Peattie Capital

What a year....

The S&P 500 gained 1.8% in December and finished the year with a 9.5% gain (excluding dividend reinvestment). Most Peattie Capital portfolios had a difficult December, and for the year Peattie Capital had mixed results. Income-oriented accounts performed well, but a number of other accounts delivered gains in the mid-single digit range. For conservative clients which have risk-management and preservation of capital as primary goals, a mid single digit return is acceptable. However, for clients with a "beat the index every year" approach Peattie Capital performed poorly.

While I understand the importance of performance measurement, I worry that obsessing over "beat the index" can be short-sighted and not appropriate for every investor. In the dot-com bust of 2000-2002, the NASDAQ dropped 80% peak to trough and the S&P 500 roughly 50%. For most Peattie Capital clients, especially those with a shorter investing horizon, losing less than the index won't matter much in a bear market, say a drop of 35-40%.

The current bull/bear debate

The most bullish prognosticator I've read is Ken Fisher, who points out (Forbes December 30) that a) about half the market's gain takes place in the final third of its duration and b) after comparable periods of "side-winding" as we've had the past 18 months, the average 24-month return was 39% with a range from -2.2% (1935) to +75% (1953-1954). In other words, very little downside and potential very strong upside.

Other bullish analysts have cited the expected pro-growth policies of the new administration, which will support economic improvement and better earnings. How much earnings accelerate remains to be seen.

The other side of the coin is that the markets have priced in lots of good news already based largely on hope and hypothetical. I would think the odds favor increased volatility, or at least more dispersion in returns across asset classes and styles (value over growth, e.g.). Consider:

• This bull market is the second longest ever (Source: Michael Santoli, CNBC, Jan 3) and the S&P 500 has more than tripled.
• At 19x, the S&P forward P/E ratio is higher than its long term average of approximately 15x and higher than recent bull market peaks of approximately 18.5x (2007) and 18x (2002)
• The Shiller P/E Ratio is now over 27x, "the highest since the market peaked in 2007." (Source: Whitney Tilson, Robin Hood Investment Conference, November 29)
• Valuation-wise, the markets are in the 10th (worst) decile, "the land that makes up the who's who list of 100 years of major bull market peaks." (Source: Hays Advisory, Market Outlook, December 15)
• This is NOT 1982, when multiples were mid/high single digits and the Fed was embarking on an easing cycle. Today's combination of extended multiples with higher rates could prove problematic.
• Higher rates are triggering another leg up for the US dollar, making US goods more expensive overseas and reducing earnings when international earnings are translated back into US dollars for reporting purposes. Tech gets nearly 60% of it's revenues from foreign operations (Source: David Rosenberg, Gluskin, Sheff, Dec. 12)
• Every Republican president since Eisenhower has experienced a recesssion in the first two years of his administration regardless of which party controlled the House and Senate. (Source: David Rosenberg, Gluskin, Sheff, December 30)
• The average interest today on the US Government's debt is 1.8% and on a net basis interest payments total $240bn. US gross debt is nearly $20 trillion. (Source: Grant's Interest Rate Observer December 23)

There are always predictions about the direction of the market, usually supported by some historical data. I think the odds of long-term investment success are better by focusing on specific companies and industries, rather than trying to predict how the market will respond to unknowable events. That said, I think the time to be cautious is approaching.

Here are a few of Peattie Capital's favorite opportunities, each of which has been a recent Peattie Capital recommendation

I recommended Abbott Labs ("ABT") in November after the CEO completed his second major open market purchase of shares in six months (totalling $60mm). Last week another executive bought shares, this time totalling $15mm, and in addition ABT announced it would close the St. Jude acquisition Jan. 4.

Monmouth Real Estate ("MNR") is known as a "mini Fed Ex" because of it's significant exposure to the delivery company. MNR owns 100 buildings in 30 states, and was running at 100% occupancy as of third quarter. Given the powerful tailwinds driving ecommerce, I think there is still good value in the shares, despite their 40% return in 2016. Current yield: 4.2%.

AMC Entertainment's ("AMC") strategy of modernizing theatres is paying dividends as renovated theatres grew revenues per screen 19% in Q3, vs. 10% for the industry. AMC expects to renovate 60% of their screens by the end of 2018 (from 25% today) and that is before getting into its recent purchases of Carmike and Odeon.

Broadcom ("AVGO") CEO Hock Tan continues to wring out excess expenses from recent acquisitions, and with the upcoming Brocade merger will be able to continue to do so. Management recently upped their guidance for EBIT margins from 40% to 45% (currently 39%) and also doubled the dividend to $4.08 annually. Current yield: 2.3%.

Cogent Communications' ("CCOI") mantra "smart people buy dumb pipes" continues to shine as revenues reaccelerated to 11% in the third quarter and have averaged 13% over the past 13.5 years (with no acquisitions). Increasing demand for bandwidth overall, especially as companies migrate to the cloud and residential users stream more "data-rich" content, will remain strong secular drivers for this low-cost provider. The CEO owns 10% of the company, which returns capital to shareholders via buybacks and an increasing dividend. Current yield: 3.9%

Based on what I know today, I expect to own each of these in most accounts for the time being.

Stock picking is still a good way to go

Peattie Capital believes that paying the right prices to own the right stocks is a good approach to the market. For some clients, depending on their specific characteristics, I might also overlay a tactical hedging program to protect against material downdrafts which might consist of boxing existing long postions, shorting, or raising cash.

For long term investors, I (generally) agree with Warren Buffett's comment that "All there is to investing is picking good stocks at good times and staying with them as long as they remain good companies." That is still the approach for most, not all, Peattie Capital clients as difficult as it is sometimes.

Here is an updated version of recent Peattie Capital recommended stocks, using closing prices from December 30.

This chart shows all PCM's recommendations for the past 24 months showing an average return of 16.3%. The total return of the S&P 500 in the comparable period is approximately 12.5%.

Additional recommendations are available on request. This table does not include speculative
and short sale candidates which are only appropriate for clients who have requested them.