Large Cap Commentary – April 2016
The month of April delivered on a portion of its catch phrase and certain sectors of the market experienced showers. Investors are left to wonder if flowers will follow. In particular, financials were hard hit. However, the decline in financials began earlier as expectations regarding the actions of the Federal Reserve shifted. Even St. Louis Fed President James Bullard seemed to do a 180 degree turn. In November of 2015, Bullard decried the lack of action by the Fed as employment was strong, and when the impact of energy was backed out, core inflation was running within the Fed’s target range. Thus, he was pleased when the Fed raised rates in December for the first time in years. By February, however, Bullard had changed his tune. The new message from Bullard was that inflation expectations were following the price of oil downward, and given this condition, the Fed was unlikely to raise rates further.
For investors like us, when the alleged experts are confused, the analysis becomes all the more difficult. In this environment of increased uncertainty, it was not surprising that financials came under pressure. What surprised us, however, was the magnitude of the decline for the financial stocks we held relative to the decline in earnings expectations for those companies. Below is a table that highlights that difference:
As you can see, the decline for Argent’s financials stocks, E*Trade (ETFC), JPMorgan Chase (JPM), Lincoln National (LNC) and SunTrust Banks (STI), matched the expected decline for the market on an earnings basis, yet the price of those four stocks fell considerably. From this we concluded that investors were assessing a very high probability that our financial companies would report results much worse than expected for the first quarter. As is always the case when one is talking about the future, that outcome – much worse than expected – was indeed a possibility.
Ultimately, our financial holdings surprised on the upside. Of the four financial stocks we hold, three reported better than expected numbers. Driving those better than expected results were lower operational costs and improved legacy loan mitigation, both of which are within the control of company management. Each of the three stocks rose nicely on the day their earnings were released. Did all of our financials beat consensus? No, unfortunately, one – LNC – had results below expectations. However, we will take a .750 batting average, especially in light of the favorable odds each stock held, given their depressed valuation, coming into their earnings releases.
It is always a question of E (earnings) and PE (price-to-earnings, or valuation). While watching a stock we own fall relative to the market is difficult, our job at Argent is to assess the future prospects of a company (E) and weigh those prospects against the stock’s current valuation (PE). We are confident that our investment process, while not perfect every time, will guide us to those companies that represent favorable odds for our long-term investors.
We have three successful equity strategies – Large Cap U.S., Small Cap U.S. and Dividend Select. If you have questions on any of these, or know others who might have an interest in our mailings, please call us.
Senior Portfolio Manager
Past performance is no guarantee of future results. Views expressed herein represent the opinion of the portfolio manager as of the date above and are subject to change. The information provided in this report should not be considered a recommendation to purchase or sell any particular security. You should not assume that investments in any securities within these sectors were or will be profitable. A list of stocks recommended by Argent in the past year is available upon request.