We come to the end of another quarter and the market just seems to keep rolling along.  The S&P 500 finished the quarter up 4.7% and up almost 18% for the year to date.  We continued to hit new highs for both the Dow and S&P during the quarter before we fell off at the end of the quarter in the face of political turmoil over the U.S. budget and debt ceiling.  The new highs in the indices came in spite of many companies having warned of lower earnings for the second quarter and delivering on these warnings. 

This trend of companies warning of lower-than-expected earnings underscores what we think is a weak growth environment and fragile recovery.  The warnings by companies also pointed out the over-optimism of many analysts.  It’s not that companies earnings did not grow.  They just did not grow as quickly as many had hoped.  Operating earnings for the S&P 500 companies was about 3.7% higher for the quarter over the same period last year.  This was in line with the growth in the overall economy for the second quarter which was about 2.5% for the quarter. 

This stalemate in Congress over the debt ceiling leading to the first governmental shutdown since 1996 is not helping this fragile recovery.  The shutdown began when some Republicans demanded a repeal of or, at least, a delay in the Affordable Care Act (aka “Obamacare”).  This has since become a cry for negotiations on budget cuts.  While we readily acknowledge that budget cuts are needed and entitlements reformed, the manner in which Congress arrived at this point has been less than stellar.  We presume Congress and the President will work this out sooner rather than later, but the longer this shutdown continues the more we run the risk of a recession.  However, we still have the Federal Reserve continuing its bond buying program.  While this quantitative easing or QE program does provide a sort of floor underneath the market, it cannot sustain the markets forever and will not keep stocks from falling.  The key is to not panic and to find ways to take advantage of these dips.

Given the turmoil in the markets, it’s a bit tricky to figure out where we stand.  For example, we recently attended a luncheon sponsored by the Baltimore CFA society.  We were treated to an okay crab cake and a talk by Dr. Jeremy Siegel author of the book Stocks for the Long Run.  Suffice it to say that  Dr. Siegel is very positive on stocks, well, for the long run.  He argued that stocks are very undervalued at the moment.  His talk was very interesting and provided us with some new insights to follow up on as we continue to research new investment ideas.  No sooner had we digested the crab cake and Dr. Siegel’s outlook, when we saw a chart on CNBC’s show Options Action indicating that stocks might be near a peak level.  The chart indicated investors are now at a point of having borrowed on margin more to buy stocks than they ever have before. The last two times margin debt was this high was just before market tops in 2000 and 2007.

So what’s an investor to do? Do we run for cover or do we wade in and start buying more?  The one thing that is certain in the markets is uncertainty.  The key to beating uncertainty is not to try to “market time” – that is, to try to pick the market bottom or top – but to focus on quality stocks that show growth potential while managing themselves conservatively.  If we believe that we are in the early innings of an economic recovery – and we do – then we should be buying on these dips. 

This past quarter saw minimal changes for client holdings.  We added one company to client accounts in the third quarter.  This was mattress material maker Culp Inc (CFI) which we bought across a number of client accounts.  Culp is a relatively small company but is the industry leader in mattress material.    Not only is this a play on a continued recovery in the economy, but it is also an indirect play on a housing recovery.  The only other change of note was the elimination in a number of client accounts of one ETF, or exchange-traded fund.  We sold off all of the iShares S&P Global Energy ETF (IXC).  We had written options against our position several times in the past and we finally had our shares called away from us this past September.  The fund was just not performing up to the standards we had hoped and many of the companies in the fund were no longer the bargains they were when we first bought shares.

Going forward, we are prepared for volatile times ahead and we already have ideas on how to take advantage of this volatility.  Do not be alarmed if you see stocks appearing in the next quarter that do not pay dividends.  While we have focused on dividend paying stocks in the recent past, we did not always do so.  Sometimes, finding a great investment means finding a company that can make better use of its capital by reinvesting it rather than paying it out.  We have a couple of names on our ‘watch list’ that meet this criterion but we are awaiting a better price.  Just because we purchase a stock that does not pay dividends does not mean we have lost our minds.  We will continue to focus on companies with great prospects and a margin of safety selling for a fair price. 

As always, we do truly appreciate the trust that you have placed in us with a portion of your assets.  If you have any questions or need to discuss any issues, please feel free to give us a call.


Alan R. Myers, CFA
President / Senior Portfolio Manager

Aerie Capital Management, LLC

(410) 864-8746

(866) 857-4095