New Team Member, New Year

April, 2013
By Darren Nyce, CFA
Senior Research Analyst, Castle Investment Advisors®, LLC

Before discussing the economic happenings and the market reactions of the first quarter, we wanted to acquaint you with the newest member of the Castle team, John Wheeler. John joined us at the beginning of this year and brings with him 17 years of experience in the industry. He has become the fourth member of our investment committee (along with Gary, Michael, and Darren) and will provide expertise to both the investment and planning sides of our business. He’s married, has 2 daughters, and lives in Fishers, Indiana. Most of his free time is spent with family as well as working on home projects, gardening, and the occasional bad round of golf. John’s approach is client focused and we look forward to you getting to know him in the months and years ahead. You will findincluded in this mailing an updated ADV (the form that the SEC requires of investment advisers describing the firm and its personnel) which includes John’s background and reflects all of Castle’s updated information.

When faced with headwinds that included rising taxes, government workers being furloughed, high unemployment, and continued economic difficulties in Europe, the stock market responded by rising to all time highs, eclipsing the levels reached in October, 2007.

Index 1st Qtr
1 Year Return 3 Year
Annualized Return
5 Year
Annualized Return
S&P 500 10.6% 14% 12.7% 5.8%
Dow Jones Industrial Average 11.9% 13.4% 13.3% 6.5%
Nasdaq Composite 8.5% 7.1% 12.1% 8.6%
Russell 2000 – Smaller Companies 12.4% 16.3% 13.5% 8.2%
MSCI EAFE – International 5.1% 11.3% 5% -0.9%
Barclays US Aggregate Bond -0.1% 3.8% 5.5% 5.5%

The following chart shows how the various sectors performed so far this year. Usually, when stocks rise rapidly as they did this past quarter, the sectors that are economically sensitive are the leaders. Notice in this case however, the sectors that are normally classified as defensive – Health Care, Consumer Staples, and Utilities – were the top 3 performers.

Some would argue that leadership by defensive companies could be a sign that investors do not have faith in the strength of the economy which could make it difficult for stocks to do well in the near future. However, it is also possible that this scenario is a reflection of an environment where investors are receiving low amounts of current income on money markets, Treasury Bonds, and CDs and have developed a growing appetite for yield, which can be found in these defensive sectors.

In the long run, the direction of the market is determined by how much profit each company earns. The following chart shows the Earnings per Share (shown by the bars and the scale on the right) and the Revenues per Share (shown by the line and the scale to the left) for the S&P 500 in the years since 2000 with 2013 shown as analysts’ estimates.

As you look at this chart, keep in mind the nice returns of 16% in 2012 and 11% so far this year. While companies are producing record profits, the revenue growth has been rather lackluster. So how is this possible? The next chart illustrates the remarkable run of profit margin expansion over the past few decades.

To gauge the profitability of the market as a whole we measure the after tax profits (of the companies in the S&P 500) as a percentage of the country’s GDP (Gross Domestic Product). This number has a historical average of 6.2% and is currently at 9.9%. Warren Buffet once commented that one has to be wildly optimistic for this number to remain above 6% for an extended period of time. While companies have done a terrific job of eliminating unnecessary expenses to enhance their profitability, it remains to be seen if they can continue to generate record earnings if these margins decrease to a more normal level.

Bright spots for the economy include growth in retail sales and automobile sales, representing rising incomes and the greater availability of credit. Inflation remains in check, coming in at 2%. Housing inventories are down and home prices are rising. Borrowing costs for both corporations and households remain quite low, while the Federal Reserve’s policy is to keep rates low for the foreseeable future. Most of the leading economic indicators show that there is a very low probability of recession in the coming months.

The most recent jobs data was the first poor report in several months. While the unemployment rate dropped slightly to 7.6%, a look behind the numbers reveals this was not due to job creation, but to half a million people dropping out of the work force. This will need to be stabilized in order for the economy to continue to gain real strength.

In this environment, we at Castle continue to beat the diversification drum, though to us diversification means an investment portfolio of more than just x% of stocks and y% of bonds. JPMorgan created the following chart that shows the performance over the past 18 years of a traditional 70/30 portfolio, consisting of 70% stocks (domestic and international) and 30% bonds. They compared this to a portfolio that added some diversifying components such as market neutral, commodities, Real Estate, and emerging markets. The results reveal that the more diversified portfolio achieved a greater return with less risk during this time period. We show this not to recommend this exact allocation (most of our client’s portfolios contain even more diversification elements) but only to serve as an illustration of the potential value that diversification could bring to a portfolio.

Thanks again for the opportunity to partner with you on your financial journey. You as our clients have our continued commitment to act in your best interest.

The Castle Investment Advisors®, LLC Investment Team

Tax, legal, and estate planning advice contained in this article is general in nature. Always consult an attorney or tax professional regarding your specific legal or tax situation.
This article was prepared for informational purposes only and does not constitute an offer to buy or sell, or a solicitation of any offer to buy or sell the securities mentioned herein. Information presented does not involve the rendering of personalized investment advice, but is limited to the dissemination of general information regarding products and services. It should not be regarded as a complete analysis of the subjects discussed. All expressions of opinion reflect the judgment of the author as of the date of publication and are subject to change. 
Any strategy discussed herein may not be suitable for all investors. Before implementing any strategy, investors should confer with their financial advisor. No current or prospective client should assume that the future performance of any specific investment, investment strategy or product made reference to directly or indirectly, will be profitable or equal to past performance levels.