Having reached a long-term goal a few months ago, I rewarded myself with a little break from monthly newsletters. I think it's time to get back to them, but on a quarterly basis. This bullet point format is meant to make the content easier to read and digest....feel free to let me know if that's the case and as always, I invite comments/questions, and I expect this will be posted on my website in a few days.
NOTE: Past performance is not a guarantee of future returns.
- The investing world has changed dramatically since early October. What had been a "buy the dip" mentality has become a "sell the rally" mentality, on the belief that global growth is slowing, that the Federal Reserve will continue to bump up interest rates, that financial conditions are becoming tighter, and that the "sugar high" of the tax cuts won't help earnings going forward. Signals of slowdown abound, from a flattening yield curve to select industries (autos and housing) and global economies, to drops in commodity prices. All of this is coming after a nearly 10-year rally, one of the longest in market history.
- To date I have largely stayed invested (client constraints depending), as I believe: 1) markets have 10% corrections somewhat frequently (once or twice annually) but unless there is a recession, they tend to regain their footing, and 2) broadly speaking economic conditions in the US are good. I don't expect 3-4% growth, but more along the lines of 2%.....not exactly a recession. Other countries' economies are growing at different rates, and have their own issues, but history has demonstrated that when the U.S. sneezes the rest of the world catches a cold.....NOT the other way around. All that said, the odds of a 2019 U.S, recession are increasing according to Morgan Stanley, which now puts the odds of one happening next year at 50% (Source: David Rosenberg, Gluskin Sheff Morning Comments Dec. 12, 2018).
- What's different this time is that the Federal Reserve is simultaneously raising short term rates and letting Treasury securities in their portfolio roll off, so there is more than the usual tightening impact. After recession, rising interest rates is at the top of my list of market concerns.....not to dismiss macro issues, they always exist, but predicting which ones the market will care about, getting the outcome right, and generating positive returns from doing so is not something I can do consistently. In addition, I don't believe I can successfully trade around headlines and tweets, and so my takeaway is to remain focused on what I believe the important trends are, to search for the right situations, and not to be distracted by noise.
- I believe the best chances for long-term investment success are in buying the right companies at a good price and staying with them over time, or as Warren Buffet would say, as long as they remain good companies. That said, I am careful not to "fall in love" with a stock or story, and to be mindful of the environment.
- I think the move to all things cloud/digital is still in the early innings, and overall I have a bias towards companies that are positioned to participate in that. Epam ("EPAM") and Globant ("GLOB") are examples of "digital ferrymen" who will have huge demand for their services and the biggest concern I have for them is whether they can hire enough good employees to satisfy that demand. Perhaps a revealing test of how this will evolve comes Thursday when Adobe reports....Adobe is the grandfather of the "SAAS" (software as a service) movement and as such is something of a bellwether for this theme.
- This is not to say that I own those types of companies exclusively. Abbott Labs ("ABT") and Independence Holding ("IHC") are the two biggest holdings across Peattie Capital portfolios and neither has anything to do with technology (except as a user of it). Being flexible, and a generalist, allows me to invest in a broad range of companies regardless of size or industry. ABT is a $130billion health care company which I noticed because the CEO bought $60million of shares a couple years ago and IHC is $.5billion insurance company.
- The recent volatility has brought valuations for many interesting companies back to reasonable levels. That said, in a recession, valuations will continue to contract. The potential for a meaningful (say 30%) drop in equity prices becomes increasingly possible, not just because of the lower earnings and lower multiples, but also because of the knock-on effects as individuals sell ETFs, which are in turn forced to sell their positions, which in turn induces momentum traders to sell, which in turn triggers algos to sell....it's a self-reinforcing downward spiral. Noteworthy is that in today's world the same holds true for the upside, with the net effect that the market can go to further in both directions than you might think...and probably faster too.
- Consumer staples (think McDonalds ("MCD") or General Mills ("GIS")) have been beneficiaries of the recent selloff, but are now trading at mid-20's multiples (the S&P 500 is about 15x) and over the past 10 years they really haven't grown much at all. I am much more interested in individual companies/securities than chasing the "flavor of the day" in terms of asset class, style, or geography. As Jim Grant says (paraphrasing) "successful investing is when everyone agrees with you later."
- In IRAs I have been much more likely to take profits as there are no tax consequences. However in taxable accounts, selling anything this year (well, almost anything) will result in material capital gains taxes next year, as many positions have appreciated significantly. Plus, doing so begs the question of when to get back in....which, if experience is any guide, won't feel comfortable until after a name (or the market) has bounced 30% off its low. The most successful accounts this year are ones where Peattie Capital manages both a taxable and non-taxable portfolio as I can reduce overall market risk by raising cash in the non-taxable account.
- I recently read (Grant's Interest Rate Observer November 30, 2018) that "in the year through mid-November, 90% of dollar denominated asset classes tracked by Deutsche Bank delivered a loss-the highest losing share since at least 1901....." Subsequently the article states "In the runner-up worst year, 1920, 84% of the then-37 monitored asset classes were in the red. In 1931, arguably the worst year of the Great Depression, 77% of asset classes made losses." In other words, this year has been remarkable in that there is nowhere to hide, and that broad-based diversification is limited and can be least effective when you need it most.
- Most recently Chairman Powell has been somewhat more dovish in his comments, and markets are now expecting a December hike and hoping for continued dovish commentary and a reprieve of some sort in 2019. Lately the markets have responded to every comment he makes, and I expect that to continue. Overall I would guess that if the 10-yr. treasury note doesn't rise materially above the 3.25% area (currently about 2.90%) that markets (indexes) are ok for the time being. Higher (and rising) interest rates are a clear headwind for equity prices as they provide a reasonable investment alternative, reduce market multiples, and generate a lower present value of future cash flows.
- Other things I'm concerned about: The market cap of the Wilshire 5000 is roughly $30trillion, about 1.5x US GDP of roughly $20trillion. This is an extreme level which has been this high in the past but never higher. (Source: Murray Stahl, Horizon Kinetics Q3 2018 Commentary). In addition, the U.S. Bureau of Economic Analysis reported after-tax U.S. corporate profits in 2017 of $1.8trillion which "marginally exceeded the 2012 level and was less than the 2014 level" (Source: IBID). Inflation has been reasonably tame given the tight labor market, but any uptick here could be problematic. It's difficult to come up with a strongly bullish scenario when valuations are this high, which is another reason I prefer individual security selection.
- 2019 Game Plan: KDWID (Keep Doing What I'm Doing). A few recent noteworthy items for Peattie Capital positions: The CEO of Howard Hughes ("HHC") bought $5mm of shares (two other insiders also bought small amounts); Mirati Therapeutics ("MRTX") expects to put one (of two) drugs into a patient in January; and DowDuPont ("DWDP") is about to split into three (Ed Breen, CEO, did this a few years ago at another company and created significant shareholder value). Also, and only for accounts that are ok with it, I have a few shorts, and I may add more. As far as shorting is concerned, it is very risky, and not for everyone. Short positions tend to be only 2% or so per name in portfolios where they exist.
Reminder that Peattie Capital manages separate accounts and so all of these comments are within guidelines established between myself and the client. Please feel free to contact me with questions or comments.