Karp Capital Management Focus

1st Quarter Report

Written by Peter C. Karp
April, 2015

2015 – What's Next?

Wall Street and Oil

We saw continued volatility in the stock and bond markets during the first quarter of 2015. As the major U.S. indices hover near all-time highs, where do we find value in the market? We have had a fairly positive outlook for the United States but the numbers for the first quarter have not lived up to expectations. As the Federal Reserve strives to normalize monetary policy by raising rates, bond investors are trying to maneuver their portfolios as the yield curve will likely continue to flatten. Oil will find a bottom at some point during the year, and many oil-related bonds have already bottomed. This is a sign that oil prices are starting to stabilize. Equities will benefit from long awaited revenue growth but will do so in an environment of elevated volatility. Our optimism is based on two major themes. Longer term trends will provide a strong tailwind for the economy, earnings and stock prices. Global monetary easing and cheaper oil creates more winners than losers. We think the fall in energy prices will be a net positive for the economy even though the results are a reduction in payroll, capital spending plans, and earnings in the energy space. A major positive will be a boost to consumer spending, something that hasn’t really come to fruition yet. Central Banks around the world are taking a cue from the Federal Reserve and are on the path of monetary easing. Canada dropped key lending rates by half of a percent in January. The Bank of Japan remains on track for massive liquidity injections. The underlying momentum of American growth remains solid. As the bull market matures there will be a shift in the sectors that will lead this market higher. A consolidation of gains seen over the past year isn’t necessarily unwelcome and it may forestall a more severe correction. While the S&P led all the markets in 2014, we do not see that trend continuing in 2015. International markets and some interest rate sensitive sectors lagged in 2014 and at some point they will begin to catch up. In this installment of Karp Capital Focus we will reiterate our investment thesis given the recent Fed notes, the consequences of a higher dollar and lower oil prices.

In This Issue:

2015 – What's Next?

Market Performance

Dollar Makes Me Holler

Europe – A Turning Point

How Did We Get Here?

Investor or Trader... Which Are You?

What Drives Great Performance?

Munis Still Make Sense

Housing – The Beginning not the End

Market Timing

Ready for Retirement?

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Market Performance

Here are the performance numbers for the major indices as of 3/31/2015 (Total Return):

March
2015

Latest
3 Months
Latest
6 Months
2014
% Change
Dow Jones Industrials
-1.97%
-0.26%
4.30%
10.02%
Standard & Poor’s 500
-1.74%
0.44%
4.85%
13.69%
NASDAQ Composite
-1.26%
3.48%
9.07%
14.82%
Russell 2000
1.57%
3.99%
13.72%
4.89%
MSCI EAFE
-1.96%
4.19%
0.18%
-4.48%
Long Term Treasury Bonds
1.15%
3.89%
13.31%
26.34%
Gold
-2.22%
-1.02%
-2.42%
-0.19%
CBOE VIX
14.62%
-20.36%
-6.25%
U.S.stocks tread water in Q1, and lagged other indices except gold. The S&P 500 managed to finish Q1 in the black (+1%), but lagged behind other asset classes for the quarter. LT Treas. Bonds were up 3.9% and the Rest of the World Equities Index was up 9.1% as interest rates fell. Despite the pick-up in volatility in March the VIX index was still down. In Q1 we saw leadership in two sectors- Healthcare (+6.2%) and Discretionary (+4.4%), both of which are domestically focused. Small Caps and low quality equities outperformed in Q1. Stocks that contributed most positively to the S&P 500 Index in Q1 were Apple (AAPL) and Amazon (AMZN), stocks which detracted most were Microsoft (MSFT), and Exxon Mobil (XOM).
Sources: Thomson Reuters; WSJ Market Data Group, Dow Jones & Co., BTN Research, BofA ML
Stock market indices do not include reinvested dividends. Data as of April 1, 2015



Dollar Makes Me Holler

Digging out the EuroThe U.S. dollar is hitting 12-year highs almost daily, while the euro seems to be plunging below dollar parity. The euro fell 12% vs. the U.S. dollar in 2014. As the euro falls, the cost of imports going to the Eurozone rises but the cost of Eurozone exports falls. Currency movements are often described as the most unpredictable of all financial variables; but recent events in foreign-exchange markets seem, for once, to have a fairly obvious explanation. For several years, investors had a lingering concern of how Ben Bernanke’s Quantitative Easing program was going to affect the dollar. The Central Bank spent trillions buying assets to suppress the currency’s value in a desperate attempt to jumpstart growth but with a muted outcome. Many investors thought that the increased liquidity would eventually decimate the dollar. The world was anxiously anticipating the end of QE, hoping it wasn’t too late to mitigate the currency debasement; yet rampant inflation never arrived and shortly after the announcement of the end to QE, the dollar started to soar. The European Central Bank (ECB) started its own brand of the Quantitative Easing program made famous by Mr. Bernanke. In a few short weeks it has sent the European stock markets up and the euro down. The ultimate reason a stronger U.S. dollar should not be seen as a negative for domestic equities is that the stronger dollar is itself a vote of confidence in the future of the U.S. economy. It signals that the collective wisdom of currency traders is giving America a big thumbs up. The U.S. bull market should not fear a strong dollar. At Karp Capital we will continue to put monies to work in Germany and Japan to take advantage of devalued currency, but will hedge given the dollar’s strength.

Europe – A Turning Point

Euro EclipseWith the bear market in oil and the strengthening of the dollar, the European Central Bank is having difficulties stimulating the regional economy. Late last year one of the most significant concerns for the Eurozone was Putin’s aggressions in the east. The conflict in Ukraine raised questions about the effect Russia’s Soviet-era world view would have on oil prices, as Russia is the main oil exporter to Europe. If the cost to import oil were to skyrocket it would hinder growth as consumer prices would also rise, tempering demand. Those worries were quickly quashed as the United States and OPEC reached record levels of production and the dollar exploded higher. Generally a drop in oil prices would promote growth as slowing inflation would boost consumer demand. The boon never came to fruition due to the unexpected and significant drop in the price of oil. With oil’s remarkable fall, consumer prices fell so much that investors around the world suddenly had a new fear, deflation. Since the announcement of the end of the Federal Reserve’s QE program, the dollar rebounded to multi-year highs against the euro. The relative strength of the euro vs. the dollar has fallen for months but the currency’s fall hasn’t translated to inflation. The deflationary pressures remained and threatened to push the European economy into recession. Since the implementation of Europe’s own QE program, its equity indices have climbed to new highs, just as we saw domestically for years under monetary stimulus. Also, just as we saw here at home, the bond markets continue to surge, driving fixed income yields sometimes through the floor into negative territory. There are many reasons to take interest in these events; the most stimulating being that a European vacation hasn’t been so affordable in decades. Airlines are performing well due to cheaper fuel costs and Americans are in the best position to profit. Also, the dollar vs. euro spread means that when you finally arrive in Paris a croissant is significantly cheaper than it was just six months ago. Another key reason to take note is the effects on domestic fixed income yields. While the Federal Reserve mulls the possibility of raising rates, their efforts are muted. In the developed world, U.S. debt issues yield significantly higher interest leaving hungry investors with a strong appetite for U.S. treasuries. Central banks and investors all over the world have continued to buy up U.S. bonds keeping rates very low and an attempt to raise them will be welcomed by those trying to mitigate the loss of income from European QE.

How Did We Get Here?

The second half of 2014 was a time for consolidation and increased volatility for most market indices. This tempering of investor enthusiasm is healthy and the rotating consolidation/corrections over the past nine months has set up the market to make some meaningful strides in 2015. Retail sales have been relatively disappointing in recent months as it appears consumers have been more interested in saving or paying off debt. History, however, has shown that it often takes a sustained period of lower prices before consumers adjust their spending habits upward. If oil prices stay between $50 and $75 a barrel, we will see the kind of stimulus package that the Federal Reserve or Congress could never achieve. The 50% drop in oil prices is a boon for consumers. AAA estimates that drivers are saving more than $500 million per day which is the equivalent of a $182 billion dollar tax cut for 2015, the largest annual tax cut in history. Prior tax cuts stimulated consumer behavior, this should be no different. Keep in mind 70% of the U.S. economy is made up of consumer spending. The big drop in prices did not hit the pumps until late October so the positive impact should begin in the months to come. Internationally, lower oil prices are a boon for oil-importing nations versus oil-exporters. Europe and the Far East will be the beneficiaries of the fall in oil prices. Leisure, retail and transportation companies (airlines and railroads) should do well. Stock analysts have been quick to lower earnings estimates for the energy sector (slashing estimated growth by almost 20%) and therefore lowering expectations for the entire market. This $500 million per day in savings is not evaporating, it will end up benefiting more companies than it is hurting.

Investor or Trader... Which Are You?

Most market participants consider themselves to be investors. This is contrary to the list of well-known money managers. They consider themselves opportunists or traders. In order to realize profits you need to know when to buy, what to buy and most important when to sell. Investors put their money into stocks, real estate, etc., under the assumption that, over time, the underlying investment will increase in value and the investment will be profitable. Typically, investors do not have a plan for what to do if the investment decreases in value. They hold onto the investment with the hope that it will bounce back and again become profitable. Investors anticipate declining markets with fear and anxiety, and unfortunately they don’t usually have a response plan. When faced with a declining market, they hold their positions, and losses continue to mount. Then a bad investment is made worse by buying more and taking on more risk. This is better known as throwing good money after bad money. Everyone makes mistakes, but the key is not letting the losses add up. Losses do occur with every great money manager but a well-managed position is what matters when calculating performance. Trading is portrayed in the media as risky, dangerous and foolish while investing is good, reliable and safe in the long term. Investors had a taste of what buy-and-hold can do to their capital in the 2000-2002 bear market. They lost again in the 2008-2009 bear market. At Karp Capital we choose to take a proactive approach to building and managing portfolios. We implement investment plans that focus on two goals... generate growth/income and reduce portfolio risk. Being a trader does not mean you must move in and out of the markets frequently. A trader simply is one who has a plan for entering and exiting a position. There are reasons for every position in a portfolio. Each stock, bond, commodity, currency and sector weighting is bought and sold with a reason…a catalyst. At Karp Capital we use both fundamental and technical analysis in our approach in order to shape our style and sector focus. We also use price to confirm trends, letting the markets tell us when to trade and in what direction. Cutting losses quickly and staying with a sector that has fundamentals with a catalyst is how to increase performance and manage risk. It takes patience and discipline to follow a strategy and many times go against the prevailing wisdom. This is true of all winning market strategies.

What Drives Great Performance?

Yellen and Wall StreetGrowth! Our sector focus is over weighted to the growth styles which are invested in healthcare, technology and consumer services. Healthcare includes biotechnology and consumer services includes leisure. It’s not surprising that these same sectors are the ones demonstrating superior earnings and sales expansion. The blended earnings growth rate for the S&P 500 during Q4 2014 was over 3.5%. Some sectors have reported higher earnings versus a year ago, led by healthcare, telecom services, consumer services, and technology. The healthcare sector reported the highest earnings growth rate at almost 24%, helped by blockbuster sales of the HepC drug from Gilead. The biotechnology sub-sector had earnings gains of almost 100% on a year over year basis. Five of the six industries reported double-digit earnings growth. Consumer services had broad-based earnings growth. This sector also saw double digit earnings gains of 11%, reporting the third highest earnings growth rate at 11.4%. Within leisure, the hotel, resorts and cruise lines earnings are up over 50%. Forecasts are for continued gains. Our clients’ portfolios are positioned in the areas of the market exhibiting the best growth. When the Federal Open Markets Committee (FOMC) meets in mid-June, the outlook for the economy might very well be solid enough to allow the Fed to announce the first rate hike since 2006. We think it’s likely there won’t be a rate hike until later in the year, if at all. Either way, both the financial markets and the business world will be given plenty of hints about such a major shift in policy long before the news makes headlines. Our concern is that as the Fed's patience ends, volatility may escalate. This could be a threat to asset prices as our analysis suggests low volatility has been a key driver of rising stocks and bonds. Increased volatility is a healthy development as it forces investors to act. We encourage clients to call us for a quarterly review to confirm risk tolerance and investment goals.

Munis Still Make Sense

Safety is part of the reason the municipal bond market is worth $3.65 trillion. To determine just how safe munis have been for investors, Moody’s, a bond rating service looked at more than 54,000 municipal bond issuers and 5,600 high-yield corporate bond issuers between 1970 and 2011. What they found is that only 71 muni issuers defaulted, whereas corporate bond defaults for the period rose to more than 1,800. What’s even more interesting is lower-rated municipal bonds, historically, had better credit quality than high-rated corporate bonds. In a similar study, Moody’s reported that since 1970, adequate (Baa-rated) munis have had a default rate of 0.30 percent. But of the corporate bonds that received the highest, extremely strong rating, 0.50 percent failed to meet their obligations. Munis had a stellar 2014, delivering positive returns each month of the year. This helped the asset class outperform both corporate bonds and high-yield corporate bonds. Many bond investors are concerned about how their holdings will perform when the Federal Reserve raises rates. When interest rates rise, bond prices drop. For this reason, the bond market reacted positively to Fed Chair Janet Yellen’s announcement that a rate hike wouldn’t occur just yet. Short-term municipal bonds are where investors want to be when rates inevitably increase. The longer the bond maturity, the more sensitive the price of the bond. Given the myopic focus of investors on the direction of interest rates, municipal bond opportunities are being overlooked. Muni bonds are generally exempt from federal taxes and state taxes in the state of issuance. Give us a call to discuss how tax free income can lower your portfolio volatility and enhance returns.

Housing – The Beginning Not the End

Housing Market Looking UpHousing demand has led to strong growth in home prices. Ongoing inventory tightness remains supportive of stable-to-improving price growth over the intermediate term. In addition, in 2015 banks are extending credit where no credit was available in recent years. Bank lending has been a drag on the housing recovery but now regulatory policy momentum is shifting away from the over-pricing of risk for the current wave of would-be borrowers and towards policy adjustments aimed at improving affordability. Residential construction employment in January saw its largest gain since November of 2005. Consumer sentiment around housing (as measured by the University of Michigan’s Good Time to Buy a Home Index) continues to advance alongside the broader rise in consumer confidence and ongoing improvement in the U.S. labor market. Couple this environment with interest rates falling below their 2014 average and it provides a boost to affordability. We think there are good times ahead for the housing markets. There was a hopeful sign in the building permits number, which showed a 3% gain. Also new home sales were particularly strong—up 7.8% in February to the highest level in 7 years. The window of opportunity will be short. If your home ownership goals have changed or your current interest rate is over 4.5% now is the time to submit a loan application and provide supporting financial data. When rates drop you can lock in the rate. If you are looking for a property for investment, or to upgrade your current properties, now is the time to step up the search. The strong dollar and job market is a signal that it is time to shed the doom and gloom of years past. We expect to see a big rebound in the next two months with the spring selling season coming up, interest rates remaining quite low, the job market continuing to improve, and the benefit from lower energy prices finally kicking in.

Market Timing

We are managing portfolios for long term performance but we do monitor how attractive or risky the markets appear as we are always putting money to work or providing distributions to clients that need cash flow. It is fascinating to study how markets are connected and vacillate. We must stay aware of market conditions, it is essential when making portfolio decisions. It is not about market timing. Market timing involves buying and selling securities based on what you think will happen to the level of the market as a whole. Many investors say they avoided the last bear market, but far more have missed out on much of the current bull market because of fear. Market timing strategies are not a good idea, and the reason is simple, the future often unfolds in ways we do not expect. Paying attention to the market’s potential rewards and risks can assist you with your portfolio decisions. During periods of greater risk, it makes sense to ensure your portfolio does not have an excessive allocation of overvalued asset classes (relative to your long-term strategy). One must tighten their sell rules and avoid riskier or more aggressive strategies and investments. During periods of greater potential reward, it makes sense to boost your allocations to undervalued asset classes (again, relative to your long-term strategy), to be more willing to put up with short-term price volatility in exchange for long-term gains, and to act in a manner that may be contrary to your emotion. The goal is not to time the market or try to determine when to get in or out of certain asset classes but rather to move within the boundaries of your long-term investment strategy. We focus on a disciplined strategy based on sector research given economic cycles. This can allow for some flexibility as long as you don’t violate the spirit or the key underlying premise of your approach.

Ready for Retirement?

Retirement AgeBaby boomers and the generation before are not retiring in the conventional sense. There was a time when a financial roadmap and a corporate retirement plan to reduce taxes and build wealth was on everyone’s bucket list. In recent years we have adjusted plans for numerous clients because their retirement date is continually pushed out. This phenomenon is true for many of our clients who are small business owners thriving late in their careers. They’ve achieved a balance between relaxation and purpose. In fact, the Americans’ Financial Security: Perception and Reality survey conducted by The Pew Charitable Trusts indicates that only 26 percent of Americans view retirement as a period in life when they stop working completely. Twenty-one percent of survey respondents said they are never planning to retire, and 53 percent anticipate doing something else, including a career or job. Some will work because they need to and others because they want to. It’s clear from these results that people are redefining what retirement means. At Karp Capital we help clients prepare for this new retirement. To help you, we must look beyond the numbers. While the masses may be unprepared financially, there’s an equally large concern that pre-retirees are unprepared emotionally. Our clients have saved carefully and certainly have enough money to support their needs in retirement. But they may have no clue as to how to replace the benefits that work can provide to most people. We are in a unique position to help prepare you for the financial aspects and offer resources for the nonfinancial aspects of retirement readiness. We look forward to hearing from you.

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All of us at Karp Capital Management thank you for your continued support. It is a privilege to help you, your family and friends reach financial goals. We’re flattered when you refer your family, friends and colleagues. If you know someone that would enjoy our commentary on the market, please share the newsletter with them. If they would like to receive our quarterly commentary please direct them to sign up for the email edition at karpcapital.com. If you have any questions on the preceding analysis, or would like to review your portfolio’s performance, please call me at 877-900-Karp. At Karp Capital, we position your financial world in the global economy.

Peter Karp
Peter C. Karp

Karp Capital Management Corporation
Registered Investment Advisor

Mailing Address: 2269 Chestnut St., #308
San Francisco, CA 94123

Office Address: 221 Caledonia St.
Sausalito, CA 94965

P: (415) 345-8185 F:(415) 869-2832
peter@karpcapital.com
karpcapital.com

If you no longer wish to receive the Karp Capital Management Focus newsletter, please contact us to be removed from our mailing list. Although information in this document has been obtained from sources believed to be reliable, we do not guarantee its accuracy, completeness or fairness, and it should not be relied upon as such. All opinions and estimates herein, including forecast returns, reflect our judgment on the date of this report and are subject to change without notice. Such options and estimates, including forecast returns, involve a number of assumptions that may not prove valid. Further, investments in international markets can be affected by a host of factors, including political or social conditions, diplomatic relations, limitations or removal of funds or assets, or imposition of (or change in) exchange control or tax regulation in such markets. The past performance of securities or other investments does not necessarily indicate or predict future performance, and the value of investments. This document may not be reproduced without our written consent. Securities offered through Infinity Financial Services, member FINRA/SIPC. Karp Capital Management is not an affiliate of Infinity Financial Services.

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