Virtually every morning our investment committee engages in a lively exploration of many topics. These discussions range from viewpoints on the macro economic environment, to geopolitical issues, market trends, sector developments, company specific changes, etc. You would find the subject matter quite diverse. Often we introduce our own analytical research to the conversation, outside news coverage of an issue, our opinions, and so on. The assessment of the subject of this newsletter changed as quickly as anyone here can remember in the almost 41 years since Jack founded the business.

It took five to six weeks to change our minds regarding the near-term path of interest rates. Toward the end of 2015 and beginning of 2016 global stock markets were declining in part due to observations of China and the oil patch. China had been the marginal purchaser of a lot of goods, including commodities, during its building binge of the early 2000’s and into the current decade. In fact, as shown in Exhibit 1, China poured 47% more cement between 2011 and 2013 than America did during the entire 20th century. So that nation had a voracious appetite for all things related to construction – whether it was building out of the need for use or the need for growth itself is another question. That means that an emerging market country, who may only produce one commodity such as iron ore, may have become dependent on China for its GDP growth. When China slowed its growth, the marginal supplier, such as the iron ore supplying emerging market country, got squeezed.

This slowdown in Chinese growth coupled with the slowdown in the oil patch as a result of oversupply led to pressure on growth in several foreign markets. The speed of that slowdown led us to reevaluate our view that the United States Federal Reserve (Fed) would increase interest rates several times during 2016, benefiting our portfolio’s financial institutions’ earnings. It became clear that the state of the global economy would inhibit the Fed from raising rates as much as we expected. With foreign growth slowing and the US dollar rising, it would disadvantage the US to raise interest rates as much as we previously assumed. Graph 1 shows the path of the 30 year treasury rate (in blue) and the price (in red). Although the 30 year rate rebounded recently, you can see the decrease from the end of 2015 through February. The idea that rates could remain lower for longer led us to diversify some of our financial institution holdings.

We began to accomplish this by continuing the investment strategy followed since the 2008 financial crisis – investing in larger US companies that can grow faster than the general economy. We believe that we made great progress in that direction and remain pleased with the complexion of the portfolio. As you know, we have remained out of oil and gas stocks since August 2014 and retail stocks since early 2015. That remains our approach. However, like with financial institutions, our view on any one sector of the economy can change as a result of our ongoing research and we will likely own stocks in those sectors within the portfolio in the future.

Thank you for choosing Darrell & King to protect and grow your assets!