Quarterly Update

This was another quiet quarter for the markets. There was a brief dip early in the quarter, but mostly the market moved slowly upwards. It’s an interesting time for markets, valuations are on the higher side, but the economy continues to show signs that it has reached escape velocity from the sluggishness created by the Great Recession. I’m maintaining my target of about 15% cash for client accounts right now because there isn’t a lot of value out there. When a market correction creates more value, I’ll put that money back into the market. I’m not targeting a higher percentage in cash because, despite my expectation that there will be a near-term market correction, the market may not correct in a significant way for a while. Short-term market movement is unpredictable and beating the market in the long-term is about holding superior stocks, not market timing.

In this quarter’s letter, I’ll look at the current state of the economy. We’ll see why the stock market is so optimistic about the macroeconomic future right now.

The Housing Market

This sector has been a drag on an otherwise strengthening economy. Recent news, however, has been good. The Pending Home Sales Index jumped an unexpectedly large 6.1% to 103.9 for May, according to a National Association of Realtors (NAR) report. Sales of new single-family homes were also very good for May, jumping 18.6% to a seasonally adjusted annual rate of 504,000, according to a Commerce Department report. The U.S. hasn’t seen new-home sales this high since May 2008. Sales of existing homes jumped 4.9% to a seasonally adjusted annual rate of 4.89 million for May. In an especially welcome sign, housing inventory increased 2.2% to reach 2.28 million homes. Homebuilders have been hesitant to boost building rates back to pre-recession levels, turning the housing market recovery into a “supply squeeze” situation with high home prices and rising mortgage rates. That squeeze appears to be retreating.

The Job Market

The job market is stronger than it has been in a while. It’s not yet back to its baseline, but the trends are encouraging. The four week average of initial jobless claims has fallen below the 400,000 level, a cutoff point that economists consider a sign of an improving labor market. So far for 2014, weekly initial claims are at an average 323,100.

Job growth has been stronger too. Monthly job growth has now averaged 234,000 for the past three months, up sharply from 150,000 in the previous three. In addition, with the latest increase, nearly five years after the Great Recession ended, the economy has finally regained all the jobs lost in the downturn.


Real gross domestic product fell at a large annual rate of 2.9% in the first quarter of 2014, according to a Commerce Department report. After growing 2.6% in the fourth quarter of 2013, absolute GDP is back down to just below the adjusted third-quarter 2013 level. On a cursory glance, this GDP report seems like really bad news. It’s not actually all that out of step with the current strength we see as it looks like GDP was delayed by severe winter weather and much of that economic activity was deferred to the following quarter. We can see that GDP is back on track by looking at the stronger housing numbers, increasing consumer confidence, and excellent manufacturing data.

Consumer Confidence

Consumers are more confident than they’ve been in over six years, according to The Conference Board’s June Consumer Confidence Index. After May’s index came in at a solid revised 82.2, the index managed to add on an additional three points to reach 85.2 for June. With four straight months of 80.0+ reports, June’s index marks the strongest reading since January 2008.

“June’s increase was driven primarily by improving current conditions, particularly consumers’ assessment of business conditions,” said Conference Board Director of Economic Indicators Lynn Franco in a statement today. “Expectations regarding the short-term outlook for the economy and jobs were moderately more favorable, while income expectations were a bit mixed. Still, the momentum going forward remains quite positive.”

Manufacturing Data

The Markit Flash U.S. Manufacturing Purchasing Managers’ Index (PMI) this month recorded its strongest reading in over four years. The “flash” estimate is typically based on approximately 85% to 90% of total PMI survey responses each month and is designed to provide an accurate advance indication of the final PMI data. An above-50 reading indicates general growth, while below 50 signals contraction. June’s report came in at 57.5, a 1.1-point improvement over May’s final reading.

“U.S. industry is booming again, with the flash manufacturing PMI hitting its highest for just over four years in June,” said Markit Chief Economist Chris Williamson in a statement. “The strong reading also rounds off the best quarter for factories for four years, adding to indications that the US economy rebounded strongly in the second quarter from the weather-related weakness seen at the start of the year.”

The Broad Perspective

Together, the above data point to an economy that is at its strongest level since before the Great Recession. There is still a lot of room for improvement, and we are by no means at the higher end of historical economic performance, but there is a solid foundation for future growth. The stock market is, as it often is, out a little bit ahead of the economy. So, despite the economic strength, we should expect a correction or at least a prolonged period of sideways market movement. Of course, that goes with the caveat that the market often doesn’t do the expected in the short-term and will confound those that try to time it. For now we’ll stay the course, keep a small reserve of cash, and look for the few worthwhile value opportunities out there right now.

  1. So, if the economy is really doing so well, why do you hold cash. Shouldn’t you get it in now?

    • A great way to reduce long-term returns is to invest cash just because you have it. With value investing the goal is to wait for the right opportunities, and to maximize your long-term returns. It’s OK if your short-term return is reduced by holding some cash, by waiting for the right stocks, you’ll increase your long-term return.

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