2015 Annual Shareholder Letter
By Mark Oelschlager, CFA
Co-Chief Investment Officer & Portfolio Manager
November 30, 2015
Dear Fellow Shareholder:
As it has for much of the current economic expansion, the US economy trudged forward over the last fiscal year, and the stock market seemed to approve, with share prices climbing modestly. The employment picture continued to brighten, with the unemployment rate falling to 5.0%, job openings rising to new highs, and unemployment claims declining to a 42-year low. This last statistic is even more noteworthy when one considers how much larger the labor force is today versus 42 years ago.
Over the past few years, waiting for the Federal Reserve to raise interest rates has been like waiting for Godot. A year ago the Fed was expected to have started raising rates by now, but underwhelming economic growth, periodic overseas crises, and low inflation have kept the monetary authorities on hold. That looks likely to change soon, as accelerating wage growth threatens price stability. In past cycles the Fed started raising rates before or just as wage growth started to pick up and well before the unemployment rate had fallen to 5%. So in that respect they are tardy this time. On the other hand, the Fed has rarely, if ever, tightened when inflation has been this low and GDP (gross domestic product) growth this sluggish. So with these conflicting signals the central bank is in a difficult spot, with no historic precedent.
We do expect the Fed to begin raising rates but are not as concerned as some about it negatively affecting the economy or stock market. Credit growth has not been ebullient, and historically stocks fare well in the initial stages of Fed tightening. More important than the launch date is the pace of hikes once the tightening starts. This will be dictated, as always, by various economic data that the Fed monitors. Given our portfolios’ large positions in the financial sector, which is currently being negatively affected by low rates, we would welcome a higher Fed Funds rate. Seeing the data on wages, the market has been pricing in higher short-term rates, as evidenced by the yield on two-year Treasury notes. From mid-October to late November 2015, such yields, which essentially are composed of forward (future) Fed Funds rates, rose from less than 0.6% to over 0.9%.
Persistently strong corporate profitability remains a defining characteristic of this economic cycle. The use of offshore labor, computers and robotics has increased profit margins and returns on capital to high levels, and to this point company managements have yet to compete it away. One source of frustration for many throughout this expansion has been the lack of aggression, or animal spirits, on the part of both corporations and consumers (merger activity is a notable exception). With memories of the financial crisis still in their minds, both companies and their customers have been somewhat reluctant to spend. This may be preventing the economy from reaching its potential, but it also is preventing a buildup of the excesses (such as debt) that typically undermine an expansion. This is another way of saying that while the calendar should be prompting us to prepare for recession, the fundamentals and actions of the key players suggest otherwise. The conservatism of managements is also helping profitability stay high, which is good for stock prices.
The current bull market has withstood many “scares” over the past several years, and the last twelve months have been no different. In June it was the prospect of Greece leaving the euro, and in August it was concern about China’s economy. In each case US stocks took a hit but bounced back. The selloff in August was sharp, and may have been exacerbated by exchange traded funds (ETFs), which have become increasingly popular. These vehicles allow one to essentially own a basket of stocks and quickly enter or exit the positions at any time during the trading day. This is representative of the “now” society in which we live, but like many innovations it is a double-edged sword. Rapid ETF trading to time the market can, and usually does, end up doing more harm than good, as few participants get the timing right. Of those who sold in late August (after the damage of the correction had largely been done) in order to preserve principal, few likely got back in before the rebound. This is why we believe in staying fully invested at all times and don’t attempt to time the market by using cash as a strategic asset. If one is lucky/skilled enough to get out at the right time, he or she still has to get back in at the right time. Pulling off both of these feats is rare.
Many well-known hedge funds were hit hard in the August correction but did not rebound. It has been an interesting time for hedge funds, which gained popularity in the wake of the financial crisis for their supposed ability to limit downside risk. But as the money has poured into these vehicles, returns have disappointed, especially in light of the rich fees they charge. For the five years ending October 31, the HFRI Fund Weighted Composite Index, a broad measure of US hedge funds, returned 3.15% annually. By comparison, returns for White Oak and Pin Oak, our two largest non-sector funds, were well into the double-digits. We suspect that investors will continue to be disappointed by the returns in hedge funds and other hot “alternative” products, which tend to be designed to fight the last battle.
Rather than getting caught up in the latest craze, our team is focused on timeless investment principles: weighing the long-term merits of each investment candidate and staying fully invested. In 2015 Oak Associates celebrated its 30-year anniversary, which would not have been possible without you. Thank you for the privilege of managing your money.
Mark Oelschlager, CFACo-Chief Investment Officer and Portfolio Manager
Oak Associates Funds
This manager commentary represents an assessment of the market environment at a specific 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 by the reader as research or investment advice.
Investments are subject to market fluctuations and a fund's share price can fall because of weakness in the broad market, a particular industry, or a specific holding.
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