3rd Quarter 2014 Commentary


Americans, consumers, men, women, and children do not seem to be happy.  According to a recent poll conducted by the Wall Street Journal/NBC News (published August 5,2014), a full 49% of our citizens still think that the U.S. is in a recession, despite the fact that the economy is in its sixth year of recovery.  Skepticism is rampant amongst investors.  Here are some figures to prove the point.

Chart 1

2014 - q3 - photo 1

The University of Michigan Consumer Sentiment Index for September came in at 84.6.  This survey reflects consumers’ moods based on their particular financial situations and feelings about both short term and long term prospects for the economy.  The recent score is just below the peak for this recovery – but the reader will note that the current reading is well below past highs registered at the “Tech Bubble” and the “Housing Bubble”. The improvement in sentiment is reflective of better short term outlooks.  But long term outlooks are still mired in feelings of angst.  People just do not believe.  The Conference Board Consumer Confidence Index, published

in August, supports the results of the Michigan Survey.  The August score hit an expansion high of 92.  However that number is still well shy of the numbers hit in the previous “bubble” peaks.  Lastly, the American Association of Individual Investors (AAII) Sentiment Survey measures individual investor sentiment towards the stock market.  Polls are taken weekly.  As the above demonstrates, nobody is wildly “bullish” about the stock market and has not been exuberant since the start of the rally.

Chart 2

2014- q3 - photo 2

The above picture we think is quite clear and educational.  It looks at the cumulative U.S. equity mutual fund and ETF flows since 2007.  Since the start of the rally in 2009, retail investors have liquidated stocks.  In the face of rising markets, people have voted “with their feet” and left equities. Oppositely, professional money managers (represented above as institutional) have added to stock positions throughout the term.  Why? Undisciplined investors make decisions based on easily recallable events and vivid memories – in short, they are emotional.  Certainly, a recollection of the “financial meltdown” of 2008 would qualify in most people’s minds as vivid and not in a good way.  Further, it has been learned from human behavior that for many, loss aversion is a stronger emotion than the good feeling achieved by making a gain.  So skittish retail investors have sold stocks and have bought bonds (which have had a huge rally over many years, but have had a more muted rally since 2008, see chart 3) or increased cash levels in their portfolios.  Retail investors just have not felt good – and still do not.

Chart 3

2014 - q3 - photo 3

So what do we think about the future?  As we have written in the past, it is hard for us to believe that there is much “easy money” left to be made in the bond market.  As the reader will note in Chart 3, yields are near zero.  Unless bond yields go negative – a possibility we grant, but highly unlikely – bond prices can only stay flat or go down raising yields.  With little upside opportunity, fixed income markets seem unattractive.  Since equities on the other hand have been “shunned” by individual investors for years, they are underweighted in their portfolios.  While stocks have gone up, we still think that while not cheap, equities are not “wildly” expensive and certainly cheap to bonds on a relative basis.  There is still the possibility that individual investors finally lose their skittishness towards stocks and succumb to another fear – the fear of being left behind, of missing out.  Their catch-up buying could ignite the final “blow off” which would make stocks relatively expensive to bonds or cash and then setup a time to sell equities.


Since we last wrote, there has been more “pushing and shoving” in numerous spots around the globe (think Ukraine, Iraq, Syria and the Gaza Strip). This has obviously created some investor worry.  China has been issuing “spotty” reports of economic progress. Japan’s growth rate has slowed. The Eurozone has worried aloud about deflation, which has unsettled some. Brazil is about to have a Presidential election.  We thought that Dilma, the incumbent, was a “shoo-in” months ago.  It turns out that she has some real political competition.  So the election is too close to call. It would be good for the Brazilian economy and the markets if Dilma lost. Joko won in Indonesia, which is what we thought would happen.  The market there has rallied.  In India, Modi has made a good start to his Presidency and India is again a favorite for investors.

In reaction to an almost frozen European economy, ECB President Draghi has again come to the fore to declare his readiness to do “whatever it takes”.  The Euro has slipped vs. the dollar by almost 8%, which will help Eurozone exports and the economy.  We think that Europe will continue to “slog” ahead, but it will not be pretty. Russia will tip into recession due to imposed sanctions for “bad behavior”.  Japan seems to want to disappoint this year.  There has not been enough reform yet.  If we get a “lucky break’ and Dilma loses in Brazil, that economy and market will rally strongly. Indonesia looks to be in an infrastructure building mode.  India is the new “starlet” on the stage with lots of capital looking to “woo her”.


Stock markets have become “twitchy” in 2014 – fears of eventually rising interest rates; worries over international strife; concerns about growth in China and deflation in the Eurozone – because of angst.  Some investors always look over their shoulder anticipating the next big market crash. Some have been anticipating that “crash” for years and have been left behind.  It is not a wise investment strategy to always position one’s portfolio for “the worst”.  Certainly it has not been wise for years.  Yes, there are problems in the world and valid concerns about them.  But are the worries so large as to overwhelm strong corporate earnings, strong cash flows, dividend increases, stock buybacks, reasonable valuations, a strong dollar and low interest rates (even if rates are increased)?  We have not thought so and still do not think so.



  • Housing will be an engine of growth for the U.S. economy. –  Still believe –snippets of encouraging info, but still soft
  • Employment will improve throughout the year. – Yes
  • Businesses will invest more money. – Still believe – some shareholder pressure for investment
  • Companies will raise dividends & buyback stock. – Yes
  • The Fed will complete its tapering late in 2014, but will not increase short-term interest rates. – Yes
  • Economic growth in China will pick up speed, as will growth In Emerging economies. – China is planning on 7.5% v. 7.7% growth – others a “Mixed Bag.”  Some periodic worries about growth
  • Asian consumer spending will grow. – Growing but with less “bling”
  • The Eurozone will do better economically – as will Japan. – No – a disappointment
  • The U.S. bond market will have another bad year. – Still believe – but not so far
  • The U.S. stock market will have another good year. So too will Eurozone & Emerging markets. – Still Believe – OK so far.


The opinions expressed in this Commentary are those of Baldwin Investment Management, LLC.  These views are subject to change at any time based on market and other conditions, and no forecasts can be guaranteed.

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