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Muhlenkamp Market Commentary 1st Quarter 2018
Ron and Jeff Muhlenkamp explain that recent tax cuts and deregulation should help keep the economy moving. Asset markets, on the other hand, could be affected by monetary tightening as the Federal Reserve and other central banks reduce or reverse their easy money policies.
In this edition of the Muhlenkamp Memorandum, Ron and Jeff discuss the Small Business Optimism Index chart which is produced by the National Federation of Independent Business (NFIB). It is based on monthly surveys of its members in order to better understand the environment in which small businesses are operating.
In the fourth quarter, the S&P 500 Index was up a bit over 7% and up 1.38% for the year. Our accounts, on average, were up 3.52% in the quarter and down 5.03% for the year. (Individual performance varies by account.) The gains for the broader Index in the quarter were mostly made by a small number of large capitalization tech stocks, Facebook, Amazon, Netfl ix, Google, and Microsoft among them.
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.
Most of the economic and market trends we've been discussing for the past few years remain in place. Russia's action in the Ukraine/Crimea may have long-term implications, particularly for Europe, but the near-term economic implications are modest. It remains to be seen whether this gets added to our long-term worry list or not.
Most of the economic and market trends we?ve been discussing for the past few years remain in place. Russia?s action in the Ukraine / Crimea may have long-term implications, particularly for Europe, but the near-term economic implications are modest. It remains to be seen whether this gets added to our long-term worry list or not.
The Fed and Its Big Thumb
Weve seen what happens when prices get ahead of the economy reality. The bubbles in the dot-coms in 2000 and the housing market in 2007 were such effects. We fear that the apparent Fed desire to continue to manipulate interest rates may engender more bubbles.
2012 was a year of mixed results on the economic front, but generally good investment returns as measured by the S&P 500 Index. Some progress was made in Europe and China, and some clarification in direction was made in the U.S. We presented our thoughts on these topics at our December 6 seminar; an archive will be available on our website.
The U.S. national election is over. Some of the uncertainty around taxes and regulations is now clarified. We're likely to get more of each. Attention has shifted to the "fiscal cliff." Much has been written and commented about the big picture, let's examine the impact to wage earners and retirees.
In his latest quarterly letter, Ron Muhlenkamp, president and portfolio manager of the Muhlenkamp Fund, re-examines Europe, China, and U.S. Politics as the major drivers of the markets. On September 7, 2012, Muhlenkamp published a Market Commentary, headlined "Threat of European Banking Crisis Recedes." In it, he discusses the Outright Monetary Transactions program, introduced by the European Central Bank. Mr. Muhlenkamp thinks this program makes credible the ECB's promise to do all it can to keep the Eurozone together.
Overall, on the negative side, European debt and banking problems, slowing Chinese growth, and U.S. fiscal challenges keep us cautious. On the positive side, dramatic shifts in energy production and use in the U.S. provide us some very interesting investment opportunities. We expect the summer and fall to remain volatile as Europe continues working through its problems and the U.S. political debate heats up in advance of the elections.
The rally in stock prices which began in the fourth quarter of 2011 carried into the first quarter of 2012. Some called it a relief rally. We believe one trigger for the rally was the announcement of the Long-Term Refinancing Operation (LTRO) program enacted by the ECB which allowed European banks to rollover debt obligations for up to three years. We believe this bought them some time, probably measured in months. This alone does not solve the problems of Europe, but its better than prior programs which bought them a few days or a few weeks; (they kicked the can further down the road).
2011 was another year of economic crosscurrents and mixed results. We began the year with some confidence that the U.S. was gradually on the mend and that Europe was beginning to deal with its problems. This actually worked out through mid year (June/July). In August it became apparent that not much was being accomplished by the leadership in Europe or the U.S., and both world and U.S. markets got hit hard. Our focus was on large, U.S.-based companies, but we still were down for the calendar year. Going forward, we believe large, U.S.-based companies remain the place to be.
More Thoughts on Europe, China, and the U.S.
The reduction in the likelihood of a U.S. recession and the shift in stance of the Chinese Central Bank give us more confidence in buying companies we believe will do well going forward. Ongoing events in Europe continue to keep us a bit cautious. We continue to try to strike a reasonable balance between taking advantage of the investment opportunities we see and avoiding losses if events in Europe get worse.
The Market Drivers: European Debt, Chinese Inflation, and the U.S. Economy
We remain concerned about Europe. In fact, the two sources of capital closest to the problem, Germany and the ECB, have stated they will not provide any additional assistance, preferring to try to incent others to provide capital instead. As the concerns about the U.S. economy and China have diminished, we have put some cash back to work, but still have a bit over 15% in cash. We anticipate putting more cash to work when it becomes apparent that the Chinese Central Bank stops constricting its money supply, and we continue to watch Europe.
Have the Central Banks Run Out of Tricks?
The big three concerns (a U.S. or Chinese recession, and a European banking crisis) continue to drive the markets, and the news got incrementally worse last week, and then better this week. The DJIA has been bouncing back and forth between about 10,700 and 11,600 since August. Could things get worse from here? Yes A U.S. recession isnt fully priced into the market, a Chinese recession isnt either, and a European banking collapse could trigger the forced selling of assets like we saw in the U.S. in 2008-2009. Could things get better from here? They could but muddle through is more likely.
Ron Muhlenkamps Market Commentary
Sovereign debt problems and the possibility of a European-led banking crisis are the focus of the markets, because effective action isnt being taken. You see this in the velocity of money, which has fallen dramatically, and the move into U.S. Treasury bills, bidding their prices up and creating the negative yield mentioned earlier. Banks are having difficulty making money on depositors funds so they are passing those costs along to their depositors. Yesterdays decline was accelerated by some margin calls on leveraged hedge funds, but the market is primarily concerned about Europe.
Quarterly Letter to Shareholders
Our ?watch and worry? list remains: 1.European government debt and banking problems; 2.China?s slowdown which could become a ?hard landing? or recession; 3.The ongoing U.S. political/economical debate on taxes and spending; 4.We do see improvement in some U.S. states, which are coming to grips with government spending at the state level. The plusses are the attractive balance sheets and current stock prices of many American (and international) companies. We think there will be ample opportunity for more aggressive investing when some of the headwinds discussed above are clarified.
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