Quarterly Letter, July 2013

By Ron Muhlenkamp

While the economic trends of the past couple of years continue, we’ve just seen an important change in interest rates and the bond markets.

First, the economic trends:

  • Europe is in a recession.
  • China is attempting to shift from an infrastructure and export focus to more domestic consumption, but the transition is hampered by reluctant local leaders and their interest in recent successes. The resulting stresses are making it difficult for China to reach its announced targets for growth.
  • In the U.S., growth continues to be tepid despite gains in autos and housing. First quarter GDP (Gross Domestic Product) growth was just 1.8% (initial estimates were 2.4%) as consumer spending on services is subdued.
  • Since the end of April, interest rates have rebounded nearly a full percentage point as the markets speculated on when the Federal Reserve stimulus would taper off.

Second, interest rates and the bond markets:

  • Since the end of April, 10-year Treasury yields have gone from 1.7% to 2.6% and 30-year mortgage rates have gone from 3.4% to 4.5 percent. Frankly, we think these moves are healthy as they are advancing toward normal levels. (Interest rates have been held below normal market levels by the Federal Reserve in a belief that this would foster economic growth.) Specifically, higher interest rates benefit retirees and pension funds.
  • S. bond markets now appear to be focusing on the likely end to stimulus and have moved interest rates higher, thereby driving bond prices lower.
  • Whatever the underlying cause, a full 1% increase in less than two months is dramatic in the bond market and potentially disruptive in the stock market. In fact, the stock market has recently sold off 5%-10% in the various indices after a strong up-move since last fall. It now seems to be stabilizing as we look forward to second quarter earnings.

In a world where the U.S. economy is growing at 2% and most other economies are also growing well below potential, we expect that the stocks of companies that can report good revenue and earnings growth will do well.

The great disappointment is that the improvements in the U.S. stock market and Federal income tax receipts (and in European bond markets) have given politicians on both sides of the Atlantic an excuse not to rein in government spending in a meaningful way.

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.