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2011 ended rather quietly after a stormy and strident October and November. With a presidential election looming here (and in almost 30 other countries) and the euro zone still unsettled it is not hard to see that this was a holiday respite and that the next few months could remain volatile. The surprising good news in the quarter was the gradual strengthening of the U.S. economy, especially in light of the widespread view held at the end of the third quarter that a recession was imminent. The economic data that was released in October showed a few weeks in August where activity dramatically slowed and then resumed and strengthened after Labor Day. Manufacturing activity improved during the quarter and the November unemployment report showed an improvement in private sector hiring, although some of that is being offset with public sector layoffs.
It looks like, for the third straight year 2012 will show slow real GDP growth of 2% to 2 ½%. This may be more impressive than it seems at first glance as there will be no help from exports to Europe. The greater certainty of a recession in the euro zone, our largest trading partner, means the U.S. economy will be reliant on domestic and Asian demand to produce even the predicted slow growth rates. The Federal Reserve has committed to keep short interest rates near zero until 2013. Unlike the past two years there are not a lot of predictions that longer term rates, represented by the ten year U.S. treasury, will rise. This may be a contra indicator, but at this time there seems to be little reason to expect a spike in rates this year.
With the uncertain European outlook, even more so than usual the year-end earnings season will be particularly important in providing some clarity for the year. We will be watching closely for management’s outlook on demand, particularly in international markets. The Edgewood portfolio does derive approximately 45% of its revenue from overseas operations, but that is biased more and more towards Asian and specifically Chinese markets. The earnings growth outlook for our portfolio has not changed; we just expect a shift in the sources of that growth. What we need is a halt to the P/E ratio compression that has occurred in the last two years, even a flat outlook would provide a double digit return year for Edgewood.
In the quarter we sold the remainder of our First Solar position as we anticipate continued decreases in solar panel prices to keep pressure on margins. We also sold Expeditor’s International in anticipation of somewhat slower world GDP growth that in our view would lead to decreased volumes and inevitable pressure on their top-line growth.
In the fourth quarter we added Mead Johnson Nutrition, the world’s largest maker of baby formula. This company is a high quality direct play on the Chinese consumer, with the leading formula market share. Several contamination scandals involving Chinese brands over the last few years have driven customers to foreign manufacturers; Mead follows strict FDA protocols in their plants. In China a growing middle class and an increase in working women will drive demand for Mead’s products. We also added Ecolabs, a very steady growth company that provides cleaning products and services to restaurants, hotels and other institutions. With their recently closed acquisition of Nalco, a leader in water treatment, they have broadened their product line and market reach. We are particularly interested in a water treatment system Nalco is introducing to clean waste water from the hydro fracturing of gas wells.
The leadership change to high quality equities began last year and the mid-year debt ceiling/euro shock waves strengthened the trend. We expect that solid balance sheets and predictable growth rates will be in demand in 2012. We want to wish you a happy and prosperous year. |
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This material represents an assessment of the market environment at a particular
point in time and is not intended to be a forecast of future events or a
guarantee of future results. This information should not be relied upon as
research or investment advice regarding the fund or any stock in particular.
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