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Matrix Asset Advisors, Inc.
Capital Markets Commentary and Quarterly Report:
1st Quarter 2014
The S&P 500 was up +1.8% in the first quarter of 2014. It was a modest but impressive
start to the year given last year's 30% plus gain. The market stumbled in January and then again
in early March for a variety of reasons including: fears that the currency crises in Turkey and
South Africa would envelop other emerging markets, renewed concerns over China’s slowing
economic growth rate, the political drama caused by Russia's mid-March annexation of Crimea,
and the unknown economic costs of an unusually cold winter in the United States.
It was a volatile quarter, with profit taking pushing the S&P 500 down by -3.5% in
January, then rebounding +4.6% in February and finishing with a +0.8% gain in March. After a
poor start, the stock market moved higher as the quarter progressed because the weight of
economic evidence is that the global economy, led by the U.S., is continuing to improve.
Matrix’s Value portfolio continued its strong gains of last year and had solid, absolute
returns as well as outpaced our relevant indices. The progress was driven by continued favorable
business developments in our companies. What is also noteworthy is that our portfolio had a
very positive reaction to market participants starting to focus on the fact that the Fed would
eventually start to increase interest rates. As the economy continues to progress this year, we
believe that there will be a greater focus on this and feel that our holdings should be a beneficiary
of this changing mindset.
The most recent economic data, released in the first week of April, showed the
manufacturing sector picking up momentum after several months of slower growth during the
coldest winter in four years. New orders and production grew in March and auto sales bounced
back strongly as the weather improved, pushing first quarter results ahead of last year’s selling
rate. The latest home price data in February showed another increase in prices, an important
indicator of consumer confidence. The March unemployment rate was 6.7%, and was
unchanged from the prior month with more people re-entering the work force (a good thing).
Some other positive data from the employment report were that hours worked in March were
higher than in February, and the previous two months’ reported job numbers were also revised
higher.
Business confidence is building, and if it continues, it will lead to more investment and
eventually the virtuous cycle of hiring and consumer spending. An early sign that this may be
starting to take hold is the April 3rd story in the Wall Street Journal reporting that “business
lending has picked back up, reversing six quarters of decelerating growth.”
While stocks were able to muddle through most of the geopolitical overhangs that
appeared during the quarter, the bond market ended the quarter with a flight to safety out of
concern about the Ukraine-Russia conflict. That and some weaker than expected economic
numbers (that we think were weather related) resulted in bond yields declining for the quarter.
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These lower yields across the maturity spectrum caused bonds to have a positive quarter.
As we will discuss in greater length in our bond discussion, we believe that bonds are at the
lower end of their 2014 trading range and expect rates to trend higher as the year progresses.
Equities
Value Strategy
The Value equity portfolio continued its gains of the past year and nicely outpaced the
modest increase in the market indexes. We were pleased that after the portfolio’s strong gains in
2013, it held up well during the January pull-back. As noted earlier, we also look at its jump
(both absolute and relative to the market) after Janet Yellen’s comments in regard to the Fed
eventually increasing rates, as a significant positive. While we build our portfolio on a stock by
stock bottom-up basis, we do believe that we are positioned in a manner which will benefit from
an inevitable, normalized interest rate environment.
A number of our 2013 standouts continued their strong gains in the first quarter with
Caterpillar, Corning, Hewlett Packard, Microsoft, Schlumberger, TE Connectivity and Wells
Fargo leading the portfolio. Some of last year’s laggards, like Devon Energy and Teva
Pharmaceutical, started to play catch up and also had healthy increases.
From a sector perspective, Healthcare, Materials/Producer Durables and Technology led
the portfolio with these groups showing high single digit returns. While Energy and Financials
outpaced the market, they lagged our overall portfolio. Consumer Staples and Consumer
Discretionary were flat to modestly lower.
It was a relatively active quarter in terms of portfolio transactions as we used a number of
our stocks’ strong gains to lock in profits. We scaled back our positions with very healthy gains
in American Express, Charles Schwab and Corning, as each stock approached its fair value. (We
completed the sale of Corning in early April.) We also sold our entire position in Archer Daniels
Midland to take advantage of its sharp stock price increase in the past year. Lastly, we made
some modest portfolio adjustments and reduced our positions in Kellogg Co. and Teva
Pharmaceutical. We continue to like both stocks but wanted to modestly reduce our exposure in
each to free up funds to allow us to add to other positions.
We used the proceeds from these sales to start a new position in Eaton Corp. Eaton is a
world class global electronics and industrial company. We like the management and believe
they are poised for a significant pick up in earnings based on an improving global economy and
synergies related to their acquisition of Cooper Industries in 2013.
We also added to our positions in Capital One, DuPont, Hologic and Pepsico.
We believe these portfolio changes allowed us to lock in some very profitable
investments, reduce the risk and volatility of the portfolio in the event of a market pull-back, as
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well as positioned us for additional upside in 2014, as the newer buys are all selling at very
reasonable prices and should build their business momentum as the year progresses.
Beyond the improving earnings and the market’s focus on fundamentals, we also believe
our portfolio has been and should continue to be the beneficiary of the recent pick up in
corporate activism, M&A activity and a number of companies’ more aggressive focus on capital
allocation. As activists have become involved in a number of our holdings, they have attempted
to focus management on doing more for shareholders and reducing the gap between the likely
intrinsic value of a company and its current market price. We believe one or more of the above
factors has, or should have, a positive impact on: DuPont, Devon Energy, Hologic, Microsoft,
Occidental Petroleum, Pepsico and Qualcomm.
One other noteworthy area of the portfolio is Financials. The group was one of our
leading gainers in 2013, and while certain stocks like BB&T, Charles Schwab and Wells Fargo
continued with their gains, many stocks in the group took a breather this year. We think the
recent stress test and the Fed’s Comprehensive Capital Analysis and Review (CCAR), combined
with a more normal economy and the Fed spending more time talking about a rising rate
environment and a more normal yield curve, should auger well for the group. As such we
believe our Financials are poised for another leg higher over the balance of 2014.
Dividend Income Strategy
Matrix Dividend Income (MDI) followed a healthy 2013 with another strong quarter
where the portfolio had favorable absolute returns and outpaced the S&P 500. Beyond the
continued slow and steady progress of the portfolio, we were pleased to see that much of its
relative outperformance started to occur after Janet Yellen’s comments in regard to ultimately
raising interest rates.
As we, along with a number of strategists and market commentators, believe that most
high dividend stocks will struggle in a rising rate environment, the quarter provides support that
our sector and industry diversification should allow the portfolio to be valued on the merits of its
cash flow, earnings and dividend stream rather than interest rate advances (often expressed in the
press as a simple risk-on or risk-off trade).
Conventional high-yield sectors of the market, like Utilities, have historically had a tough
time in a rising rate environment. Our Dividend strategy emphasizes companies with strong and
stable businesses that have the ability to nicely increase their dividends as their profits grow,
thereby aiming to offset some or all of the competition from higher bond rates.
Sector-wise our strongest gains came from Financial Services, Healthcare and Materials
and Processing. Our large Consumer Staples and Utilities positions also contributed to the
portfolio’s gains, while Consumer Discretionary, Energy and Technology were only modestly
positive. Producer Durables took a breather this quarter after last year’s +40% plus gains and
was the only sector that was modestly lower for the period.
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While many of the portfolio’s stocks had modest increases for the period, Air Products &
Chemicals, BB&T, Johnson & Johnson, Wells Fargo and Merck all had high single-digit gains.
On the flip side, we believe some of the most recent quarter’s laggards such as General Electric,
UPS, Chevron and Consolidated Edison are poised to play catch up as the year progresses.
The one constant during the geopolitical scares and the market fluctuations was that our
holdings continued with their slow and steady increase in their dividend rates. For the quarter
we looked for seven of our holdings to raise their dividends. All did, for an average increase of
+7.1%, which increased the total portfolio income stream by +1.8% for the period.
We reduced our oversized positions in Air Products and Chemicals and Merck into their
stock price strength and used the proceeds from these sales to increase our position in Verizon.
These changes allowed us to lock in some profits and modestly increase the yield of the
portfolio.
As of 3/31, the portfolio’s yield was about 3.3%.
Looking forward, we think the portfolio’s returns will be primarily influenced by each
company’s fundamentals, earnings, cash flow and dividends. In addition, we believe certain
factors that have positively impacted our Large Value portfolio like corporate activism, M&A
Activity and more aggressive capital allocation strategies should also have similar implications
for our Dividend Income portfolio.
Equity Outlook
In the first quarter of 2014, the stock market managed to rise despite the economic
challenges of an awful winter, a continuing war in Syria and a new international crisis in the
Ukraine. The Federal Reserve’s policy of slowly withdrawing stimulus (often cited as a threat to
further stock market appreciation) is proceeding as the economic data confirms improving
economic growth.
In a keynote address at an energy conference on March 24, Schlumberger CEO Paal
Kibsgaard said “In spite of continued concerns relating to some of the emerging markets, the
global economy is likely to see the fastest growth in four years driven by encouraging data from
the United States; expansion in all major Eurozone countries; promise of a stabilizing situation in
China; and strong growth in the rest of Asia.”
With corporate earnings and dividends expected to rise in 2014 and beyond, we expect
further gains in the stock market. Many investors, still stung by the market’s decline in the Great
Recession five years ago, remain overweight in cash and bonds and underinvested in stocks.
Even a modest rebalancing of portfolios towards a higher weighting of stocks could have a
meaningful impact on market performance.
While we expect more volatility over the year and more modest gains than in 2013, we
believe our portfolios are well positioned to continue to grow in the upcoming periods.
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Bonds
While the stock market was ultimately guided by corporate fundamentals and earnings,
bonds took their lead from macro issues. Geopolitical concerns like the Emerging Market
Currency Crisis and the Ukraine-Russia conflict caused flights to safety which pushed down
yields. Bond yield declines were also caused by some weaker-than-expected economic data
points which included an unexpected slowdown in the labor market recovery. Yields had a brief
rally based on Janet Yellen's comments late in the quarter, but then moved lower at the quarter’s
end on mixed economic data.
Matrix Bond Portfolios participated in the better bond environment and had positive
returns for the period. These gains were in line with the relevant benchmarks. Our near cash
equivalent portfolios were modestly higher, but fairly anemic and in line with the very low
interest rates that are paid on very short term fixed income investments.
We continue to think that a rise in interest rates is inevitable, and feel the decrease this
past quarter is temporary and has moved interest rates toward the lower end of the interest rate
range that we envision for this year.
We believe our focus on the shorter end of the yield curve should provide greater
protection as rates start to drift higher again. We look for rates to move higher as a result of an
improving economy, the Fed completing its Tapering Program and the market starting to focus
on the Fed eventually moving to a less accommodative policy.
Like last year, our defensive short term fixed income posture should be particularly
timely as the year progresses. When we are well into the rising interest rate cycle, we do plan on
opportunistically extending maturities at more attractive rates. Though we believe we are still a
ways off before those changes will make sense.
Balanced Accounts:
Our balanced accounts continued to benefit from our over weighting to stocks during the
quarter. The strong gains of the past 52 weeks have pushed many accounts above the high end
of their targeted allocation band. We used the February and March strength to scale back on a
number of positions to get balanced portfolios back into our targeted range. These scale backs
included modest sales of a number of positions that we still like and were merely selling to get
back to a normal sized position in each, and to reduce the overall portfolio equity exposure.
Even after a number of these sales, we continue to be at the upper end of our targeted
range as we believe stocks still offer a more attractive reward vs. risk outlook to bonds.
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There has been a great deal of discussion in the past two weeks about Michael Lewis’
new book, Flash Boys, which argues that the market has become rigged as a result of High
Frequency Trading. This quarter’s Ideas About Investing will provide some insight and
perspective on these market activities and participants.
We wish you all a happy and healthy spring and thank you for your confidence and trust.
Please contact any of us with any questions at 800 366-6223 or 212 486-2004.
Best regards.
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