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Quarterly Letter to Clients 

January, 2016

Indices at quarter-end (December 31, 2015):

    Dow Jones Industrials:             17,425.03       4Q'15         +7.00%          YTD      -2.23%

    Standard & Poor's 500:             2,043.94        4Q'15         +6.45%          YTD      -0.72%

And on the seventh year the market rested.  Just when we got used to stocks going ever higher.

Someone recently wrote that if you totaled up each day's move in the Dow Jones it would be roughly 30,000 points.  After all of that noise and smoke, we finish the year almost unchanged.  It is a bit comical.  But, you can't argue, the markets were due for a rest after their long run up.

During 2015, if it was any currency other than the U. S. dollar, it was lower.  If it came out of the ground it's price was lower; and if it was tied to interest rates, it traded lower as well.  Nor did stocks provide much shelter.  Cash proved to be a pretty good bet on the year.

For the second year running, the dollar was up against almost every other currency in the world.  We may not notice this in our day-to-day lives.  We are perhaps much more attuned to the price of oil, and it's derivative, gasoline, where lately we have been paying half the price of a year or so ago.  But it isn't just oil; almost all metals and minerals and many agricultural products saw dramatic price declines.  Oversupply seems to be the culprit.

Over in the bond market prices were lower across the board, as the Fed, in a widely anticipated action, closed the year by finally moving to hike interest rates after six years of bouncing along at near-zero.  Also in December a major high-yield bond fund ran into liquidity problems, exacerbating declines in bond prices that had otherwise been gradual during the year.

As for stocks, they were lower as well, breaking a run of six consecutive up years.  The decline was only marginal, especially in light of that run, which carried us up more than 100%.

So what might we look for in the new year?  In 2004 the Fed began raising rates with a 25-basis-point move.  They continued doing that each month for a total of 17 months, lifting rates from 1% to 5.25%.  By 2007 the cracks were beginning to show in the nation's economy and the Fed began cutting.  By 2009 we were at a level just above zero, where we have stayed until this latest move.

I relate this to show that it is not just the one move that might effect us, but rather the possibility of multiple moves that would take rates substantially higher.  During the financial crisis of last decade the Fed began pumping cash into the banking system.  Now they will try to pull that cash back out.  These moves have implications across the spectrum of investment assets and the economy as a whole. 

I do have to note that the Fed has said the push up will be gradual and I believe they will be true to their word.  What I expect is perhaps four to six more boosts over the next 12-18 months.  I also note that the Fed's action is a positive sign, indicative of the general health of the economy. 

For the year ahead it would not surprise me to see lower stock prices.  If you are a buyer, you should welcome the discount, as Warren Buffett has said on more than one occasion.  After all, every market drop in our long history has proven to be a good opportunity.  But, so far, outside of oil stocks, prices have not really come down enough to tempt a conservative investor like me.  Would you be tempted to go into a store that advertised "2% Off!"  You might think that they had skipped a digit.

Stocks and bonds are not garments, however, and when they get marked down by double-digit percentages, most people do not look at it as a good thing.  They get scared and think that something is seriously wrong.  The thought process is something like this:  if it is down 20%, maybe it will go down 40%.  As always, fear versus greed.

But it is difficult to imagine any meaningful decline in the overall stock market at this point.  So we must look for attractive entry points in individual issues.  I always look to be a buyer of quality equities.  I am, after all, a long-term investor.  In bonds, however, I believe that the thirty-five year bull market has come to an end, and it will be much trickier to generate the returns we have seen previously.  We shall see what the Fed has in store for us going forward, but I suspect that the best buys--and the safest--may be in shorter-term paper.  I have been holding higher than normal levels of cash in my stock and bond accounts and I am prepared to take advantage of opportunities when and if they appear.

I wish you a happy, healthy and prosperous new year.


Jim Pappas

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