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Quarterly Letter to Clients 

July, 2019

Indices at quarter-end (June 30, 2019):

    Dow Jones Industrials:             26,599.96       2Q'19            +2.59%          YTD      +14.03%

    Standard & Poor's 500:             2,941.76        2Q'19            +3.79%          YTD      +17.35%


I constantly ask myself, what is the easiest direction for the market? Is the greater risk in owning stocks, or in holding cash? These are not always easy questions to answer.

The pundits are pointing out that stocks and bonds are flashing differing signals. Stocks are saying that everything is going great, while bonds are saying caution is warranted.

The second quarter was strong but manic. April was a slightly positive month, with a gain of about 500 Dow points; in May the index saw fit to give up almost 2000 points; and by June, the herd decided to buy, driving that index up to new highs.

The two main drivers of those swings were the escalating trade-war rhetoric and interest rates.

For the moment, we seem to have forgotten about ďthe wall,Ē and about Canada and we are now concentrating on trade issues with Mexico and China.

It is possible, perhaps even likely, that we come to some agreement with Mexico. As relates to China, the recent ďcease fireĒ notwithstanding, while we may someday reach an accord, I doubt that we will ever have a true, enforceable trade agreement there. But the almost daily news on tariffs is what makes the market swing.

I have said this before: Tariffs are a tax on U.S. citizens; tariffs are not good for business. That is why the markets react so violently to them. Perhaps that tax is how our profligate government hopes to balance its budget.

The secondary factor in the market moves was interest rate pronouncements. After raising rates four times in 2018, presumably to dampen an ebullient economy, the Fed has decided that ebullience is over and telegraphed that it might lower rates. In late June, they deferred action, but hinted that a lowering was still on the table. Some observers expect two cuts this year.

The market will undoubtedly meet any lowering of rates with a cheer. But when the Fed stops raising and starts lowering, they are saying something important to the market: that things are not as rosy as they might appear.

The folks who research these things claim that our rate of growth is slowing. (Weíre still growing, mind you, just at a lesser pace.) They are looking at things like factory utilization, new home sales and auto sales, durable goods orders. Retailing and many malls are clearly suffering, victims of online sales and home delivery. Employment remains full, but layoffs are beginning to appear. Perhaps the researchers are right. Whether we are slowing enough to warrant a rate cut is my question. And if we are slowing that much, what does that portend for the markets?

The 10-year Treasury currently yields right around 2%. If it is true that the economy is slowing, I have difficulty seeing how an interest rate lower than that will help anything. When things eventually turn ugly, I am afraid that the Fed will not have anything left with which to stimulate. Maybe they will go negative, another recent phenomenon, internationally at least.

What I can tell you is that with rates as low as they are, and stocks as high as they are, it is very difficult to be a buyer of either asset class.

Look at new issues. Recently, Slack (which provides a variant of email) went public, and trades at over 30 times itís sales. For me, 30 times earnings is generally too high. (Of course, they use sales as a valuation point because there are no earnings.) Why we should use Slack rather than plain old email, or, *gasp*, the telephone, eludes me, not to mention how the company might ever earn money, but maybe Iím just old, maybe earning money is not so important any more.

Private companies are lining up to sell stock at these levels, an IPO boom not seen in almost two decades. Recent new issues and some on deck include Uber, Lyft, Chewy, Zoom Video, PagerDuty, Fiverr, Beyond Meat, AirB&B, WeWork, SpaceX, Palantir and SoFi. Some you may know, some you donít know. I donít think any of them have earnings. Some will survive and thrive, many will fall by the wayside. But their financial backers, private equity firms, will laugh enroute to the bank.

It is a frothy market, not unlike that of 1998-99. But, as in that earlier time, most of the froth is in new, untested companies. The stodgy, old-economy companies, the ones that provide us with food, electricity, clothing, banking, autos, fuel and dividends, are only marginally participating. As for me, I canít buy a company if I donít understand what they do. And I just canít bring myself to pay a multiple of sales simply because there are no earnings to multiply.

Plus, gee, I really like dividends.


Jim Pappas

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