Economic & Market Overview
The third quarter was the worst of the year for broad stock and bond market indexes, all of which finished lower. Stock prices faltered on fears of slowing growth, and bond prices dropped as interest rates continued to rise. The bright spots for the quarter were in commodities and the US Dollar, each of which rallied during the period.
Index Results 2023
|S&P 500 – Gross Return
|MSCI EAFE – Net Return
|Bloomberg U.S. Aggregate
|Bloomberg Global Aggregate
|Bloomberg Commodity Index – Total Return
|MSCI EM (Emerging Markets) IMI – Net Return
|Russell 1000 Growth – Total Return
|Russell 1000 Value – Total Return
|U.S. 10-Year Yield
|U.S. Dollar Index
Source: Bloomberg Finance LP
Global Value Investment Corp.’s (GVIC) three strategies all had positive results for the quarter, outperforming their respective benchmark indexes. We believe this is the result of our concentrated holdings, which allows us to focus closely on the underlying fundamentals of each of our stock and bond investment holdings.
Economically, we continued to see improving inflationary trends, stable to slightly rising levels of unemployment, a leveling off of energy prices as the quarter ended, and — as desired by global central banks — evidence of slowing economic growth, which has alleviated inflationary pressure.
At the end of 2022, economic pundits were broadly calling for a recession in 2023. Q1 and Q2 produced solid economic results (as measured by gross domestic product, or GDP); Q3 GDP has not yet been reported, but we expect it too will reflect economic growth, albeit at a slowing pace. It’s hard to see GDP in Q4 indicating a recession, even with the current slowing trends we have observed in economic data. Signs of slowing demand continue to appear in economic and corporate earnings releases, but the issues that have plagued businesses over the past twelve to twenty-four months, including supply chain disruptions and labor shortages, have generally abated.
Over the past three years, we’ve witnessed a new discipline across the companies that issue the bonds in which we are currently invested. A near singular focus on deleveraging their balance sheets is evident. Debt has been repaid or refinanced at a magnitude we’ve never seen – all for the better. This suggests that most companies may be in better shape to weather the current environment of higher interest rates and slowing demand considering their substantially reduced debt loads. The notable exception to this discipline has been governments across the globe, which generally added sizeable amounts of debt, with the US leading the pack (this is a topic for another letter). We don’t think the US government will default on its debt as long as it has taxing authority, despite the continued fiscal battles occurring in Washington, DC.
Recent comments from US Federal Reserve Bank (the “Fed”) members have been rather dovish, suggesting an end to the current rate-hike cycle may be in sight. The Fed’s next announcement will be on November 1.
The Fed’s logic has been to raise interest rates in an attempt to slow demand which would allow supply of goods and services to reach an equilibrium level. At this point, we would expect prices to stabilize, as supply and demand are balanced. The Fed targets a 2% annual rate of inflation; the most recent inflation report (as measured by the Consumer Price Index for All Urban Consumers) came in at 3.7% on a trailing-twelve-month basis — a vast improvement from the peak measurement of 9.1% in June 2022.
Basic economics dictates that prices will move to a level where supply and demand balance. In the absence of adequate supply, prices will rise. If prices become too high, demand will decline, and supply will contract. Over the past two years, demand exceeded available supply, causing prices to rise (inflation). This was due in large part to: a) changing consumer habits, b) more discretionary income available by a near fully employed labor force along with government stimulus programs, and c) extended and unanticipated disruptions in the global supply chain causing inadequate supply to meet demand. Those trends have by and large corrected themselves or run their course. We are seeing a steady reversion to an equilibrium as the rate of price increases has slowed, as reflected in current inflation data.
A big concern among market participants across most classes of securities is the threat of recession, which is when an economy experiences contraction (consecutive periods of negative growth). To date, nearly all global developed market economies have shown amazing resiliency to higher interest rates and contracting demand. Central bankers hope to orchestrate what they call a “soft landing”, or in “Goldilocks terms,” not too hot, not too cold. We suspect a recession is not immediately forthcoming.
At GVIC, we review economic data to understand macroeconomic trends, then invest in a limited number of ways to exploit what we believe will be the consequence of actions like interest rate hikes, slowing housing trends, flat auto demand, changing consumer preferences, shifts in global supply chains, reorientation of work-from-home economics, etc. At this point, we assume central bank rate hikes for this cycle are nearing completion, inflation will continue to decline, market interest rates will continue to fall, housing and auto demand will pick up, the US dollar will stabilize or soften, and various sectors of the economy will perform well as we return to a new order of global trade with a broadening base of consumers in emerging and developing economies.
As always, we ultimately take a company-specific view and only invest when we understand a business and believe there is an adequate margin of safety in our purchase price, allowing for protection of principal over time regardless of what happens with macroeconomic forces. We look for idiosyncratic risks that we believe are temporary or transitory in nature and where we can exploit the mispricing of a security by other market participants. We believe markets have frequent periods of uncertainty, leading to price inefficiencies due to investor expectations and sentiment swinging too far in either direction.
We believe our thorough and focused research process assists us in developing an information advantage over other market participants, giving us confidence when committing capital when others may be anxious and trying to sell. We also have a great advantage with our investment timeframe: we generally have a five-year outlook when appraising a situation, whereas most investors have significantly shorter investment horizons, leaving less time for an investment thesis to fully develop.
During the quarter, we made or added to several investments in bonds, where we locked in yields coalescing around 8%, which we view as a very favorable return given our expectation of receding inflation. We believe these bonds will provide a rate of return well above inflation, and with the likelihood the Fed will begin easing rates in the foreseeable future, we think the return on investment will exceed our expectations. We were pleased to be able to look out several years as opposed to several quarters — a reflection of the sophistication of our client base.
Several of our research analysts visited Core Molding Technologies, Inc. (CMT) in mid-August. This was a return visit for us and coincided with the near completion of management’s business turnaround. We met with management and once again had an extensive tour of the company’s production facility in Colombus, OH.
We had a few attendees at the Rocky Mountain Chocolate Factory, Inc. (RMCF) annual meeting of stockholders on August 18 in Durango, CO. The meeting included a tour of their chocolate process and production facilities.
Loop Industries, Inc. (LOOP) is a new holding for us. We had several analysts travel to the Montreal, Canada area in mid-September to spend a day with management and tour their PET recycling facility.
Finally, all of our US-based analysts and advisory team members attended the Capital Link Maritime Conference in New York City on October 11, where one of our portfolio managers, JP Geygan, spoke on a panel of expert shipping investor during one of the conference sessions. We have attended this conference many times over the years and find the information gained from a gathering of executives and investors from all over the globe to be a particularly valuable investment of time. We were honored to have a representative from our firm participate in this excellent event.
Whether we are onsite or meeting over video, we continually speak with company management to assess and appraise the condition of the businesses in which we invest. More and more, we are hosting company management in our offices, primarily in our Boston location. We find one-on-one conversations with executives to be very productive and help us leverage what we call our “information advantage” when performing valuation analysis.
From Our Library
We recently finished Financial Shenanigans, a book written to highlight some of the worst historic frauds and abuses committed by companies some of which ended up costing investors billions in investment losses. We prefer to read and learn from other’s mistakes as opposed to committing those ourselves. The final chapter offered 10 tips for alert investing, which I’ve copied below.
APPLYING THE FORENSIC MINDSET
- Skepticism is a competitive advantage.
- Pay close attention to changes – always ask “why?” and “why not?”
- Look past “accounting problems” to see if business problems are being covered up.
- Pay attention to corporate culture and watch for breeding grounds of bad behavior.
- Never blindly adopt the company’s profitability framework.
- Incentives matter: pay close attention to how executives are compensated.
- Even in financial disclosures: location, location, location.
- Like in golf, every shot counts.
- Patterns of behavior provide a reliable signal.
- Be humble and curious, and never stop learning.
I’ll only comment on the final point: for years we have aspired to continue learning, which is in part why we hold our weekly book club, reading through a wide range of books and articles designed to stimulate discussion and debate as to the best way to approach investing. A precondition to learning is having an insatiable curiosity and open mindedness to discover new things and see the world in different ways. The market itself is a great “humbling machine,” reminding us on a near-daily basis when we are wrong. We remain committed to investment excellence and continuous learning, which go hand in hand.
Charels Schwab completed its long-planned merge with TD Ameritrade in early September. We have clients who use both of these custodians. For those who were with TD Ameritrade, your accounts are now being custodied by Charels Schwab. GVIC’s role is unchanged. In both cases, the custodian simply holds your securities, executes most of your trades at GVIC’s direction, and sends you a monthly statement with an accounting of your investment holdings and activity. We use several custodians and find the difference from one to the other to be minimal. In some instances, we actually execute buy and sell transactions away from your primary custodian and have trades settled in your account; we do this where we can get better pricing for you on the trade executed through a different broker. Please let us know if you have any questions about your custodian or how GVIC works with them on your behalf.
When we penned our year-end letter, we stated that we still saw significant investment opportunities and encouraged clients to contact us regarding adding capital for investment management. Each of our portfolio strategy composite results were positive in the third quarter, despite broad markets producing negative returns; this includes our Concentrated Equity Value Strategy (all-equity strategy), Total Return Value Strategy (a blended strategy investing in both stocks and bonds), and Focused Fixed Income Value Strategy (all-bond strategy). We remain calm, alert, and opportunistic, seeking attractively priced investments during this time of elevated economic uncertainty.
If you’ve had changes in your investment objectives or financial situation that warrant adjustments to your portfolio, please let us know. We are happy to schedule time to discuss ways in which we can adjust your investments to more closely reflect your changing objectives and better align with your current situation.
Thank you for your continued confidence.
Your Investment Research & Advisory Team
Global Value Investment Corp.
 Yield to Maturity (calculated as the discount rate at which the sum of all future cash flows (from coupons and principal repayment) equals the price of the bond).
This document is published by Milwaukee Institutional Asset Management (MIAM), a division of Global Value Investment Corp. (GVIC). MIAM is the institutional investment advisory division of Global Value Investment Corp., providing investment advisory services to institutional investors including Registered Investment Advisors and Broker-Dealers. All statements or opinions contained herein are solely the responsibility of Milwaukee Institutional Asset Management. The material, information and facts contained in this report were based on publicly available information about the featured company and were obtained from sources believed to be reliable but are in no way guaranteed to be complete or accurate. This report is for informational purposes only and should not be used as a complete analysis of any company, industry or security discussed within the report. This report does not constitute an offer or solicitation to buy or sell any security, nor shall there be any sale of the security herein in any state or domicile in which said offer, solicitation or sale would be unlawful prior to registration or qualification under the securities laws of any such state or domicile. An investment in any security referenced in this report may involve risks and uncertainties that could cause actual results to differ from the analysis provided herein, which may not be suitable for all investors. Past performance should not be taken as an indication or guarantee of future results. No judgment is hereby expressed or should be implied as to the suitability of any security described herein for any specific investor or any specific investment portfolio. Employees of GVIC may have positions in securities referenced in this report. ‘Intrinsic’ or ‘Appraised’ value refers to MIAM’s quantitative and qualitative assessment of the value of an enterprise. Market capitalization is a measure of the total dollar market value of all of a company’s outstanding shares. Market capitalization is calculated by multiplying a company’s shares outstanding by the current quoted share price. MIAM’s investment strategies generally invest in a smaller number of securities than some other strategies. The performance of these holdings may increase the variability of a strategy’s return. There is no assurance that dividend-paying stocks will reduce price variability. Value investments are subject to the risk that their intrinsic value may not be reflected in market prices. For purposes of distribution in the United States, this report is prepared for persons who can be defined as “Institutional Investors” under U.S. securities regulations. Any U.S. person receiving this report and wishing to affect a transaction in any security discussed herein must do so through a U.S. registered Broker-Dealer. Neither Global Value Investment Corp. nor Milwaukee Institutional Asset Management is a registered Broker-Dealer.
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