1st Quarter 2012 Commentary

7/31/2019 1st Quarter 2012 Commentary

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ECONOMIC OvErvIEw

Hope Springs Eternal

The US economy remains almost comatose. The slumpalready ranks as the longest period o sustained weakness

since the Depression. The economy is staggering under

many structural burdens, as opposed to amiliar cyclical

problems. The structural aults represent once-in-a-

lietime dislocations that will take years to work out.

Among them: the job drought, the debt hangover, the

banking collapse, the real estate depression, the health-

care cost explosion, and the runaway ederal defcit.

And now or the quiz: when was this quote written?

While it certainly sums up the prevailing sentiment

at the beginning o 2012, it was not written three

months ago. It is rom Time magazines September,1992 edition. Thus we once again observe the truth

o the old French proverb: Plus a change, plus cest

la mme chose. (The more things change, the more

they stay the same.) The our consecutive quarters o

economic contraction rom July 2008 through June

2009 totaled -18.7%. This truly was the longest and

deepest economic contraction since the 1930s. By way

o comparison, the oil embargo o 1973-74 tossed the

economy up and down over seven quarters with a net

change o -10.7%. Nearly 10 million jobs were lost in

the most recent downturn, ar exceeding the 3.2 million

lost in 1974. In percentage terms, the job losses during

the Great Recession were the most since 1945 when

many war-related jobs were terminated. As we noted in

our 2009 ourth quarter commentary, healthcare costs

in the US are at an all-time high o 15% o GDP, the US

governments total debt exceeds $16 trillion and our

FIrST QUArTEr 2012QUARTERLYCommentary

nsidethis Issue

CONOMIC OvErvIEw

: Hope Springs Eternal

ASSET MANAGEMENT

: At A Price

EATUrED STOCK

: Praxair

IXED INCOME

: Why Stocks Are Better

than Bonds (For Now)

PECIAL TOPICS

: Nelson Roberts

Investment Advisors

in the Community

www.nelsonroberts.com | 650.322.4

annual Federal budget defcit is over $1.4 trillion.We wonder what the pundits will be saying about all

o these structural problems twenty years rom now.

In the ace o all this gloomy recent history and senti-

ment, the stock market is o to the best start since

1998s frst quarter 13.9% return. Hope springs etern

that maybe, just maybe, we are fnally seeing frm sig

o economic recovery and we can at last put ears o

deation behind us. The stock markets resilience th

quarter has been nothing short o remarkable. The

oreboding ides o March included US bank stress test

and the Greek bond payment deadline, yet neither th

Greek debt swap negotiations, the vitriolic politics othe US, rising oil prices, Chinas economic slowdown

nor simmering Middle East conicts have been able to

derail the stock market.

INDEX PErFOrMANCE Q112 YTD

Dow Jones Industrials 8.83 8.83

Standard & Poors 500 12.58 12.58

EAFE (international stocks) 10.99 10.99

Russell 2000 (small stocks) 12.43 12.43

Barclays Interm. Gov/Credit 0.61 0.61

Barclays Municipal 1.75 1.75


2/6

35

25

SEPTEMBER 27, 2010 MARCH 27, 2012

OCT

15.23

DEC

VIX INDEX

20

2012 Bloomberg Finance L. P.

FEB

2010 2011 2012

MAR MAY JUN AUG NOVSEP DEC FEB MAR

30

40

45

50

NOV JANJAN JULAPR OCT

Malkiel projects the return on stocks to be the sum

o dividends (currently averaging 2%) plus the long

run growth o nominal corporate earnings (which he

estimates at 5%). So his comparison is a 7% return on

stocks versus 2% on bonds. I we actor in the current

rate o ination using the most recent CPI report o

2.9%, the real returns are projected to be +4.1% or

stocks and -0.9% or bonds. Furthermore, there is an

argument to be made that the US governments inatio

statistics or consumer and produc

prices understate the degree to

which prices are rising.

Today stocks are airly valued. Bon

are severely overvalued. This calls

or a prudent re-evaluation o ev

portolios asset allocation. Howev

we should not allow the current

low stock market volatility to lul

us into a alse sense o security.

Headline news ranging rom

Israel bombing Iran to urther

debt problems in Europe to a

negative unemployment report

could again stimulate big market

gyrations. We will use those gyratio

to adjust allocations, purchase

new stocks and add to thosethat we already own. (Please see the article on Page 3

entitled At a Price or urther discussion o how and

when we decide to purchase equities.)

Moreover, the stock market has risen steadily with very

low volatility. With little anare, bonds have meanwhile

backed o rom their record low rates. Long term bonds,

which were up 18% last year, were down 3% in the

frst quarter. It is possible that fxed income investors

are fnally ocusing on the act that US Treasury securities

which normally provide a risk-ree return are now

priced to provide return-ree risk, as Shelby Cullom

Davis, a long time investment banker and ambassador

to Switzerland rom 1969 to 1975 so pithily put it.

Burton G. Malkiel, the ather o passive investing and

author o A Random Walk Down Wall Street, wrote in

his March 24th Wall Street Journalopinion piece What

Does the Prudent Investor Do Now? that at a yield

o 2.25% the 10-year US Treasury is a sure loser.

Stocks are a saer choice.

Hope springs eternal that maybe, jrecovery and we can at last put ea

top

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ECONOMIC OvErvIEw

Hope Springs Eternal (contd)

The VIX index is the Chicago Board Options Exchange Volatility Index. It reects a market

estimate of future volatility, based on the weighted average of the implied volatilities for a

wide range of options.


3/6

maybe, we are nally seeing rm signs o economic defation behind us.

ASSET MANAGEMENT

At A Price

well-managed companies with excellent prospects and

making sure that we do not overpay or those companies.

Our team looks to add great companies that have the

potential to be great investments into our client portolios.

Our defnition o a great company is one that:

has a well-defned strategy that is clearly articulated

by management

has a defnable product or products and market

opportunity

has a history o executing on the strategy and reporting

back to investors on the success or modifcation o

that strategy

has growth potential with new products, product

extensions or market expansion.

We oten do the research on a company and fnd that it

meets all o the undamental criteria set out above but

does not meet our valuation criteria. That is, we have

concluded that there is a greater risk o ailing to meet

investor expectations than there is o exceeding them.

Rather than completely throwing out a company idea,

we will come up with a price that we believe compen-

sates or the risk. These price targets may occasionally

be met by a company-specifc event such as a quarterly

earnings miss or an unoreseen signifcant expenditure.

More oten, price targets are hit when the prices o

all stocks go down due to a disappointing economicreport. In either case, the target prices have already

been established and the research done so we can be

proactive when a buying opportunity presents itsel.

In aggregate, we continue to believe the table is set

or a bull run in the equity markets. Corporations have

maintained impressive earnings growth rates and are

generating cash ow. The resulting increases in dividend

payouts and buybacks will support current market levels

and provide a compelling argument or higher value.

The frst quarter o 2012 proved to be a proftable one

or stockholders. The earnings o corporations not only

continued their growth but stock prices have fnally begun

to reect the intrinsic value o many companies. The

S&P 500 was up 12.58% and the Nasdaq composite hit a

new all-time high o 3,122, up 18.9%. As recently as six

months ago, the S&P 500 was at just 1,099.

The markets positive perormance was widespread with

contributions rom many sectors. For example, fnancial

stocks surged more than 20% in the frst quarter, as

many banks received a green light rom regulators to

resume paying dividends. Technology stocks also rose

nearly 20% ater lagging the overall market in 2011. Utility

stocks were the only sector with a negative perormance

as they took a breather rom a win o 19.6% in an

otherwise at 2011 stock market.

Despite the strong perormance o the equity markets,

investors are maintaining their skepticism about uture

returns in this asset class. Money ows into equity unds

have not begun to accelerate, while fxed income unds

continue to garner a lions share o new investment

dollars. According to Morningstar, $44 billion o investor

dollars were allocated to taxable bond unds through

the frst two months o 2012 compared to just $11 billion

owing into equity unds. This degree o risk aversion

on the part o investors demonstrates how shaken up

many still are ollowing the economic turmoil o thelast several years.

Nelson Roberts portolios had only one transaction in

the frst quarter o the year, which was the sale o Sigma

Aldrich. Following the unexpected death o the CEO a

year and hal ago, we thought that company management

was not nearly as clear and ocused. Having just a

single transaction in the quarter should not be mistaken

or lack o activity by our research team, however. We

are always centered on two key priorities: identiying


4/6


FEATUrED STOCK

Praxair

Praxair is the largest industrial gas supplier in North

America. In addition to industrial gases, the company

also makes and packages process gases. Industrial

gases include oxygen, nitrogen, argon and rare gases.

The process gases are carbon dioxide, helium, hydrogen,

acetylene, electric gases and specialty gases. Gases are

used by a wide variety o customers in many dierent

markets. Praxairs end users are companies in manu-

acturing, chemical production, health care, ood and

beverages, metal abrication, energy and more. While

the company is certainly sensitive to economic cycles,

its extensive customer list allows it to partially dampen

swings in revenue. Even though industrial gases

represent a minuscule portion o the cost structure o

most manuacturers, having a reliable supply o gases

is critical. This means that customers are willing to signlong-term (up to twenty years) contracts with Praxair as

their supplier.

The company serves markets worldwide, with two-

thirds o its $11.2 billion in revenues coming rom

overseas. The gases are delivered to customers in our

dierent ways: merchant distribution (31%), onsite

(25%), packaged gases (27%) and other (16%). The

onsite mechanism is especially interesting, as it is exactly

what one might imagine. Praxair actually builds a

gas production plant adjacent to a major customer

(or example, an energy production plant) so that the

gases can be supplied without transport costs. The

long-term contracts allow Praxair to do this proftably.

Over the last several years, Praxair has outperormed

its competition in both operating margin and return on

capital. Earnings were up 15% last year and the stock

price has risen rom $82 to $114 since our purchase.

The company is ocusing on three key strategic

initiatives: expanding services in emerging economies,

increasing its business with the energy industry and

developing new environmental applications. In 2011,

Praxair had its best-ever saety perormance. Last year,

the company was named one o the Worlds 50 Most

Innovative Companies by Forbes. Praxair was ounded

in 1907 and today employs more than 26,000 people

around the world, with over 9,000 employees based in

the US. Praxairs perormance has led the research team

to conclude that we should add to the position we hold

in our client portolios and we are waiting or a down

day in the market to do this.

100

80

MARCH 31, 2009 MARCH 30, 2012

JUN

114.64

SEP

PRAXAIR STOCK PRICE

70


DEC

2009 2010 2011 2012

MAR JUN SEP DEC MARJUN SEP DEC MAR

90

110

i

n t e g r i t y

Where do you fnd integrity?

It emanates rom tradition, endures market cycles, and sustains long-term

partnerships. Trust lies at the heart o what we do, how we serve and who

we employ.

[in tegr te] n. honesty, sincerity, completeness


5/6


FIXED INCOME

Why Stocks Are Better than Bonds (For Now)

Ater many years o being ignored, dividend-paying stocks are back in the spotlight. Historically, investors

looking or dependable streams o income flled their portolios with high-quality bonds. This was an easy

decision when bond yields were 6% or more. But recently, bonds are yielding little while stock dividends

have steadily gone up.

Prior to the 1950s, companies paid their stockholders higher dividends than their bondholders in order tocompensate investors or the greater risk o holding equity. Over time, this standard changed as investors

began to avor higher growth stocks that paid a small dividend or no dividend at all, but instead rewarded

investors through signifcant price appreciation.

Today, the trend has reverted back to where many companies stocks are now yielding more than their

bonds. This is partly due to the Federal Reserve lowering interest rates, but also dividend payouts have

been rising. The roughly 2.0% yield on the S&P 500 is in line with the yield o the 10-year Treasury and

above the 5-year Treasury

yield o 1.0%. For example,

Verizon Communications

(VZ) pays its stockholders

a 5% dividend compared to

the 1.8% investors wouldreceive i they bought a

5-year bond.

One o the reasons dividend

yields have trended higher

is that companies are more

willing to return capital to

their shareholders. Ater the

credit reeze that occurred

during the all o 2008,

companies hoarded cash

and were reluctant to use it or purposes other than to pay down debt or invest in technology that would

result in cost savings. As management teams have become more optimistic about uture economic growthand the prospects or their businesses, they have been more willing to part with cash.

Generally, there are three ways companies can spend cash: 1) reinvest it (increase spending on research

and development, build new plants or hire more employees), 2) strategically acquire another company

or 3) return cash to shareholders in the orm o dividends or share repurchases. So ar this year, 226

companies in the S&P 500 have increased their dividends.

Dividend-paying stocks are presenting investors with an opportunity to replace declining income rom

bonds. The tradeo is essentially swapping interest rate risk or equity risk. With improving economic

conditions and large piles o cash sitting on the balance sheets o US companies, we think this is a

tradeo worth considering.

: : Nobody spends somebody elses money as wisely as they spend

their own.

Milton Friedman on why economic policies that cause people to have

some skin in the game are more eective.

4.00

3.00

January 1, 1999 March 29, 2012

5.00

1999 2000 2001 2002 2003 2004 2005 2006 2008 2009

1.0386

2007

STOCK YIELDS VS. 5-YEAR BOND YIELD


2 010 2 01 1 2 01 2

6.00

7.00

1.9538

Stock yields have trended upward asbond yields have fallen (1998-2012)

Bond Yields

Stock Yields

1.0386

1.9538


6/6

1950 University Avenue, Suite 202

East Palo Alto, CA 94303

tel 650-322-4000

eb www.nelsonroberts.com

email [email protected]

Past perormance is not necessarily a guide to uture perormance. There are risks involved in investing,

including possible loss o principal. This inormation i s provided or inormational purposes only and does

not constitute a recommendation or any investment strategy, security or product described herein. Please

contact us or a complete list o portolio holdings.

For additional inormation on the services o Nelson Roberts Investment Advisors, or to receive our

Newsletters via e-mail or be removed rom our mailing list, please contact us at 650-322-4000.

2012 Nelson Roberts Investment Advisors

SPECIAL TOPICS

Nelson Roberts Investment Advisors in the Community

Investment Team

Brian Roberts, CFA, MBA

Brooks Nelson, CFA

Dennistoun Brown, MD

Ann Oglesby, MD, MBA

Steve Philpott, CFP, MBA

For avid baseball ans, springtime marks the pinnacle o optimism surrounding

the prospects or a successul season. For many philanthropic organizations,

springtime marks the kicko o major undraising eorts to urther their

charitable missions.

Nelson Roberts Investment Advisors is a proud supporter o organizationswithin the communities we serve. The frm and its members donate both

money and time to the ollowing:

Menlo-Atherton Little League

Peninsula Humane Society

Santa Clara University

Menlo Park Atherton Education Foundation

Wildlie Conservation Network

Eastside Preparatory School

Canopy

Serra High School

University o Colorado College o Music

(Boulder, Colorado)

Stanord University

Boulder High School (Boulder, Colorado)

Documents

1st Quarter 2012 Commentary