Our October letter began thus:
More uncertainty lies ahead. Expect increased volatility as the US election draws to a close; including executive change and possibly a change of control in Congress.
With the election results, both the equity and debt markets experienced volatility – for equities mostly higher pricing, for debt mostly lower pricing.
We went on to say:
December 13-14 will likely mark the Fed’s next rate hike – nearly one year since its first hike in the cycle. Although not statistically significant, a rate hike of .25% does reflect a continuation of a forward looking policy oriented toward a return to normal, meaning more rate increases will follow.
Now it’s official. President Trump and a Republican controlled Congress will be setting fiscal policy for the foreseeable future (at least two years). The Federal Reserve did raise rates during its December meeting. Further, recent public comments from Chairwoman Yellen indicated additional rate hikes are likely in the near future. The Fed’s Open Market Committee (FOMC) meets on January 31st and February 1st, then again on March 14th and 15th. If economic data continues to indicate moderate growth, increasing inflationary trends and steady employment gains, a rate hike of .25% at the conclusion of the March meeting seems reasonable to expect and may already be factored into the yield curve.
Again, from our prior letter’s Outlook:
Predictably, the US dollar will strengthen versus other major global currencies…
It is notable from a currency perspective that both that German and Japanese 10 year bond rates have increased. Recall in our last writing both were trading to yield either zero or a slightly negative rate –truly foreboding of market uncertainty. Today the 10-year German bond trades to yield .46%, while the Japanese 10-year bond trades to yield .08%. These modest improvements suggest a move back towards a more normal interest rate environment with improved investor sentiment.
The US Dollar has continued to strengthen since the presidential election. This is an issue closely tied to international trade and related rhetoric surrounding import/export, tariffs and tax policy. We expect to hear more about this in the coming months. The Chinese RMB, reflecting a continued slowdown in the economy, has weakened to 6.87/US Dollar – a sharp decline from the record high of 6.05 in early 2014.
A strengthening dollar is generally construed as positive, but makes US exports more expense in foreign markets, and foreign imports less expensive in US dollar terms and local markets – effectively importing deflation. The new Administration has made this a central focus for its “Buy American, Hire American” policy.
As always, we remain calm, alert and opportunistic – continuously seeking price discrepancies in the markets allowing for opportunistic buying and selling.
Thinking About a Business:
Global Value Investment Corp, (GVIC) and its investment research team spend the vast majority of time evaluating businesses. Once the evaluation is done and an estimated fair market value is established, the team monitors the company’s stock and bond price movement in order to make a buying decision when share price fluctuates below our estimated value. In some cases this doesn’t happen and an ownership position is not established. In other cases, the share price moves below GVIC’s estimated value and a position is added to client portfolios.
The nature of the ‘market’ is such that security prices fluctuate, sometimes widely, above and below estimated value. Despite the many academic studies that assert market pricing is efficient, our actual market experience suggests the opposite. Our trading team can attest to the occasional irrational pricing of both stocks and bonds. GVIC enjoys price volatility, as it creates opportunity to buy and sell securities at prices below or above our estimated fair value.
We caution investors to be cognizant of this phenomenon in the market place, but to ignore the day to day variability in pricing unless it provides opportunity to buy or sell.
Business values generally change far less rapidly than their publically traded shares suggest. As Ben Graham states in The Intelligent Investor, his popular text for the casual investor,
“The market is a pendulum that forever swings between unsustainable optimism (which makes stocks too expensive) and unjustified pessimism (which makes them too cheap). The intelligent investor is a realist who sells to optimists and buys from pessimists.”
Philip Fisher, author of Common Stocks and Uncommon Profits, goes further in describing market activity by saying “The stock market is filled with individuals who know the price of everything, but the value of nothing.”
The appraisal process involved in determining the “value” of stocks, as Fisher states, involves the study and analysis of a company’s financial statements, including:
- Income Statement (aka Profit & Loss Statement)
- Balance Sheet
- Statement of Cash-flows
- Change in Shareholders’ Equity
Despite these financial statements being common to every enterprise, both public and private, they tend to vary in presentation and format to a surprising degree. Thus, it is important to understand not just the letter of the law but the spirit of the law. Properly analyzing a corporation’s financial statements requires skill, experience and judgment.
Throughout the financial statement review and analysis process, many questions arise with respect to what has been presented and in some cases, what has been omitted. US GAAP accounting rules (generally accepted accounting principles) have improved over the years but are far from perfect and continue to change. Further, most public company chief financial officers (CFO) will concede they have some amount of discretion in presenting a wide variety of financial statement items. GVIC’s research process necessarily includes a conversation with company management during the analytical process. GVIC’s research team identifies abnormalities and then seeks clarification from management. Rest assured, when convincing answers aren’t available, our team will pass on investing. GVIC employees ‘eat their own cooking’ and invest in the very same issues as those recommended for clients, a practice that we believe aligns everyone’s interests.
From Our Library:
Our investment research team’s ongoing education involves weekly readings during which we discuss books with particularly valuable investment thinking or perspective. We are reading a classic by Seth Klarman, Margin of Safety. The following excerpts are relevant to our current letter.
Investment research is the process of reducing large piles of information to manageable ones, distilling the investment wheat from the chaff. There is, needless to say, a lot of chaff and very little wheat. The research process itself, like the factory of a manufacturing company, produces no profits. The profits materialize later, often much later, when the undervaluation identified during the research process is first translated into portfolio decisions and then eventually recognized by the market. In fact, often there is no immediate buying opportunity; today’s research may be advance preparation for tomorrow’s opportunities. In any event, just as a superior sales force cannot succeed if the factory does not produce quality goods, an investment program will not long succeed if high-quality research is not performed on a continuing basis.
Indexing is the practice of buying all the components of a market index, such as the Standard & Poor’s 500 Index, in proportion to the weightings of the index and then passively holding them. An index fund manager does not look to buy or sell even at attractive prices. Even more unusual, index fund managers may never have read the financial statements of the companies in which they invest [emphasis added] and may not even know what businesses these companies are in.
Investors should be encouraged when corporate insiders invest their own money alongside that of shareholders by purchasing stock in the open market. It is often said on Wall Street that there are many reasons why an insider might sell a stock (need for cash to pay taxes, expenses, etc.), but there is only one reason for buying.
We remain cautiously optimistic and anticipate an increase in the number of potentially undervalued securities available as price volatility has returned. GVIC and its clients have embraced a long-term investment horizon, recognizing superior results are achieved over time through careful and diligent security analysis and portfolio management.
The firm continues to invest in its technology, infrastructure and people. We are currently migrating to the latest version of Windows on a new computer server. During December we held our annual security review with our third party security partner. We remain alert to the threat of security breaches and take maximum advantage of resources available to insure continuity of business. To that end, in addition to our normal business insurances, we also carry a cyber-insurance policy.
If you’ve had a change in, or would like to update your investment objectives or portfolio restrictions please let us know so we can make appropriate adjustments.
We are ever mindful of the trust and confidence placed in us by our clients and continue to dedicate ourselves to investment excellence.
Very best wishes,
Your Investment Research and Advisory Team
Global Value Investment Corp.