John Dessauer Investments, Inc.

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Bartholomew Terry
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1 John Dessauer Investments, Inc. John Dessauer s market review and update as of Wednesday June 25, 2014 The Federal Reserve and the International Monetary Fund (IMF) have reduced forecasts for the U.S. economy this year. This is good news for bonds, but questionable for stocks. Stocks have been celebrating news that interest rates are likely to stay low well into next year and perhaps longer. There is a connection between interest rates and stock prices. As Wharton professor Jeremy Siegel has explained, bonds have adjusted to the current slow growth with low interest rates environment. Stocks, however, continue to trade at P/E multiples that prevailed during times when interest rates were much higher. His conclusions are that stocks are not overvalued and there is room for modest P/E expansion. He also has explained that a stronger economy, which would justify somewhat higher interest rates, would be good news for corporate profits and stock prices. In other words, slow growth and low interest rates go only so far in providing underlying fundamental support for stock prices. Because of the popular focus on interest rates, there is a growing risk that we may be heading for a more volatile stock market. As we saw last June, markets can move quickly without fundamental justification. Fear of higher interest rates pushed stocks down temporarily last year. That can happen again if P/Es keep expanding, or if we get news of real improvement in the rate of economic growth. The bottom line is to be prepared for stock market volatility, but don t lose sight of the fundamentals. We are just starting to see second quarter earnings. Indications so far are

2 that earnings, especially for technology companies, are likely to be better than now expected. Just two days apart, the IMF and the Federal Reserve issued updated and muted outlooks for the U.S. economy. The IMF now sees the U.S. economy growing at a 2% rate this year. That is down from an earlier 2.8% forecast. The IMF urges the U.S. to counter high unemployment and slow growth by increasing infrastructure spending and education spending, reforming the tax system - especially for corporations - and introducing a federal value-added tax. The IMF further concluded that a greater reliance on growth-enhancing fiscal policies could allow the Federal Reserve to retreat more quickly from its extraordinary monetary stimulus. However, the IMF said such an approach remained elusive. Without changes, the IMF sees U.S. interest rates remaining at extreme lows beyond the middle of next year and sees a return to full employment taking longer - to If pressed, I expect Federal Reserve Chair Yellen and her fellow board members would largely agree with the IMF s dismal assessment of the current state of growth in the U.S. economy. Economists in high ranking positions such as the IMF and the Federal Reserve have to be very careful. They want to be honest, but do not want to be pessimistic. They know their analysis and forecasts can influence major changes in financial markets. They prefer having markets react to fundamentals rather than their economic forecasts. That is why they go only so far in providing details about the reasons for the current economic malaise and the risks they fear could develop. Nevertheless, it is clear that the IMF believes Washington politicians are in large measure to blame for the

3 high unemployment and sub-par growth. It is also clear that the IMF does not expect the situation to improve any time soon. The board of our Federal Reserve has also revised its outlook for the U.S. economy. A month ago they expected growth of 2.9% this year. At their latest meeting they revised their forecast down to 2.1%-2.3%. Not wanting to provide fuel for the pessimists, the board also expressed confidence that the recovery is largely on track. And, as expected, the Federal Reserve reduced its monthly bond buying program from $45 billion to $35 billion. That is consistent with expectations of stronger growth ahead. U.S. Interest Rates There is disagreement between the IMF and the Federal Reserve on the outlook for interest rates over the coming year or so. The Federal Reserve board members see short term interest rates rising to 2.5% by the end of next year. That is an increase from their March forecast of 2.25%. The IMF economists see short term U.S. interest rates staying near zero beyond the middle of next year. The disagreement is the result of the dismal U.S. economic performance in the first quarter. The IMF economists see that as an indication of weak underlying fundamentals that will keep growth low for the next several quarters. The Federal Reserve board members believe bad winter weather was the culprit in the first quarter and that we will see a rebound this quarter and beyond. From a stock market perspective, we can hope our Federal Reserve is right, but be prepared for the slower growth the IMF expects. This is a time to stay invested in stocks in companies with strong balance sheets and solid cash flows When it comes to interest rates over the long term the Federal Reserve is in line with the IMF. The Federal Reserve has lowered projections for the federal funds rate in

4 the longer term to 3.75% from 4% last March. This is consistent with the IMF view that it will be several years before the U.S. grows quickly enough to reach full employment. The good news is that neither the IMF nor the Federal Reserve expects inflation or interest rates to become a threat to stock prices this year or next. The disappointing news is that neither sees growth increasing very much. That indicates slow growth in corporate profits and therefore stock prices. The days of 20%+ growth in corporate profits are gone for the foreseeable future. Profit growth of 6%-8% seems achievable in this environment. Add dividends of 2%-3% and stock holders can look forward to total returns far better than those of bonds or cash. Iraq The fighting in Iraq rages on. Oil markets are rattled, but prices have not soared. Iraq s current production is 2.5 million barrels a day. That, as can be seen from Libya, is not likely to fall to zero. Libya s oil production has fallen from 1.5 million barrels a day in 2011, to just under 1 million today. What disturbs oil experts is that Iraq was expected to be able to increase its production to 4.4 million barrels a day by the end of next year. That now looks to be out of reach. Oil prices are likely to stay above $100 a barrel. This is positive for oil producers such as BP, NYSE, BP, $ BP s stock price has moved higher to a 52 week high of $ Still, the generous dividend, $2.34 a share, provides a yield of 4.4%. BP remains an attractive long term investment. Rite Aid, NYSE, RAD, $7.20, reported first fiscal quarter results that some saw as disappointing. Earnings were $0.04 a share, down sharply from last year s $0.09 a share. That was the reason for the disappointment. Management, however, affirmed their

5 full year earnings guidance of $0.30-$0.40 a share. There was a lot of good news. Sales were up 2.7%. Same-store sales rose 3.1% and same-store pharmacy sales rose 4.6%. Rite Aid is not even half way along with its store remodel program. About 29% of stores have been remodeled to Rite Aid s wellness approach. These stores are showing strong growth in sales, both front end and pharmacy. Rite Aid is also adding mini-clinics, seven so far. They also are a source of strong growth for Rite Aid. The earnings decline was caused by rising drug costs, lower reimbursement rates, and higher taxes. Management has already made changes to restore profit margins and boost per share results. The details from the opening quarter are encouraging. Rite Aid s management has shown that the store changes are a source of sustainable growth. As more stores are remodeled, cash flows and earnings will grow. The debt is still a burden and a risk, but is beginning to come down. I am optimistic, but still rate Rite Aid as a hold. I will have the next market review and update for you one week from today on Wednesday July 2, All the best, John Dessauer June 2014

John Dessauer Investments, Inc.

John Dessauer Investments, Inc. www.johndessauerinvestments.com John Dessauer s market review and update as of Wednesday October 1, 2014 The Fed debates, the Dow dances, and the economy continues to move