source/memos/2015-09-09-its-not-easy.pdf?sfvrsn=2 This entry was posted in 2016, Commentary on June 8, 2016 by RGAIA. March 2016 Investment Commentary: You Cant Smooth the Lumps Charlie (Munger) and I would much rather earn a lumpy 15 percent over time than a smooth 12 percent. Warren Buffett We called February a tale of two halves and the same can be said of the first quarter. The S P finished the quarter up 1.3% after selling off by 10.7%. The Russell 2000 ended the quarter down 1.5% after dropping 16.6% in straight-line fashion to start the quarter. The reversal was led by a bounce in last years most down-trodden sectors: energy, mining and industrials. The 10 year Treasury yield ended 2015 at 2.27%, but headed steadily lower to close the quarter at 1.78%. The staples and utilities sectors stayed strong throughout the quarters volatility as a proxy for the move in rates. Valuations in the staples are really starting to concern us, and we will speak more to this point in future commentaries. Take your lumps along the way: The lead quote from Warren Buffett is perfectly suited for a conversation about this past quarter and the lumpy nature of returns in the stock market. Over the very long run, individual stocks and stock markets follow the path of earnings; however, in the short run, there can be significant disparities between an earnings stream and its trading price (this applies equally to indices as it does to common stocks). This disconnect is embodied in the multiple investors are willing to pay for a given earnings stream. When investors are enthused (concerned) about the future, this multiple rises (falls). Multiple compression is the phenomenon whereby earnings continue to grow while the multiple investors are willing to pay contracts. Oftentimes multiple compression results in an extended period of range-bound, sideways price action for a security. The following chart from JP Morgan offers a great visualization of multiple compression in action:[1] We highlighted the relevant portions in red. Notice that the market traded sideways for years at a time. There were four such periods in the U.S. markets since 1900, with the most recent one having lasted from 2000 through 2013. While the price action hardly felt sideways in real-timewith two crashes in the midstthe improved perspective that hindsight offers highlights this period for what it is: multiple compression. People love saying that the stock market has averaged 6.7% real returns over the last hundred years. This is good and we encourage such a long-term perspective. At the same time, this view must be grounded in reality. Returns are anything but linear. Bernie Madoffs hedge fund returns were the closest example of linear returns that weve seen in a century, and we all know how that result was achieved. Ultimately market returns are very lumpy. Time alternates between rewarding investors and testing their patience. Since the end of 2013, we have argued that markets rallied too far in the short-run and were due for a breather, with the most likely path being a sideways period.[2] We felt sideways was more likely than an outright decline for one key reason: big declines typically happen alongside a turn in the economy, and the economy has been accelerating and improving throughout this entire sideways period. Oil threw a small curveball in this assessment, as the decline in oil-related investment threatened to throw the economy into recession. Our thesis that the tailwind to consumer spending wrought by cheaper oil would ultimately outweigh the investment decline is finally looking like the most likely path. Dont depend on a straight line in your path: Per Wikipedia, path dependence in markets explains how the set of decisions one faces for any given circumstance is limited by the decisions one has made in the past, even though past circumstances may no longer be relevant. Path dependence is a concept from physics, borrowed by economics. One application to markets is the notion that the trajectory a price takes is determinative of the underlyings value in the future. The trajectory also can influence the decisions stakeholders make with regard to their own economic choices or the asset itself. This relates directly to the idea that markets move in lumpy fashion. An investor who expects a smooth 6.7% annualized real return cannot expect to earn that return in accordance with any calendar. If however the investor plans on spending a portion of his or her investment assets each year, premised on a linear return, the path markets take would very much matter. Were markets to drop before rising, there is the potential for a shortfall relative to a need right away. Further, in selling to meet the spending need in the face of the initial drop in asset prices, this investor would be in line to fall short of the 6.7% real return from their starting point even if markets did in fact deliver this return over the long run. This would be so even if markets went sideways instead of down to start, but the result is even more pronounced when initial losses are incurred. Some numbers will help make clear why this is true. Lets say we have two investors, each with $1,000,000 to invest. Each also will spend $100,000 at the end of every calendar year. For simplicitys sake, lets also assume the expected return is 6.7% annualized (leaving aside real or nominal considerations) and that there is no tax obligation. Investor 1 was blessed with the capacity for straight-line 6.7% annualized returns, while Investor 2 must face Mr. Markets fluctuations along the way, yet still, for the purposes of this write-up, he is guaranteed 6.7% annualized returns over the long term. In year one, Investor 1 earns $67,000 in income. After spending the $100,000 he will be left with $967,000. Investor 2 meanwhile is dealt bad luck for year one and loses 10%. At the end of the year, after spending $100,000, Investor 2 is thus left with $800,000. In year two, Investor 1, with a 6.7% gain and $100,000 expense, is left with $931,789. Investor 2s luck reversed and he earns a 26.5% return. This is the exact return needed to offset last years 10% decline and return to the 6.7% annualized pace Investor 2 is guaranteed. After the 26.5% gain and the $100,000 expense, Investor 2 ends the second year with $912,000. This amount is $19,789 less than Investor 1. Even if from here on out both investors earn a smooth 6.7%, Investor 2 would end up behind Investor 1. The path thus consequentially changed the outcome for these two different investors. We take the concept of path dependency very seriously when constructing portfolios for clients who may be vulnerable to its consequences. We are also attuned to path dependency on the company level when we do our bottoms up analysis. So far this year, hardly a day goes by without a headline pertaining to Valeant Pharmaceuticals (NYSE: VRX). This stock in many respects is the perfect embodiment of path dependency in action. In May of 2015, Bill Ackman made a presentation entitled 45x at the Ira Sohn Investment Conference in New York. This number represented the spectacular returns earned by two platform companies (Jarden and Valeant) up to that point in time. Here is the chart introducing Valeant in Ackmans slide: Valeant generated the 45x return for shareholders who held the company from February 1, 2008 to May 1, 2015. The stock continued to trade higher into early August 2015, before its chart turned into a cascading waterfall. Here is what the Valeant chart looks like from May 1, 2015 through the end of Q1 2016: Note that the stock is down 87.88% in the above timeframe. Much ink has been spilled over Valeant, and we could continue to write about this company and its stock ad nauseam. Since your time is sparse, we will focus on what we think is the important and broadly applicable take-away. Both the rise and fall in Valeant were directly related to the path dependency inherent to its business model. Leaving aside some of the secondary sources of growth, Valeants primary means for achieving its growth target was via acquisition. In order to finance these acquisitions, the company used a combination of equity and debt. As the stock price rose, Valeant had a growing currency in the form of its shares to use for acquisition financing. With a rising stock price, also came increased debt capacity. On its ascent, each acquisition by Valeant further boosted its share price. Each extra boost in its stock price created greater equity and debt capacity for financing future acquisitions. This enabled the company to make larger acquisitions every step of the wayas is evident on Ackmans slide above highlighting the main events in Valeants history. As a result of its success, investors priced in growth premised on Valeants continued ability to make value-enhancing acquisitions. For a variety of reasons, Valeants stock price started falling. It started slowly and subtly. The stock kept falling and the narrative and sentiment eventually started turning sour. A moment of truth occurred in October 2015 when Roddy Boyd of the Southern Investigative Reporting Foundation unearthed some unscrupulous practices happening at the companys wholly owned, specialty pharmacy Philidor.[3] From that point on, it became clear that Valeant would be essentially incapable of completing another acquisition until it patched some holes in its trove of businesses. The exposure of problems at the company alongside a falling stock price categorically changed the fundamentals of the business. This is important to grasp, for it was not the business that changed, thus pulling the stock with itas is typical in the stock market. Instead, it was the stock dragging the business down. We think this would have happened to the company irrespective of what the precise catalyst was. Why? First, these problems precluded another acquisition, thus pricing out any potential growth via M A from the stock. Second, they precluded the company from using its existing practices to squeeze out growth from their products. Third, all of these factors collectively forced doctors, patients and the other health system stakeholders to question whether they should even use Valeants treatments at all when safe alternatives were possible. These factors all led to a second big moment of truth in March, when the company reported earnings and guidance that missed consensus estimates by a significant amount.[4] The forces at work here, whereby the stock price influences fundamentals and vice versa is something we covered with respect to MLPs, oil and ETFs. This relates back to George Soros notion of reflexivity and the prevalence of positive feedback loops, another physics concept adopted by finance to better understand financial markets. We are speaking about these concepts again here, because this quarter was exceptionally volatile in financial markets and Valeant is a widely covered story in the media. Both factors have created sympathy selling in our holdings that are in the same sector as ValeantTeva Pharmaceuticals (NASDAQ: TEVA), Sanofi Aventis (NYSE: SNY) and Vertex Pharmaceuticals (NASDAQ: VRTX). None of these stocks share the features that have impacted Valeant on the way down and it is only a matter of time before the strong fundamental backdrop for our holdings reasserts itself. What do we own? Returns reflect US dollar denominated returns over our holding period. The Leaders: GrubHub Inc (NYSE: GRUB) +26.9%[5] Priceline Group (NASDAQ: PCLN) +17.7%[6] PayPal Holdings Inc (NASDAQ: PYPL) +6.6% The Laggards: Vertex Pharmaceuticals (NASDAQ: VRTX) -36.8% DXP Enterprises (NASDAQ: DXPE) -23.0% Exor SpA (BIT: EXO) -21.6% Thank you for your trust and confidence, and for selecting us to be your advisor of choice. Please call us directly to discuss this commentary in more detail we are always happy to address any specific questions you may have. You can reach Jason or Elliot directly at 516-665-1945. Alternatively, weve included our direct dial numbers with our names, below. Warm personal regards, Jason Gilbert, CPA/PFS, CFF, CGMA Managing Director O: (516) 665-1940 M: (917) 536-3066 jason@rgaia.com Elliot Turner, CFA Managing Director O: (516) 665-1942 M: (516) 729-5174 elliot@rgaia.com [1] https://am.jpmorgan.com/blob-gim/1383280028969/83456/jp-littlebook.pdf [2] http://www.rgaia.com/december-2013-investment-commentary-our-2014-outlook/ [3] http://sirf-online.org/2015/10/19/hidden-in-plain-sight-valeants-big-crazy-sort-of-secret-story/ [4] http://www.cnbc.com/2016/03/15/valeant-pharmaceuticals-reports-fourth-quarter-2015-earnings.html [5] Position commenced intra quarter [6] Position commenced intra quarter This entry was posted in 2016, Commentary on April 12, 2016 by RGAIA. February 2016 Investment Commentary: The Yield Curve is Flat Wrong On the month, the S P lost 0.19%, while the Russell 2000 shed a modest 0.22%. On the surface, February appears to be an uneventful market month. In reality, the month was a tale of two halves. At one point, the S P was down 6.52% intraday, while the Russell was down 9.05%. Throughout, the markets correlation with oil (highlighted in our January commentary) continued.[1] In essence, the market lends itself to the conclusion that it bottomed because oil did. This relationship is neither actionable nor enduring. We remain resolute in our conviction that markets are being driven by liquidity needs of sovereign wealth funds in oil-rich nations (or shall we say oil poor these days?) and the portfolio effect of large investors whose portfolios became too tied to the energy sector. Markets driven by liquidity needs ignore the underlying fundamentals at the company level. In the short-run this creates risk, while in the long-run it creates opportunity. As a result of this action, we have greatly increased our turnover in the past few months. We assure you, this is a temporary occurrence and it will normalize in the not-too-distant future. In our October 2013 commentary describing our Actively Passive Investment Strategy we highlighted some statistics from John Bogle, the founder of Vanguard that are worth repeating today: in 1950, the average holding [period] for a stock in a mutual fund portfolio was 5.9 years; in 2011, it was barely one year. As of 2011, annual turnover of U.S. stocks was over 250% per year![2] There are robust performance, behavioral and tax reasons to keep turnover low and believe this is a core tenet of quality long-term investment. The Yield Curve is Flat Wrong Last month we spoke about the markets (micro) mistakes in valuing some great companies that distinctly benefit from strong network effects.[3] Here, we will focus on a macro mistake. The yield curve is both an important determinant of economic activity as well as an indicator. When the yield curve is steepening (flattening), the market is expressing increasing (falling) inflation expectations. We can get further into the nuances of the shape of the curve, but this basic explanation is sufficiently important. So far this year, the yield curve has flattened substantially. A visual of then (1/1/2016) verse now is helpful: (Source: Bloomberg LP) Given the relationship between the yield curve and forward expectations of inflation, one would expect inflation to be falling alongside, or shortly thereafter a flattening of the yield curve. We went through the case for rising inflation in our 2016 Preview, premised on a tightening labor supply, a tightening housing supply, and increasing flexibility for discretionary spending on account of the oil dividend.[4] That case has only strengthened so far this year on all fronts, despite what the yield curve is telling us. We caveat that this reemergence of inflation is healthy. It is not an event to be feared. Instead inflation reflects the normalization of our economy after a period of tumult. The Fed has ample tools at its disposal to keep inflation from getting to the point where it would be a concern. If inflation is not falling, then what forces are driving this action in the yield curve? We think there are two explanations: Traders are being tricked by oil. This happened when oil was rising in years past too; with Jean Claude Trichet, the former ECB President falling for it. As Matt Busigin explains so nicely in a piece entitled, only Bernanke knew oil is not inflation.[5] In reality, the fall in oil will ultimately be inflationary as consumers start spending their savings on discretionary items. This is a contrarian view today; however, we expect time to prove us right. We simply have to wait out the time lag between the short term pain and the long-term gain. Negative Interest Rate Policy (NIRP) around the world. When Japan shocked the world and joined Europe in adopting NIRP, a wave of slippery slope thinking took hold of the financial world. Traders started speculating about which country would be next, and how long it would be before NIRP came to the US. Additionally, global investors and institutions who need to find yield were likely to find the US increasingly attractive on a relative basis, leading to further flows (and thus downward pressure) on the yield curve here. With the aforementioned inflation backdrop, any conversation about NIRP in the US is misguided. Mr. Markets Collective Memory In the 1960s, some old-timers on Wall Streetthe men who remembered the trauma of the 1929 Crash and the Great Depressiongave me a warning: When we fade from this business, something will be lost. That is the memory of 1929. Because of that personal recollection, they said, they acted with more caution than they otherwise might. Collectively, their generation provided an in-built brake on the wildest forms of speculation, an insurance policy against financial excess and consequent catastrophe. Their memories provided a practical form of long-term dependence in the financial markets. Is it any wonder that in 1987, when most of those men were gone and their wisdom forgotten, the market encountered its first crash in nearly sixty years?[6] The safest time to fly is in the days following a plane crash. Everyone involved in the safety processes, from the ground crew to the pilots are on heightened alert in an effort to avoid any further mishaps. In markets and economies, this is no different. Finance is far healthier in the aftermath of a crash, because the excesses have been wrung from the system and the actors have been humbled. For those who recently saw The Big Short, you would have been reminded about how few people in position to do so actually saw a crash coming. In fact, those who warned about a crash were all outsiders, viewed with a degree of scorn by the mainstream in finance. Now, hardly a day goes by without another publication referencing the potential for another 2008. The fresh wounds from 2008 are exactly the kind of collective market memory for preventing another 2008 from happening. This does not mean we wont have more recessions and bear marketswe willhowever, it does mean that they will be different and that the consequences for the economy will be far less ominous. The fact is: unless we live a very long time (which hopefully we all will!), we will only experience a once-in-a-lifetime crisis once in our life2008s. Thank you for your trust and confidence, and for selecting us to be your advisor of choice. Please call us directly to discuss this commentary in more detail we are always happy to address any specific questions you may have. You can reach Jason or Elliot directly at 516-665-1945. Alternatively, weve included our direct dial numbers with our names, below. Warm personal regards, Jason Gilbert, CPA/PFS, CFF, CGMA Managing Director O: (516) 665-1940 M: (917) 536-3066 jason@rgaia.com Elliot Turner, CFA Managing Director O: (516) 665-1942 M: (516) 729-5174 elliot@rgaia.com [1] http://www.rgaia.com/robust-networks-for-the-long-term/ [2] http://www.rgaia.com/october-2013-investment-commentary-our-actively-passive-investment-strategy/ [3] http://www.rgaia.com/robust-networks-for-the-long-term/ [4] http://www.rgaia.com/mixedmessages/ [5] http://www.macrofugue.com/only-bernanke-knew-oil-is-not-inflation/ [6] Mandelbrot, Benoit. The Misbehavior of Markets: A Fractal View of Financial Turbulence. Location 2676. This entry was posted in 2016, Commentary on March 10, 2016 by RGAIA. January 2016 Investment Commentary: Robust Networks for the Long Term January 2016 got off to a fast start in the wrong direction. The first trading day of the year saw the S P fall 1.4% and the selling continued from there. The S P ended the month down 5.0%, though halfway through the month the index was down over 10% year-to-date. In the last 30 years, for the first month of trading, only January of 1990 and January of 2009 fared worse. Meanwhile the S P 500 in many respects masked a lot of the stock-specific carnage. The Russell 2000 was down 8.5% on the month, with many stocks down in excess of 20%. The performance of a handful of Consumer Staples and the Utility sector helped the S P appear better than the performance of its constituents. As the month pressed on, the S P essentially traded in lockstep with crude oil: In effect, the fortunes of the market thus far in 2016 have been tied directly to the price of oil. One of the points we have emphasized with regard to oil for some time now is that the benefits of the pronounced drop in price happen in a nuanced way over time: people dont immediately spend their oil dividend but they do receive it, and either save it (which is supportive of longer-term investment), or eventually spend it on extra discretionary items. Meanwhile, the negatives are immediate and pronounced: investment in new oil capacity and from industrial companies servicing the sector drops quickly and precipitously. We think the timing of the selloff this year is suggestive of a force we first referenced in our September commentary entitled A Liquidation Move.[1] With the turn of the calendar comes a new budget year for countries. Oil wealth nations in need of maintaining their expenditures thus had to come up with a way to patch the hole in their budget deficit created by the sharp drop in oil prices and the rolling off of existing hedges. These states are filling widening budget deficits with the proceeds from the sale of global assets. These flows overwhelm the balance between supply and demand across markets in the short-run. As markets kept declining, concerns evolved from the oil effect to China and now the banking sector, particularly in Europe. We are hyper-alert to broader economic risks, but maintain our case from the 2016 Preview that strength in the consumer and financial sector balance sheets and the employment situation create a strong buffer against the downside risks in the economy and are supportive of continued growth.[2] We are reminded of renowned economist Paul Samuelsons following quote: Wall Street indexes predicted nine out of the last five recessions! And its mistakes were beauties. Where are the markets mistakes? Over the past few months we have given a certain kind of company a central role in our portfolios. While as of now we appear early to these investments, we think they are some of the most unique long-term opportunities in the market today. Collectively, we think of them as dominant business and commerce platforms for the future, with proven business models, robust cash flows and large growth runways. We subscribe to the philosophy of buying Growth at a Reasonable Price (GARP) and to that end, we think we have found some extremely compelling growth at prices that over the next three to five years should prove very reasonable. Before listing the companies, let us introduce the traits that they each have in common: Two-sided networksthese companies all unite sellers of goods or services with consumers, at a scale that is on the one hand, large and defensible, and on the other, very lucrative. Capital leanthese networks require very little incremental capital investment. There is little CAPEX needed for either maintenance or growth. Most of the actual investment flows through the operating line (R D in some cases, marketing in others), thus actually suppressing what we believe to be the true long-term earnings power of each of these businesses. High margin businessesdespite investment flowing through the operating line, these companies generate substantial operating profit margins and/or have the capacity to ramp these margins as the businesses further scales top line growth. Further, each incremental customer who buys or a good or is serviced on these platforms has very little incremental cost to the platform itself. As such, revenue growth has two effects: 1) the ramp of growth itself; and, 2) an upward pull on margins. Here are the companies in alphabetic order: eBay (NASDAQ: EBAY) Envestnet (NYSE: ENV) Grubhub (NASDAQ: GRUB) Priceline (NASDAQ: PCLN) PayPal (NASDAQ: PYPL) Three of these are large cap companies, while two of them are small cap companies. Notice that while these businesses have the aforementioned similarities, all are very different and serve unique end markets with little overlap in the drivers of demand and thus macroeconomic risk. The end products are general goods and services, asset management, food delivery, travel and payments. The most sensitive of this batch to the economic and market actions of January is Envestnet since it generates a material portion of its revenues from asset-based fees. Declining asset prices puts downward pressure on investment managers billings, which is a near-term concern; however, the secular growth driver of brokers and their assets shifting to Registered Investment Advisors offsets these short-run market declines. Plus, licensing revenues with very sticky, recurring relationships (upwards of 95% renewal rates) have been growing as a share of the business, cushioning the reliance on asset prices. eBay, Priceline and PayPal are global companies with exposure to currency fluctuations. While these moves are a headwind to growth in the near-term, currency effects have a strong tendency to balance out over the long-term. Importantly, all of these companies benefit from secular trends that will persist regardless of what happens to markets or the economy in the short-run. In fact, certain kinds of economic disruption could further advance the businesses of the two with financial exposure (Envestnet and PayPal) as people look to new solutions for old problems that are not being solved by the legacy players. All have relatively low multiples and are cheap using conservative assumptions within an appropriate timeframe in our Discounted Cash Flow (DCF) analysis. Each has multiple drivers of growth (typically users and activity per user) which compound on each other and offer extra leverage to revenues moving higher. In markets like these, people sell what they can, not what they want to. In our November 2014 commentary, we first warned of the oil investors who dont even know it.[3] While recognizing this reality was a helpful lens through which to view potential troubles in High Yield in particular, we did not anticipate the extent to which everyone would effectively be an oil investor at the behest of Sovereign Wealth Fund sell orders. Needless to say, it has created some unique opportunities where investors are throwing out some precious babies with the dirty bathwater. In our October 2013 Investment Commentary[4], we referenced Benjamin Grahams observation that in the short run the market is a voting machine, but in the long run it is a weighing machine. We noted that, this game of arbitrage is reflective of an important market reality: the short-term is the arena of randomness, while the long-run is the home of the investor. During these days of uncertainty, fear, and randomness, one must focus on the long-term, with an emphasis on the fundamental values of businesses that are best positioned for tomorrow. Thank you for your trust and confidence, and for selecting us to be your advisor of choice. Please call us directly to discuss this commentary in more detail we are always happy to address any specific questions you may have. You can reach Jason or Elliot directly at 516-665-1945. Alternatively, weve included our direct dial numbers with our names, below. Warm personal regards, Jason Gilbert, CPA/PFS, CFF, CGMA Managing Director O: (516) 665-1940 M: (917) 536-3066 jason@rgaia.com Elliot Turner, CFA Managing Director O: (516) 665-1942 M: (516) 729-5174 elliot@rgaia.com [1] http://www.rgaia.com/a-liquidation-move/ [2] http://www.rgaia.com/mixedmessages/ [3] http://www.rgaia.com/the-oil-investors-who-dont-even-know-it/ [4] http://www.rgaia.com/october-2013-investment-commentary-our-actively-passive-investment-strategy/ This entry was posted in 2016, Commentary on February 11, 2016 by RGAIA. December 2015 Investment Commentary: Mixed Messages Our 2015 outlook was the second consecutive to include the notion that markets would be weaker than the broader economy. Specifically, we said that we continue to expect markets to be weak and volatile compared to the economy[1] and this is largely what happened. If one checked the S P 500s price at the close of December 31, 2014 and not again until the close of 2015, it would appear that not much happened on the year. The S P 500 had a -0.81% price return, alongside a 1.23% total return. The Dow dropped 2.19% pricewise, but added 0.09% in total. Global markets and small caps were particularly weak, with the MSCI All Cap World Index shedding 4.58% on price (-2.15% total return) and the Russell 2000 dropping 5.85% (4.40% total return) respectively. The most notably poor performing asset class was the High Yield Corporate Bond Index (as represented by HYG) which had a negative total return of 4.75%. While the S P 500s performance was seemingly flat, the underlying performance in specific stocks tells a vastly different story. Through the course of the year, 534 total stocks were in the index at some point (due to corporate actions, compositional changes, etc). The average return of those 534 stocks was a negative 3.94%. 301, or 56% of the stocks in the S P ended negative. 200 stocks experienced double-digit losses, compared to 142 double-digit gainers. 11% of the stocks in the S P lost one-third or more of their value, versus 5% that gained more than one-third in value. Fourteen stocks shed over half their value, while 5 added that much. There are two notable points worth emphasizing: Dispersion between the winners and losers in 2015 was extreme. If you look around the market, there was far more pain than there was gain to be had. This was the second consecutive year of markets littered with minefields. We feel good that in our commentary last year we forewarned the death of commodities as an investable asset class and saw much pain in the MLP space. While we are not wavering longer-term in our conviction that the benefits [of cheaper commodities] in nearly all respects outweigh any reason for concern [about declining capex],1 we think we missed an opportunity to approach this belief with more patience. In several cases, we thought the investor base in some high quality, non-energy companies would be willing to look past some of the nearer-term headwinds. Investors spent most of the year wondering if and when the Federal Reserve would raise interest rates, thus ending the Zero Interest Rate Policy (ZIRP) that commenced in an effort to stave off the Great Financial Crisis. It took until halfway through December to get an answer and after seven years, rates finally moved up to 0.25%. We long argued that the first rate hike would be a reflection of economic strength and with the November unemployment rate at 5.0% (we do not know year-end as of the time of this writing), that certainly is the case. Throughout the year, market commentators blew a lot of hot air prognosticating about the FANGs and concerns about Chinas long-term GDP growth rate. In case you have not heard of The FANGs (you would be better off for it), that is the acronym coined for the four most significant standout performers in 2015: Facebook, Amazon, Netflix and Google (the company formerly known as Google, now Alphabet, but who would let a technicality ruin a good narrative?). One of these is not like the other ones (hint: its the one we own). In fact, it is so different as to render the narrative a vapid, but marketable headline. In our first two sections below, you will see that there is a yin and yang side to each of the major themes from this past year and how they setup for the future. Each strength came alongside a form of weakness. These forces do not truly offset each other and we will attempt to wrap it all together for you. Consumer Tailwinds: The Prolonged Benefits of Low Rates, Part 1: The benefits of cheaper financing arent going away. One of our favorite charts for a few years has been household debt service as a percent of disposable income: The difference from 2006 to today is massive and serves as one of the clearer lenses through which to see a primary force behind the Great Financial Crisis: household expenditures on the interest component of debt was at its highest level in recent history. This improvement is consequentially related to the low interest rate policy at the Fed. Many overemphasize gross debt levels as a source of risk, to their detriment. The debt service situation for households is as healthy as it has been in over three decades. Lets talk through the benefit of low rates even further: people who bought houses or refinanced their mortgages to longer duration, lower rate structures have locked in prices for the single largest annual household expense. Per the BLS, the average household with a married couple dedicated 30% of their total expenditures to Housing.[2] Housing includes more than just shelter; however, shelter accounts for somewhere around 60% of that amount. This means the average household that owns a home spends 18% of their budget on shelter, or what would be covered by mortgage principal and interest payments. With just shy of 64% of households owning houses, the affordability of housing will improve every year for two-thirds of American households. A little exercise helps highlight the long-term benefits. Lets take a sample household, who for the sake of simplicity spends $100 per year. Assuming the 18% spent on shelter is in a fixed mortgage. Each year, $18 will go towards housing and $82 to everything else. The Fed sets its target rate of inflation at 2%. On one hand, average inflation over the past century has been closer to 2.5%; on the other hand, we have been below trend for the past decade. For arguments sake, lets set the inflation rate at 2%. With this, we will assume that wages grow at the inflation rate, and further that expenditures grow at the same rate as wages. In 10 years, the sample household will have $121.89 available to spend. $18 will still go to housing, but now $99.96 will go to everything else. In effect, this household will have about 0.3% per year extra to spend on the everything else category, which over 10 years adds up to 3.23%. This might not seem like a lot, but in 10 years, given the average household spent $53,495 in 2014, this will leave an extra $1,727.88 for households to spend in other areas. Multiply this by the 115 million plus households in America and that is a big number for the economy. These benefits increase quickly if inflation accelerates above 2%. For context, here is average hourly earnings versus core CPI: When the yellow line is above the blue, workers are benefitting from real wage growth. Real wage growth means the purchasing power of the average employee is rising quicker than his or her expenses. Note that since 2000, average hourly earnings have grown at a faster clip than CPI excluding food and energy. Thus we think this scenario outlined for an average household above is a modest example of the benefits that will accrue to nearly two-thirds of American households. The Oil Dividend The longer-term impact of low rates combines nicely with 2015s second biggest story for consumers. In 2014, the average weekly price for gasoline was $3.358. In 2015, this average fell to $2.429 and a gallon ended the year at $2.034. On average, gasoline was 27.7% cheaper in 2015. If gas prices stay flat in 2016, they will effectively be 39.4% below the 2014 level. According to the BLS, the average household spent $2,468 on gasoline and motor oil in 2014. At 27.7% cheaper, this is a $683.64 savings per household, and at 39.4%, it is a $972.39 savings. This understates the true savings from cheaper energy, as heating bills, energy bills, and several other expenses tied to energy decline apace. It takes time for people to judge whether the oil savings are a temporary or long-term effect. Now that we are more than one year past the most severe portion of the decline, people are beginning to accept cheaper gas as a normality. The Atlanta Fed, on its Macroblog, put out a great piece last year on the consequences of the energy price decline and they conclude that as far as consumption is concerned, there is a short-run drag before the longer-term boom(the short-term drag is misleading considering consumption measures all expenditures including those on gas. If gas declines and all other spending stays constant, consumption in aggregate will decline). [3] We see evidence that consumers are embracing cheaper gas when we look at vehicle miles traveled: Only this past year did Americans drive more than the pre-crisis level and this enthusiasm was backed up by continued strength in car sales, with SUVs a notable standout.[4] The Strong Dollar, Part 1 Last year we jokingly labeled a section The Strong Dollar Yellen Fed (take THAT conventional wisdom) and lo and behold, the strong dollar got even strong. Our jab was meant to be ironic considering many were concerned that Yellen was too willing to embrace policies that were negatives for the dollar. Thus far we can draw one of two conclusions: Yellen is actually a hawk in disguise. Fed policy matters less than meets the eye, especially in the short run. Good thing that we believe in nuances and that such dichotomies are not truly mutually exclusive options. On the year, the trade-weighted dollar index rose 23.1%: Since we import a lot of consumer goods into the US, the strong dollar helps improve the affordability of many items that households buy on a regular basis. The Earnings Recession The Prolonged Benefits of Low Rates, Part 2: The Hunt for Yield Turns Sour This is one of the most nuanced topics out there today. In part this section could have been written as a strength; however, its important to speak to some of the risks right now. Cheaper financing will be a part of many companies for a long time. Financing is not going to get materially more expensivedespite the rate hikeanytime soon. A chart showing net debt to EBITDA on the corporate level is the equivalent of our household debt service chart above for companies: This is a similarly constructive setup, especially when combined with our discussion from last year about how non-financial corporations were the sector of the economy most ripe to add leverage. So far, everything we said is a positive, so why is this in the yang section? If you will recall our letter entitled The oil investors who dont even know it, we expressed concern about the extent of exposure in high yield bond indices to energy.[5] This year, that exposure came back to bite in the form of a significant widening in energy-specific spreads, but also a broader de-risking in the high yield bond space. The best way to show this is with the spread of high yield debt over Treasuries: The impaired values of energy sector bonds have taken their toll on other sectors by decreasing investor willingness to buy new high yield issues. Oil (ex-) Dividend,The Earnings Recession: High yield bonds were not the only victim of corporate energys woes. The earnings in the S P will actually register a decline (also known as an earnings recession) in 2015 (the yellow line in the chart below): The market tends to follow the direction of earnings over longer timeframes. You can see in the above chart the gravitational pull of this relationship. Excluding energy, the S P will register modest growth in 2015; however, the 36% drop in energy sector earnings was too much to outweigh everything else. Take a look at our September commentary for a deeper look at the sectoral breakdown of earnings.[6] Oils impact spreads beyond the energy sector through the industries that help service and build out energy production and transportation capacity. In the aforementioned Atlanta Fed piece, they offered an estimate of the near-term woes in capital expenditures and when to look for a leveling off. While this was published after the most acute phase of the oil decline, prices continued to drop throughout the year: The effects of this capex shock will begin to subside early in 2016 and will be gone by 2017. With the economy near full employment, the potential for a negative feedback loop should be contained, as workers laid off from energy-impacted jobs can transition to other areas of need. The Strong Dollar, weak profit: The strong dollar was the other force conspiring against S P earnings growth. The U.S. is home to many multinational companies who do considerable business abroad. When