Ken Heebner's Q2 Letter To InvestorsVW Staff
Ken Heebner’s Q2 Letter To Investors
CGM Mutual Fund increased 4.2% during the second quarter of 2014 compared to a return of 5.2% for the unmanaged Standard and Poor’s 500 Index and 2.2% for the Bank of America Merrill Lynch U.S. Corporate, Government and Mortgage Bond Index. For the first six months of the year, CGM Mutual Fund returned 1.1%, the unmanaged Standard and Poor’s 500 Index, 7.1% and the Bank of America Merrill Lynch U.S. Corporate, Government and Mortgage Bond Index, 4.2%. In late June, the Bureau of Economic Analysis released a revised estimate for first quarter 2014 gross domestic product which indicated negative growth of 2.9%. Severe winter weather in much of the country was at least partially to blame, along with a late-falling Easter holiday though some pundits and media outlets were quick to predict a return to recession. However, data for the second quarter of 2014—specifically in housing and auto sales—suggests a rebound in economic growth.
CGM Mutual Fund: Market recovery after cold weather
In fact, with the arrival of milder weather as early as March, the economy began to pick up. The Institute of Supply Management’s manufacturing index rose to 53.7 from 53.2 in February, and March employment numbers clocked in at a respectable 192,000 jobs added. Inflation remained relatively benign with the Consumer Price Index rising a slight 0.2% in March and 0.3% in April. On the first Friday in May, April employment numbers were released with 288,000 jobs reportedly added. The following month, May new job numbers were made public and the addition of 217,000 new hires, in our view, effectively dismissed many of the winter fears of a returning recession.
Meeting in late April, the Federal Reserve Board voted once again to reduce its bond buying program by another $10 billion, lowering the rate to $45 billion monthly from a recession high of $85 billion monthly. Despite its continued confidence in the recovery, the Fed noted the housing market has been slower to rebound than other sectors of the economy. Then, in mid-May, April new housing starts were reported, soaring 13% though most of the gain was in multifamily housing starts, rather than single family homes. The month-over-month jump was primarily in the Northeast and Midwest, parts of the country hardest hit by the extreme cold weather earlier in the year. Existing home sales which comprise 90% of the housing market rose 1.3% in April, increasing for the first time in 2014 though still coming in at levels below one year ago. This may be attributable to an 11% spike in home prices in the past year along with mortgage rates that have risen nearly a full percentage point to increase a potential home buyer’s monthly mortgage outlay by as much as 25%. Yet, despite rising expenses, existing home sales in May increased 4.9% and new home sales jumped 18.6%.
CGM Mutual Fund: Auto sales helped economic recovery
Auto sales have provided a significant boost to the economic recovery with sales in May up to an annual rate of 16.7 million vehicles, the highest since February 2007. Credit remains available for purchases and with the average age of cars on American roads exceeding eleven years, we believe that auto sales are likely to continue at a healthy clip. Consumer Confidence, as measured by the Conference Board Index, is on the upswing from 82.2 in May to 85.2 in June which, in our view, also bodes well for auto sales.
A potential drag on the recovery is geopolitical uncertainty in the Middle East. The threat to oil supplies drove oil prices higher in the second quarter of the year and pushed the Consumer Price Index up 0.4% in May. The Fed noted the slightly higher inflation rate at its meeting in mid June, but again reiterated its confidence in the recovery by voting yet again to reduce its bond buying program to $35 billion per month.
The yield on ten-year U.S. Treasury bonds was 2.72% at the beginning of the second quarter, dropped to as low as 2.42% on May 28 and has since recovered to 2.52% on June 30. We believe most of the decline in yield reflects a “flight to safety” prompted by conflicts in the Middle East and Ukraine. With bond yields at such low levels, the S&P 500, which is selling at near all-time highs, is priced at 16.4 times this year’s earnings, which we consider to be a reasonable level.
On June 30, 2014, CGM Mutual Fund was 26.4% invested in U.S. Treasury securities. The three largest industry positions in the equity portion of the portfolio were in housing and building materials, electronic components and money center banks. The Fund’s three largest equity holdings were D.R. Horton, Inc. (housing and building materials), Lennar Corporation (housing and building materials) and Micron Technology, Inc. (electronic components).
Robert L. Kemp
July 1, 2014 President