Muhlenkamp & Company’s All-Cap Value SMA conference call transcript for the month of September 2016.
Muhlenkamp & Company’s All-Cap Value SMA (Separately Managed Account) is designed for investors’ accounts over $100,000. We employ full discretion, applying fundamental analysis.
We seek to maximize total after-tax return through capital appreciation, and income from dividends and interest, consistent with reasonable risk.
We invest in undervalued assets wherever they may be found. Typically, this results in holding a portfolio of companies we believe are materially undervalued by the market. Bonds may be included in the portfolio if they are a good investment.
We start with a bottom-up scan of domestic companies, typically looking at most U.S. companies at least four times per year. We add to that an understanding of the sector dynamics in which companies are operating, an assessment of the business cycle, and a review of macroeconomic conditions.
Our primary screening metric is return on shareholder equity (ROE). We are looking for companies with stable returns that can be purchased cheaply, or for companies with improving returns that have not yet been recognized by the market.
We don’t believe that a holding period of “forever” is appropriate in all cases, but are comfortable holding companies as long as they continue to meet expectations.
We define investment risk as the probability of losing purchasing power over long periods of time, which is quite different from Wall Street’s definition of price volatility in very short periods of time. Taxes, inflation, and spending will ALL impact the purchasing power of your assets.
Muhlenkamp & Company Conference Call Transcript
Tony Muhlenkamp: Good afternoon, everyone. We appreciate you joining us. Our goal for this conference call is to share our thoughts and observations about current market conditions and how that translates into the decisions we make regarding the portfolios we manage for clients and shareholders. While that’s usually a wide-ranging conversation, we may not address all your questions or topics. If so, please call us or email us after the call; we’d be delighted to talk with you. With that said, let me introduce the two speakers, portfolio manager Ron Muhlenkamp and comanager Jeff Muhlenkamp. Let’s begin the conversation with Jeff.
Jeff Muhlenkamp: Welcome everybody. I thought we’d start, as we often do, with the big picture and work our way down to narrower and narrower subjects.
When you look around the globe and start with the economy, economies around the globe are generally still pretty slow. Europe is at less than 1% real GDP1 growth. The United States, for the first half of the year, has averaged about 1% real GDP growth. China is slowing down from 7-8% growth, which it had done a couple of years ago, to now, 5-6% at best, depending on the numbers you want to look at. Japan is flat at about no growth.2 The emerging markets are somewhere between growing decently and, in Brazil’s case, in a deep recession.
Central banks3, in response, the big ones, the ones that most concern us, are goosing economies for all they are worth. They are doing that by keeping interest rates very low. In the case of Europe and Japan, interest rates remain negative—that is, they are pushing short-term interest rates down, so that it is a negative nominal value.
They [central banks] are also buying assets. The European Central Bank (ECB) continues to buy both government and corporate bonds. In fact, some European corporations are intentionally front-running the ECB, they are crafting bonds that specifically meet its requirements, so they have been bought up in that fashion. The United Kingdom, after the Brexit vote that happened in late June, had decided to push interest rates down and to start up its bondbuying program; so they, too, have joined the QE (Quantitative Easing)4 crowd. Japan’s central bank continues to keep nominal rates negative and to buy government bonds and Japanese ETFs (Exchange-Traded Funds).5 So, Bank of Japan is accumulating equities of Japanese companies, as well.
Ron Muhlenkamp: Just to give you an indication of how large this has become, there are $12 trillion in sovereign (government) bonds that now have a negative interest rate. Among Japan, Europe, and the United States, the central banks have bought $25 trillion of bonds and stocks. Just as a comparison, the total value of the S&P 500 Index6 in the U.S. is about $20 trillion, so these have been major sizes of assets bought up by the central banks.
Jeff Muhlenkamp: The effect on folks overseas…The goal of the central banks, their stated goal, has been to inspire growth. That’s not really happening. Certainly it’s driven down the interest rates that countries are paying, so it has helped the likes of Spain and Greece to afford their debt and roll over their debt as necessary. It’s also driving savers to buy things like safes. We have seen news articles from Japan, and now Germany, that safe sales are going up as individual savers are more interested in holding cash in their basement than they are in holding cash in the banks. The reason they want to do that is that the banks are getting squeezed. So, as the net interest margin (the difference between the rate at which a bank borrows and the rate at which it lends) shrinks, the banks are trying to pass their costs on to their customers. In many cases, those are retail consumers. To the extent that they can do that, the banks will continue to be profitable. To the extent that the retail customer pulls money out and keeps it in a safe, the bank will be unprofitable. So we are seeing a squeeze internationally on banks—and also on insurers, which are large buyers of bonds that, historically, match their liabilities quite nicely. Insurers are also getting squeezed by the negative rates.
Shifting now to the U.S. economy…The U.S. economy at the end of last year, last fall, the industrial portion of the economy took a step down. When we spoke with you at that time, we argued that the industrial portion of our economy was largely in a recession. Frankly, that remains true. The companies in that portion of the economy have not seen an improvement, nor a degradation, in the activity of their business.
Ron, please talk about how the consumer is doing vis-a-vis the industrials.
Ron Muhlenkamp: The consumer [economy] has growth, but low growth: we’re seeing 0-2%. We’ve gone about six years where the estimates coming in each year were 3%-plus growth and each year it has been less than 2 percent.
As Jeff mentioned earlier, for the first six months of this year, U.S. GDP has been growing about 1% real (net of inflation). Looking at the consumer economy, it still looks as if we’re growing at a modest rate: we are seeing 0-2 percent.
If you look at the industrial economy, frankly, it looks as if we’re in a recession. Businesses are still not hiring people in large measure, and they certainly are not expanding capacity because they are told that economic growth going forward is going to be 1-2%, the “new normal”—and for that you