2015 Year in Review

We at Bow River would sum up 2015 as an eventful and relatively challenging year for the U.S. economy and investment. The S&P 500 ended the year down 0.73%, representing its worst performance since 2008, with the DOW down 2.23%. The decline in the markets was accompanied by a rise in volatility largely due to market shocks from global headlines (think China and Greece) and fall out from a continued commodity price bust, which in a year filled with developments, we view as amongst the most salient as it relates to Bow River. Fueled by oversupply concerns in both the oil and natural gas markets, the Bloomberg Commodity Price Index declined roughly 25% during 2015, and at the end of the year stood at its lowest point in over 15 years.

On the sunny side, 2015 did bring with it a continued recovery in the U.S. labor market. In November, the U.S. unemployment rate stood at 5% down from 5.6% last December, and at times during the year, initial jobless claims figures flirted with 42-year lows. The strength in the job market was cited as a major factor in the Fed’s December decision to raise short-term interest rates for the first time in nearly a decade.

While strength in the U.S. labor market (and lower fuel prices) did bring with it some wage growth, and an associated uptick in consumer spending, we note that some of this benefit was not spent but rather absorbed by an uptick in the average savings rate in the U.S. to 5.5%. Overall, it appears that 2015 U.S. GDP will shake out in the 2.3% range, which while solid, is disappointing to those still waiting for a “real” recovery.

Another interesting 2015 development–particularly pertinent to Bow River–was a large divergence in the performance of the ISM Services Index vs. that of the ISM Manufacturing Index. Before last year, as the chart below demonstrates, these indices tended to largely move together; however, this year we have generally seen the opposite occur.

ISM Manufacturing vs. Services PMI Index

Source: Institute for Supply Management, Bow River Format

Bow River is more cautious than some about what is to come in 2016. Regarding the general economy, we believe that the Dollar/oil/low interest benefit to the consumption sector has likely peaked, which should slow the recent upward momentum in the personal consumption (70% of GDP) portion of GDP. Generally, a weakening dollar would be expected to benefit U.S. manufacturers, however, the ISM Manufacturing Index referenced above, and recent commentary out of major industrial companies, is supportive of our belief that weakness here will persist into 2016. Net-net, we believe this shakes out to 2016 GDP growth worse than 2015–in the 1.5-2.0% range.

Given our expectations for slowing overall growth in the economy and continued margin pressure, we expect minimal corporate earnings growth and a subsequent decline in the U.S. stock market as we believe the FY16 EPS multiple of 17.4x (on consensus EPS projections) to likely be on the rich side to begin with.

Regarding commodity prices, we stand in the “lower-for-longer” camp and think oil prices will be no higher than low $50’s by year end. This belief is predicated on the unwillingness of OPEC to curb production, together with our assumption that production out of several key non-OPEC countries (U.S., Canada and Brazil) will actually continue to rise in 2016 in spite of the low price environment, leaving the global supply/demand rebalance pushed out into at least 2017.

Global Oil Supply and Demand in MMb/d

Source: EIA, Bow River Format

We expect that the Fed will increase short-term interest rates further this year, but in small, uneven steps—not enough to have a material impact on deal flow in the lower middle-market buyout sector that Bow River roams. We believe that the overall LMM M&A market will remain active as strategic acquisitions remain a popular avenue for growth considering our expectations for low organic growth in the broad market. Therefore, we expect multiples to remain elevated, leaving it a difficult environment to put capital to work. We do think slower growth and higher debt costs will put some pressure on these valuations this year, and owners (sensing a market peak on valuations) may be more motivated to sell.

Bow River is reviewing 200+ company offerings per month. Markets/themes, we believe, to have an attractive outlook in 2016 are: cybersecurity, particularly related to the healthcare space, infrastructure services, particularly integrity and maintenance services, and factory security and automation. We plan to expand on these themes and other relevant developments in further updates throughout the year.

Lastly, we wish to extend 2016 well wishes to all of our investors, partners, and contacts, and as always we appreciate your continued support!

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