Investment Strategy–November 24, 2015
We believe that stocks are currently selling at attractive valuations based on historical valuation measures. The Fund temporarily had a higher than normal cash position at the end of its fiscal year, due to concern regarding socio-economic and geopolitical events. One of these valuation measures is a company’s price earnings ratio (the “PE ratio”) relative to inflation, interest rates and the economic outlook. Another valuation measure is a company’s PE ratio relative to its forecasted earnings growth rate (the “PEG ratio”). Many stocks of high quality companies are currently selling at PE ratios and PEG ratios below their average historical ranges relative to inflation, interest rates and the economic outlook. We believe that they are attractively valued.
The U.S. Economy
The U.S. economic recovery that started in mid-2009 has continued so far in 2015. The U.S. economic recovery has been affected by a number of secular factors that are continuing to alter the pace and composition of growth. The U.S. economy in 2015 has been affected by greater prudence and less speculation in lending, low inflation and a higher savings rate. Although the U.S. economy is growing, it is growing at a lower than ideal rate. Currently, unemployment is around 5.0%. The Federal Reserve’s third round of economic stimulus, which involved purchasing open-ended mortgage-backed securities, has ended. This stimulus lowered longer term interest rates and added to economic growth. U.S. Gross Domestic Product (GDP) increased 2.4% in 2014, 1.5% in 2013 and 2.3% in 2012. GDP increased at an estimated inflation-adjusted annual rate of 1.5% in the quarter ended September 30, 2015. GDP is estimated to increase at an inflation-adjusted annual rate of 2.2% in the quarter ended December 31, 2015. GDP is forecast to increase 2.4% for the year ended December 31, 2015 and to increase 2.4% for the year ended December 31, 2016. For 2015 and 2016, the outlook remains for slower than ideal growth, accompanied by somewhat higher than normal unemployment, low inflation, a strong public sector and a weaker private sector.
U.S. inflation numbers have been helped in the last few years by global competition and technology innovations that are helping to lower production and distribution costs. Inflation, as measured by the Consumer Price Index, increased 1.6% in 2014, 1.5% in 2013 and 2.1% in 2012. U.S. inflation increased at a 0.1% rate in the third quarter of 2015. U.S. inflation is estimated to increase at a 0.5% rate in the quarter ending December 31, 2015. U.S. inflation is forecast to increase 0.2% for the year ended December 31, 2015 and to increase 1.8% for the year ended December 31, 2016.
There are some current and potential economic and investment negatives at the present time: (1) worldwide economic growth continues at a slower than ideal rate; (2) growth in Japan, Brazil and Russia has been weaker than many other areas; (3) the U.S. economy grew at a slower than expected rate in the third quarter partially due to a slowdown in inventory building, (4) new home sales and durable goods have recently been somewhat weaker than expected, (5) although continuing to improve, unemployment at 5.0% is still high; (6) mortgage rates are low, but mortgage credit is still somewhat tight; (7) the manufacturing sector remains mixed; (8) a widening disparity between higher and lower income levels; and (9) problems with the Middle East and other parts of the world.
Some current and potential economic and investment positives are: (1) monetary policy and financial conditions generally are very supportive of growth; (2) the U.S. economy has grown in the last twenty-four quarters and growth should continue in 2015; (3) the rise in residential property values and in stock market prices has added to net worth and households have strengthened their balance sheets; (4) consumer spending remains strong, (5) employment and payrolls are increasing with unemployment currently at 5.0%, the lowest in more than seven years; (6) although the Federal Reserve probably will be raising interest rates sometime in the next few months, interest rates will still be very low by historical standards; (7) gasoline prices are lower; (8) there has been an increase in the willingness of companies to commit capital as evidenced by the increase in merger and acquisition activity; (9) businesses have been able to use the credit markets to strengthen their balance sheets; (10) many companies are repurchasing their shares; (11) current valuations of stocks are below the midpoint of the historical average taking into consideration inflation and interest rates; (12) the U.S. economy currently has better fundamentals than the economies of most other industrialized countries; (13) China continues with stimulus for their economy; (14) many central banks worldwide continue with monetary stimulus to boost growth; and (15) worldwide economic growth does not appear to be strong enough to lead to a significant rise in global inflationary pressures.
The World Economy
The global economic recovery that started in mid-2009 is continuing in 2015, although at a low rate. The world economy is forecast to increase 2.9% in 2015 and to increase 3.1% in 2016 after increasing 2.7% in 2014, 3.0% in 2013 and 2.7% in 2012.
The Eurozone’s GDP is forecast to increase 1.5% in 2015 and 2.0% in 2016, after increasing 0.9% in 2014, decreasing -0.4% in 2013 and decreasing -0.5% in 2012. The United Kingdom’s GDP is forecast to increase 2.4% in 2015 and 2.2% in 2016 after increasing 2.8% in 2014, 1.7% in 2013 and 0.3% in 2012.
Among larger industrialized economies, Canada’s GDP is forecast to increase 1.2% in 2015 and 2.0% in 2016 after increasing 2.5% in 2014, 2.0% in 2013 and 1.8% in 2012. Japan’s GDP is forecast to increase 0.6% in 2015 and 0.9% in 2016 after decreasing -0.1% in 2014, increasing 1.5% in 2013 and increasing 1.9% in 2012. Korea’s GDP is forecast to increase 2.5% in 2015 and 3.0% in 2016 after increasing 3.3% in 2014, 3.0% in 2013 and 2.0% in 2012.
The biggest developing economies are many times referred to as the “BRIC” economy, which is short for Brazil, Russia, India, and China.
China currently has the second strongest growth among “developing economies.” It is also currently the world’s second fastest growing major economy. China’s population is approximately 18% of the world’s total population of approximately 7.3 billion. In the second quarter of 2010, China overtook Japan and became the world’s second largest economy after the U.S. Many economists believe that China has a particularly good long-term outlook. Near term, however, there have been cross currents in China’s economic outlook and growth has been slowing, although economic growth is at a high rate. China’s GDP is forecast to increase 6.9% in 2015 and 6.3% in 2016 after increasing 7.4% in 2014, 7.1% in 2013 and 7.7% in 2012.
India’s population is approximately 17% of the world’s population. India currently has the fastest growth among “developing economies” and it currently is the world’s fastest growing major economy. India’s GDP is forecast to increase 7.3% in 2015 and 7.3% in 2016 after increasing 6.9% in 2014, 4.6% in 2013 and 5.0% in 2012.
Brazil is Latin America’s biggest economy. GDP is forecast to decrease -2.3% in 2015 and -1.0% in 2016 after increasing 0.1% in 2014, 2.3% in 2013 and 0.9% in 2012. Russia’s GDP is forecast to decrease -3.7% in 2015 and increase 0.0% in 2016 after increasing 0.7% in 2014, 1.0% in 2013 and 3.4% in 2012.
Opportunistic Investing in Companies of Various Sizes and Diversified Among Various Industries
The Reynolds Blue Chip Growth Fund usually invests in companies of various sizes as classified by their market capitalizations. A company’s market capitalization is calculated by taking the number of shares the company has outstanding multiplied by its current market price. Other considerations in selecting companies for the Fund include revenue growth rates, product innovations, financial strength, management’s knowledge and experience, plus the overall economic and geopolitical environments and interest rates. The Fund’s investments are diversified among various industries.
The long-term strategy of the Reynolds Blue Chip Growth Fund is to emphasize investment in worldwide “blue chip” growth companies. These companies are defined as companies with a minimum market capitalization of $1 billion. In the long-term these companies build value as their earnings grow. This growth in value should ultimately be recognized in higher stock prices for these companies.