2013 Q4 Client Letter

Dear Clients:

Happy New Year! We are pleased to share with you our overview of investments as well as other exciting news for our firm.

We welcome Theresa O’Donnell to our team as our Client Services Manager, where she will be assuming some of the responsibilities previously managed by Cheyne.  She comes to us from US Trust where she was working with their wealth management clients on their investment, trust and banking needs.  You can reach Theresa at 800.685.7884 or todonnell@nwic.net. We are also excited to share that Cheyne has been promoted to Associate Portfolio Manager where he will continue his analytical work on both stocks and bonds.

In today’s busy world we want to make sure that as your trusted investment partners, we are sharing with you relevant and important investment and wealth planning information.  We invite you to take a moment to review our blog linked to our website www.nwic.net where we discuss topics of interest in the capital markets and others areas we believe may be important to you.  You can also follow us on Twitter where we tweet links to our blog as well as other informative articles. Follow us on Twitter by searching for @NWInvestment. We also invite you to follow us on our LinkedIn company page where we post articles of interest.  Finally, please know that we are a here for you and we are always just a phone call or email away.


Stocks wrapped up one of the best years in quite some time, as various market indices were up anywhere from the high-20%  to high-30% range, depending on how one slices up the stock market.  While final numbers won’t be in for a few months, it looks like earnings growth for the S&P 500 will be in the 10% range.  Our calculation tells us that the price-to-earnings ratio (P/E, a simple but very common valuation metric) rose during the year (earnings went up, but prices went up even more).  In fact, at the start of 2013, the trailing 12 month P/E was 14.7 and rose to 17.2 by the first days of 2014 (source: S&P 500 operating earnings).  To us, that seems slightly on the high side given the current macro-economic environment and based on our fundamental, company by company, research process.  As we look at companies to buy for inclusion in client portfolios, we see a lot of fairly-valued, and even over-valued stocks.  Bargains are fewer and farther between than they have been in some time.

That said, it is not time to press the panic button, in our view.  The economy appears to be strengthening, stubborn unemployment may be coming down slightly, and inflation is still benign.  A big key is the continuation and pace of the Federal Reserve tapering its bond purchases as this will most likely push interest rates higher.  All else held equal, higher interest rates create a headwind for stock prices.  However, the various moving pieces of the economy as a whole, and the specific results of individual companies, result in complex outcomes.  So, we continue to own a portfolio of stocks that we think offer good potential, and are searching for additional stocks to own but are finding the list of suitable candidates to be shorter than normal.

NW Equity Income

Equity Income stocks – stocks that pay above average dividends – continued to be in favor with investors looking for income.  With bond yields at low levels throughout the year, many investors were willing to take the additional risk of owning a stock and capturing a dividend yield that might be three to four times what the bond market was offering.

In corporate news, 3M announced a 35% dividend increase and also raised the amount it expects to spend on share buybacks from 2013-2017 to between $17 billion and $22 billion.  Also, Sysco Foods announced it is purchasing rival US Foods in the fourth quarter.  There were many more news items, but these are a couple of the more noteworthy.

For the year, you may recall we trimmed back a number of consumer stocks as they grew to be large positions and towards the expensive side of things.  This would include companies such as Sherwin Williams and Home Depot.  Also, we completely sold our position in Exelon subsequent to management’s decision to reduce its dividend.  Potash was our most recent purchase in this portfolio.

Looking back to the beginning of 2013, recall that AbbVie was spun out of Abbott Labs on January 1st.  Abbott has done well without the pharmaceutical business, and in fact, will be increasing its dividend 57% in 2014.

NW Blue Chip Growth

Large multinational firms, which populate the Blue Chip Growth portfolios, performed well during the year and the fourth quarter, and our picks as a whole were slightly better than the market.  Trading activity was fairly muted throughout 2013 in this portfolio to our advantage.  Some of the laggards from an industry standpoint were utilities and REITs, both of which are generally viewed as income vehicles.  We avoided both areas (having sold our REIT position early in the year).

Every quarter brings a host of corporate news items, a few of which we highlight.  Oracle continued to be active on the acquisition front, announcing that it is purchasing Corente, a cloud-based services company.  This continues Oracle’s activity to expand its presence as more and more activity is moving to the cloud.  Microsoft announced in Q4 that it was increasing its dividend 22% over the prior quarter.  As growth has slowed somewhat for Microsoft over the last few years, it has been fairly diligent in returning cash to shareholders via growing its dividend payout.  Automatic Data Processing, or ADP, increased its dividend by 10%, marking the 39th consecutive year it has raised its dividend.

NW Smaller Companies

Our Smaller Companies portfolio performed well in the year.  This portfolio has a mix of small- and mid- cap stocks in it, which turned out to be the best performing areas of the stock market this year.

Shortly after December 31st, we did sell all of our Janus Capital Group holdings after a decent run-up in the stock in 2013.  Part of our thesis was that Janus needs to merge with a larger asset management firm, but that seems unlikely since they inked a deal with Dai-ichi Life Insurance Co Ltd in 2012 which includes a 15-20% stake in Janus for Dai-ichi.

In reviewing the year, the two most significant transactions of the year were the purchase of Navigant Consulting (NCI) in Q2 and our continuing sale of CoStar Group (CSGP); a solid company, but a stock price which leaves little margin of safety.


Many people have said, “I’m so thankful 2013 is over.  I couldn’t wait to see it go.”  While not all of you may agree with that statement, we can be thankful that several events in 2013 didn’t occur.  For instance, we avoided multiple sovereign debt crises/cliffs, sidestepped a double dip recession, and avoided a complete destabilization of the Middle East.  We do live in interesting times.

If we contemplate the effects of these and other world events on the performance of the average investment portfolio, we see that while the connections may not be obvious, they are pronounced.  For instance, just the idea of ending quantitative easing (QE) in September was enough to send interest rates higher, bond prices down, and stocks into a correction.  However, now that tapering of QE has begun, we can forget about trying to predict its beginning and start concerning ourselves with what a more normal Fed policy holds.  What do we mean by “normal”?  For starters, no QE, in any of its iterations, and open market policy that more closely adheres to the historical target levels of inflation and unemployment.  The road to a life without QE will be varied and long; the government does nothing quickly.  As we approach this long awaited environment, a few comments regarding our portfolio management style seem timely.

For several years our bond portfolios have been managed to a few main tenants.  First, manage portfolios to a target duration.  Second, insist on high credit quality.  Third, seek opportunities in corporate debt.

Currently, the NW Intermediate Fixed Income strategy target duration is lower than its benchmark, the Barclays Intermediate Government Credit index, which stands around 3.75.  The lower your duration the less your bond price will change as interest rates change.  This is one of the main reasons NWIC is keeping duration low.  The other reason is that we believe longer maturity bonds do not provide a favorable tradeoff between risk and return.

Another characteristic we look for in bonds is high credit quality.  Many investors are tempted to reach for yield by lowering the acceptable credit standards for inclusion into the portfolio.  This can be very dangerous.  It’s not that high yield bonds are inherently bad.  The question is, are you being compensated for the risk you are assuming?  If you buy a junk bond yielding 5%, what have you gained?  Sure you received a few more percentage points of return over the life of the security, but what is the probability that bond will default?  Well, based on data from Moody’s spanning the period 1970-2010, over 20% of bonds beginning the year rated “Ba” (the highest speculative, or junk, category) defaulted after 15 years.  Call us old fashioned but, we are generally unwilling to take that kind of risk with the safest part of your investment portfolio.

Our last bond management guideline is to manage corporate debt exposure.  Corporate debt can be an enticing place to put your bond money due to typically higher yields than government debt, but the risks are greater.  Our exposure at any given time limits our risk while still providing an increase to overall portfolio performance.  As interest rate rise, these higher yielding and typically shorter maturity securities will play an important role in your portfolios performance.

These are several of the important criteria we look for when buying fixed income securities and we continue to manage bonds as the safest part of your investment portfolio.  As 2014 unfolds we are sure to see the gradual withdrawal of Fed stimulus and with it a less constrained level of interest rates.

We thank you for the trust you have placed in Northwest.  Alleviating the responsibility that comes with managing wealth is what we do. Numerous studies show that the individual investor’s emotions take over when it comes to managing their own money and thus they underperform the markets.*  We would be more than happy to have an initial meeting with anyone you know that is looking for assistance in the management of their wealth.

Should you have any questions or would like to set up a quarterly portfolio review meeting, please do not hesitate to contact us at 800.685.7884.