Quarterly Letter, July 2015

By Ron Muhlenkamp, Portfolio Manager and Jeff Muhlenkamp, Investment Analyst and Co-Manager

Economic news and domestic equity markets have been pretty quiet since we last wrote to you in April. On the domestic economic front the revised numbers for 1st Quarter Gross Domestic Product (GDP) came in at -0.7%, significantly worse than most expected. A number of other economic indicators in April and May also came in somewhat lower than expected. Collectively, these weak economic figures are likely the reason the Federal Reserve did not raise short-term interest rates in June, contrary to what it was indicating in March.

While short-term interest rates in the U.S. have remained low, long-term interest rates have begun to move higher with the yield on U.S. 10-year treasuries moving from roughly 2% at the beginning of the year to 2.4% in early June. Bond prices move opposite the direction of yields, so higher yields mean the price of those bonds has come down. The dollar, which had been very strong relative to most all other currencies, weakened as it became clear the Fed was not raising short-term rates in June. The price of crude oil, which had dropped precipitously from $110 per barrel to a low of $44 per barrel in March, strengthened and is now at about $60 per barrel. Margin debt in stocks, which had plateaued for most of 2015, is once again rising.

Outside the U.S., things have gotten interesting. Greece is on the edge of bankruptcy and its banking system is shut down, yet European and U.S. equity markets haven’t reacted much, at least not as of this writing. In late May and early June, long-duration European government bond yields rose violently while short-duration bonds remained at negative nominal yields in many countries, an aberration we highlighted at our May 5 seminar. It is not clear what this rapid steepening of the yield curve means; so far, even European equity markets have mostly ignored it. It does have our attention and we continue to work to better understand what is happening and the implications for our investments, if any. In the Far East, the Shanghai stock market, which had been on a tear, rising 150% since January 2014, has dramatically reversed and lost almost 30% in three weeks. In early June, the Chinese government took a number of measures to try to stop the decline in their stock markets. Time will tell.

In general, our performance year to date has been slightly better than the broader U.S. markets.* Airlines, which did very well for us as the price of crude oil declined, have given back some of their gains as crude oil prices have risen and doubts have been raised about pricing discipline in the airline industry. Otherwise, our performance has been driven by individual company performance, not sector trends. We’ve invested a little bit in the broader European markets on a currency hedged basis** as we believe bond buying by the European Central Bank will drive up European equity markets even though it won’t do much for European economies.

Looking forward, we expect the U.S. economy to grow at approximately 2% as it has for the past several years. We do not see signs that a recession is imminent. We remain of the opinion that higher interest rates would be beneficial for the economy, though we have no opinion regarding when the Federal Reserve might start raising short-term rates. We have harvested a number of the investments we made in years past, and have put a little new money to work in the few companies we think it is profitable to do so.

The comments made by Muhlenkamp & Company in this commentary are opinions and are not intended to be investment advice or a forecast of future events.

Refer to the SMA All-Cap Value Fact Sheet for the Top 20 Holdings and performance data as of the most recent quarter-end.

*The S&P 500 Index is a widely recognized index of common stock prices. The S&P 500 Index is weighted by market value and its performance is thought to be representative of the stock market as a whole. One cannot invest directly in an index.

**Currency hedging is the act of entering into a financial contract in order to protect against changes in currency exchange rates.

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