Ken Heebner 2013 Letter: Continued Bets On Rising RatesVW Staff
CGM Mutual Fund increased 8.1% during the fourth quarter of 2013 compared to the Standard and Poor’s 500 Index which grew 10.5% and the Bank of America Merrill Lynch U.S. Corporate, Government and Mortgage Bond Index which declined -0.2% over the same period. For the twelve months ended December 31, 2013, CGM Mutual Fund increased 21.0%, the S&P 500 Index returned 32.4% and the Bank of America Merrill Lynch U.S. Corporate, Government and Mortgage Bond Index fell -2.3%.
Ken Heebner: The Year in Review and Economic Outlook
The economy continued to gain traction in 2013 though the recovery was choppy, uneven, and from time to time, seemed almost to stall. The housing market rebounded in many parts of the country and unemployment numbers declined, lifting consumer confidence and, as the year drew to a close, reassuring the Federal Reserve Board and also the equity markets, which closed the year in record territory.
The new year 2013 dawned with Congressional action in January raising taxes for some, but preserving the “Bush tax cuts” for those earning less than $400,000 annually. The higher tax rate for wealthier Americans went largely unnoticed as single family housing starts and sales of existing homes took off in the first two months of the year and more than a quarter of a million new jobs were added to the economy in February lowering the unemployment rate to 7.7%. The consumer, however, was not impressed: the Conference Board’s Consumer Confidence Index dropped from 65.1 in December of 2012 to 58.6 in January 2013 with a bounce back to 69.6 in February and a drop again to 59.7 in March. Restoration of the payroll tax in January and the advent of “sequestration” cuts in Federal government spending in March may well have influenced sentiment.
The second quarter of the year opened on a down note with the release of disappointing March employment numbers and the Institute of Supply Management’s (ISM) nonmanufacturing index which fell to 54.4 in March, a seven month low. The jobs report, however, was better in April reducing the unemployment rate to 7.5% and the May jobs report was stronger still. The consumer took note and the Conference Board’s Consumer Confidence Index jumped to 69 in April, to 74.3 in May and up again to 81.4 in June. The Fed was harder to convince and held fast to its “quantitative easing” bond buying policy. Nonetheless, longer term interest rates began to move in May with the yield on the 10-year Treasury bond rising from 1.63% in early May to 2.13% at the end of the month. In mid-June, the Fed intimated that it might “taper” bond purchases should the recovery remain on track and the yield on the 10-year Treasury bond jumped to 2.61% on June 25, an increase of nearly one full percent in just one month.
Strong new home sales in June were reported early in the third quarter, up 6.8% from July of 2012, although these sales figures were still somewhat less than healthy from a historical perspective. July new home sales, however, were abysmal, down 13.4% from the prior month while auto sales soared 14% year-over-year and a decrease in jobless claims pushed the July unemployment rate down to 7.4%. Housing sales rebounded in August and U.S. manufacturing ended the quarter on a strong note with the ISM’s Purchasing Manager’s Index closing out September at 56.2, its fourth straight monthly gain and highest mark since April of 2011.
Consumer confidence, as measured by the Conference Board’s index, which had remained in the 80-81.5 range over the third quarter plunged to 72.4 in October, probably at least in part as a result of the 16-day partial Federal government shutdown and debt ceiling squabbling. On October 9, President Obama nominated Janet Yellen to replace Ben Bernanke at the helm of the Federal Reserve Board in January. Like her predecessor, Ms. Yellen is a proponent of easy monetary policy and seems unlikely to pursue a higher interest rate policy in the near future. New jobs were added at a rate of 204,000 in October and 203,000 the next month pushing the unemployment rate down to 7.0% in November. Inflation, as measured by the Consumer Price Index was muted coming in at 1.2% (annualized) in November. Consumer confidence declined again in November, though only slightly, to 72. The Fed met on December 17 and 18 and announced it would begin to scale back its $85 billion bond buying program by $10 billion per month in January 2014 with further reductions in store if the economy improves and the jobless rate further declines. The announcement underscored the Fed’s conviction the recovery is sustainable and sent major stock indices to new highs at year end while the Consumer Confidence Index rebounded to 78.1 for December.
The yield on the 10-year U.S. Treasury bond began the year at 1.76% and closed 2013 at 3.03%, which is still historically low, especially compared to the S&P 500 Index’s 6.5% estimated 2014 earnings yield. We believe the U.S. equity market offers better value than the bond market and will continue to do so in 2014.
Ken Heebner: Portfolio Strategy
CGM Mutual Fund was positioned in a way designed to benefit from growth in the United States economy during 2013. The largest industry concentrations were in money center banks and homebuilding companies. The Fund also owned a number of economically sensitive companies which we believed to have favorable prospects. The banking stocks contributed significantly to the Fund’s performance as did positions in the personal care (consumer products), containerboard (packaging) and airline industries. Homebuilding stocks held by the Fund were significant underperformers during the year. The homebuilding companies we owned reported strong earnings growth, but price appreciation in these stocks was limited as, among other factors, investors remained skittish fearing the negative impact of rising mortgage rates as well as affordability constraints in the face of increasing home prices.
Investments in the automobile and semiconductor (peripheral) industries also negatively affected the Fund’s performance.
The fixed income component of the portfolio fluctuated between 23% and 27% of total Fund assets during 2013 and was invested exclusively in short term treasury notes in anticipation of rising interest rates.
On December 31, 2013, CGM Mutual Fund’s three largest industry positions in the equity portion of the portfolio were in housing and building materials, money center banks and leisure. The three largest nusequity holdings were Morgan Stanley (NYSE:MS) (money center bank), Nu Skin Enterprises, Inc. (NYSE:NUS) (consumer products) and D.R. Horton, Inc. (NYSE:DHI) (housing and building materials). The Fund was 26.9% invested in short term treasury notes.
Robert L. Kemp
G. Ken Heebner