Quarterly Commentary

Market Update

July 28, 2017


During the second quarter, stock market returns were moderate, but still positive. Stock markets may lose some momentum during this third quarter with rising concerns about much anticipated tax reform being delayed into next year or not executed at all.

We have said all along that corporate tax reform was the “low hanging fruit” and that both Republicans and Democrats were in favor of lower corporate tax rates in order to make the U.S. more competitive and attractive globally for business. Again, in our view, much of the stock market gain since the Presidential election has been a result of this widely anticipated U.S. tax policy change. We still expect that outcome, but are not so optimistic that individuals will receive significant reductions to their tax structure like capital gains in personal income tax rates. For that reason, we are advising clients not to delay decisions in anticipation of broad tax reform. It will likely be the fourth quarter before we have additional clarity on tax issues, but, again these delays could weigh on the stock market near-term.

Our performance for stocks has been positive for the second quarter and year-to-date, but below the benchmark returns. This is solely due to our significant exposure to value stocks. We always have a balance in portfolios of both growth and value stocks. Value indexes have significantly underperformed the growth indexes. Why do we maintain the value exposure? Value stocks have a very consistent history of hedging the growth stock exposure in down markets and provide better long-term returns with less volatility. Also, their dividend yields (current cash flow) tend to be higher.

Our discipline of maintaining value as well as growth exposure will remain as we anticipate a slowing in growth stock performance near-term. This long-term hedge effect has kept us confident in keeping your stock exposure near your maximum for your risk objective.

You have, no doubt, heard ad nauseam about the leadership of the FANG stocks. Facebook, Amazon, Netflix and Google. Yes, that handful of stocks have been hard chargers, significantly outperforming the broad stock market averages. However, our technology stock picks have strongly outperformed the FANG stocks. So despite our controlled lower exposure to technology (15% versus approximately 25% for the indexes) we have kept up nicely. Josh Taenzler, our technology analyst, has helped us to navigate this difficult space. Stocks like Adobe, ATOS and Electronic Arts have had strong performance relative to the FANGs. Of the technology stocks in our core portfolio, only Netscout has had single digit returns year-to-date.

The results of the recent U.S. bank stress testing were solid for all of the largest U.S. banks. That is good news for the U.S. economy and even the broad stock market. We are pleased with our exposure there - Bank of America, Citigroup and Bank of Montreal (which has good management and a growing U.S. market share). The results of the U.S. bank stress testing will allow banks to raise dividends and buy back more of their shares. Less anticipated new regulation is also beneficial to the banks.

The sector that continues to experience the most challenges is the Consumer Discretionary area, especially retail. Earlier this summer, I attended an important global consumer discretionary company conference. At the time, the biggest “buzz” was the recent acquisition of Whole Foods by Amazon. This was quite disruptive and disconcerting for many CEO’s there. In my view, Whole Foods (long out of favor and an underperformer) was likely a bargain for Amazon, and highlighted that even online retailers need a retail space to build their image and brand awareness.

Consumer spending is not dead. Consumption is by far the largest contributor to U.S. economic growth. Yes, consumption patterns and execution are changing fast and dramatically with more and more focus on convenience, but the convenience and competition is creating a “Nirvana” for buyers. Both the millennials and even the next generation Z (individuals born after 1999) are “consumers.”

Our Health Care names, where we also maintain “healthy” exposure, are selected based on their individual fundamentals, from proprietary technologies or drug pipelines, rather than a bet of any outcome changes to Obamacare.

In my view, Janet Yellen is doing an outstanding job as Fed Chair. Quite frankly, there is only so much that monetary policy can accomplish now with such an absolute low level of interest rates and the tapering of the Treasury’s past aggressive bond buying program. In 2008, long before Chair Yellen was Chair, I heard her speak in Vancouver as a Fed member and she meticulously described how the U.S. treasury balance sheet would be significantly expanded and changed in order to create U.S. economic growth so that we could pull out of the global recession. The good news is that it worked! However, even back in 2008, she also described how this radically changed U.S. treasury balance sheet must, over time, revert back to its pre-recession position as the “strongest in the world.” I have maintained since then, that she is not a “dove” but longer-term a “hawk,” and for the times, a pragmatic realist.

We continue to purchase bonds, another hedge for challenges to stock market returns. We strongly prefer investing in individual bonds in order to control interest rate risk. In this rising interest rate environment, bond total returns are moving targets, so we closely monitor the relative attractiveness and consistency of the cash flow yields, whether from taxable or tax-free bonds.

Our clients generally appreciate our disciplined approach to diversification in order to help control downside risk. This stock market is now a bit frothy and the economic recovery still slow and below historic norms; and the Fed has few monetary tools remaining, making this recovery more tenuous. Thank goodness inflation remains under control making both stocks and bonds still competitive investment alternatives.

I encourage you to watch our second quarter webcast, with presentations from me, Dr. Jim Kee, President and Chief Economist; and Christian Ledoux, CFA®, EVP, Director of Equity Research and Senior Portfolio Manager. Click here to view webcast.

Finally, we are pleased to share with you our quarterly nonprofit spotlight featuring our client, Friends of the Texas Historical Commission.

Thank you for being our client.


Jeanie Wyatt, CFA®
Chief Executive Officer & Chief Investment Officer




This letter is not intended to constitute investment advice. Market and economic views are subject to change without notice and may be untimely when presented here. You are advised not to infer or assume that any securities, sectors, or markets described in this letter were or will be profitable. Securities identified in this letter do not represent all of the securities purchased, sold, or recommended for advisory clients, and you should not assume that the recommendations made in the future will be profitable or will equal the performance of the securities identified above. A complete list of all equity recommendations made by STMM during the past year is available upon request. Past performance is not indicative of future results. There is a risk of loss.

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