Letter - July 2016





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Bad Dream Redux

In our April newsletter, we noted that the gyrations the market had endured during the previous six months were only bad dreams as after each sharp decline the market rallied back to near the highs of the last 15 months. In the quarter just ended, investors were visited with another bad dream. This time, instead of recession fears or doubts about earnings growth, it was a political development, the British vote to leave the European Union, or Brexit. US stocks tumbled over 600 points in one day. The foreign exchange value of the pound versus the dollar also fell 15% in the following days. The Euro fell as well, though to a lesser extent. World stock markets fell sharply.

Fears were that the post-war international order was about to unravel. Widespread disruption was at hand. Treaties between Britain and the EU would have to be renegotiated, a grueling and lengthy affair. Scotland, which voted to stay with the European Union, has intimated that it might vote to split from the United Kingdom and remain in the EU instead. Other members of the EU might be encouraged and find reasons to withdraw. Uncertainty was everywhere. Reflecting that uncertainty, precious metals, gold and silver, have been the best performing asset class this year.

But as things stand today, it was once again only a bad dream. A week later, the US markets had recovered 80% of their losses. And the week after that, the S&P 500 closed above its all time high. It appears that the US markets shrugged off the Brexit because it seems to believe that Britain and to a lesser extent the Euro zone will bear most of the cost. Britain will likely enter a recession as its access to the EU will be hindered. Any impact on the US is likely to be limited because Britain is a relatively small (4%) trading partner.

Here in the US, growth continues a slow, steady grind upward. Expectations are for 2.5% growth in the second quarter. The recent monthly jobs report for June was stunningly good after a stunningly bad number the month before, lifting animal spirits and consumer confidence. Corporate earnings are expected to bottom out in Q2 after more than a year of declines. Should the economy falter and/or corporate earnings disappoint, the US market would be vulnerable.

Bear markets approach their bottom when stocks stop going down in the face of continued bad news. Conversely, bull markets approach their top when they get increasingly skittish and sensitive to bad news. Bears say that we are approaching a turning point. We agree but donít know quite what to do about it. Markets have a tendency to rise or fall to extremes. Rallies tend to go on longer than the bears expect. So we are patient.

One of the reasons stocks have been so stubbornly rising is because of what is known as TINA: There Is No Alternative. With a yield under 1.4% for the ten-year treasury, historically low, stocks with 3%-4% yields become an alternative. But the case for TINA is disingenuous. Be warned. Stocks have higher risk than bonds and on any given day can shed enough value to wipe out dividends. In a bear market, dividends do not support stock prices.

Politically, the world has not changed for the better. The US election will be won by the candidate that has the least bad approval rating. Racial tensions in the US are increasing. ISIS continues to terrorize around the globe. The Middle East simmers in violence. Interest rates are suppressed by central bankers, which produces little income for savers and pension funds. The growth prospects of Britain and the Euro zone are in question. The Russians remain antagonistic to the West, and China and North Korea provocative in the East.

2016 has been good to our clients so far. First half results range from high single-digits to low double-digit returns. The S&P 500 with dividends included rose 3.8% over the period. (Past performance is not indicative of future performance.) Above average exposure to gold mining and energy shares, which restrained results in 2015, has proven its long term worth.

After seven years of generally rising stock prices the market seems picked over. Stocks that are down generally deserve to be down. Valuations appear to be fairly valued to overvalued. Earnings growth has been and likely will remain subdued. Our strategy remains the same. We are pragmatic: Be willing to take profits, hold cash positions of around 20% as an anchor against volatility, and take advantage of sharp declines to buy if the opportunity presents itself.

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PR Herzig & Co. has moved to another office in the same office complex. Our phone and fax numbers remain the same. The ADV Part II has been adjusted accordingly. The new mailing address is:

PR Herzig & Co., Inc.
4 Expressway Plaza, Suite 220
Roslyn Heights, NY 11577


Tom Herzig


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