Quarterly Letter, October 2014

By Ron Muhlenkamp

My first draft of this letter, which I wrote three weeks ago began with:

  • Europe has not solved its problems;
  • Nor has Japan;
  • Nor has China;
  • Nor has the U.S.

The rest of that draft is now obsolete.

Since mid-September, several items have changed—some economic, some market-related, some psychological.

Economically…

  1. The International Monetary Fund (IMF) has lowered its estimate of world Gross Domestic Product (GDP) growth going forward.
  2. Germany (the strongest economy in Europe) has reported disappointing numbers, particularly in capital goods. It looks like Europe is back in recession.
  3. The U.S. Federal Reserve Bank (Fed) lowered its estimates of U.S. GDP growth for the next four years.
  4. Crude oil, which was trading in a range of $100-$110/barrel, fell to $82/barrel The surprise was an announcement by Saudi Arabia that they would not try to keep the price above $100/barrel. This is a change from their prior policy.

Markets…

  1. Many hedge funds are having a poor year and are facing redemptions. CalPERS (California Public Employees’ Retirement System) announced that they were withdrawing $25 billion from hedge funds. This drives “forced selling” by those funds. The difficulty is estimating the size of the forced selling.
  2. Ten-year U.S. Treasury bond yields fell from a range of 2.40%-2.6% to (briefly) below 2 percent. A huge move in a short period of time, the headline is “A Flight to Quality.”

(Mostly) Psychological…

  1. The battle against ISIS in the Middle East.
  2. Ebola and the Centers for Disease Control (CDC): It appears that the Center is not prepared for disease control.

All of this together resulted in stock market declines of 7%-12% in a month, depending on which index you measure. The size of this “correction” was not unexpected, but the short timeframe was unusual. On some days the forced selling appeared to feed on itself and bordered on panic liquidation. As I write this letter on 10/17, this selling has abated, at least for the time being. The good news is that we raised some cash coming into this period, and that we’re seeing more and better values than we did 2-3 months ago. The bad news is that we didn’t raise enough cash (in a downturn, you never do) and the prices of our holdings fell with the marketplace. It remains true that although economic data changes gradually, the markets’ response to that data can be rapid.

The comments made by Ron Muhlenkamp 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.

One cannot invest directly in an Index.

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