David Rolfe’s Wedgewood Partners Q3 2014 Portfolio Commentary
David Rolfe’s Wedgewood Partners – Review and Outlook
Our Composite (net-of-fees) was basically flat (+0.30%) during the third quarter of 2014. This rounding-error gain is below both the gain in the Standard & Poor’s 500 Index of +1.13% and the gain of +1.49% in the Russell 1000 Growth Index.
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Our Composite year-to-date gain of +3.8% has lagged substantially the gains in the Standard & Poor’s 500 Index and the Russell 1000 Growth Index of +8.3% and +7.9%, respectively. A somber fact: Over the past six months, nearly two-thirds of our current portfolio has underperformed the S&P 500 Index. In the never ending zero-interest rate environment of Quantitative Easing the chase for return and yield continues to reward the stocks of poorer quality (i.e. low/no profits), higher debt- leveraged company stocks and reward company stocks that pay out higher 2 percentages of earnings in the form of dividends. Individual stock selection mistakes aside, we believe that our investment focus on higher quality growth companies at reasonable valuations is simply ill-suited in the current ebullient environment. In fact, 2014 may well go down as one of the worst years for active equity managers in the past two decades. According to The Leuthold Group: Last year provided managers not only with huge gains but also with comparatively favorable odds of beating the S&P 500. In 2013, about 60% of the issues in the 1500 composite topped the +29.6% gain in the S&P 500. That percentage has been cut in half over the last nine months. The latest reading of 30.2% compares to those recorded in the late 1990s’ “bifurcated bull” – an excruciating time for active managers that ultimately ended badly for all.
And speaking of the late 1990s, according to Jay R. Ritter, a professor of finance at the University of Florida, already in 2014 72% of IPOs have “negative earnings.” The typical level according to Ritter’s studies is approximately 40%. In 2013, 64% of all IPOs had negative earnings. The highest levels since 1980 were the tech bubble years of 1999 and 2000 when IPOs then had negative earnings of 76% and 80%, respectively – the garbage-bin crop of IPOs in 2014 isn’t far behind. But notably, we have been in such periods of cheap, easy and bubbly cost of debt (2007) and equity (2000) before. Such periods don’t tend to end well either. A word or two in this Letter on the Fed seems in order as well. The correlation of the relentless growth in the Federal Reserve’s balance and the relentless rise in the S&P 500 Index has be nearly 90% since 2009. According to Gluskin-Sheff, over half of the U.S. Treasury market sits on the balance sheets of the world central banks. Three more still, zero-profit motivated global central banks have actually increased their purchases of net new issued U.S. Treasury notes and bonds – net $540 billon over the past year, or 80% of the flow of new U.S. debt. Global central banks now own a staggering $6.4 trillion of U.S. debt. We should all remember that the high-priest Mandarins guiding our nation’s monetary policies have been unusually consistent over the past few decades of either being far “too-easy” for far too long - or either far “too tight” for far too long. The future exit by Fed Chairman Yellen from our current grand experiment with Quantitative Easing will follow, we believe, and we fear, the Fed’s woeful track record on this score. At Wedgewood Partners, company-specific investment discipline will always trump Fed mandarin-watching theatre.
David Rolfe’s Wedgewood Partners – Portfolio changes and added positions
Our worst performers during the third quarter were Cummins Inc. (NYSE:CMI) (-14.5%), Schlumberger Limited. (NYSE:SLB) (-13.8%) and Cognizant Technology Solutions Corp (NASDAQ:CTSH) (-8.5%). Our best performers during the quarter were EMC Corporation (NYSE:EMC) (+11.1%), Berkshire Hathaway Inc. (NYSE:BRK.A) (NYSE:BRK.B) (+9.2%) and Apple Inc. (NASDAQ:AAPL) (+8.4%). During the quarter we trimmed positions in Apple as it approached our maximum position weighting of 10%. We added to existing positions in QUALCOMM, Inc. (NASDAQ:QCOM), LKQ Corporation (NASDAQ:LKQ) and Cognizant Technology Solutions Corp (NASDAQ:CTSH) – all on improved prospective risk-reward on respective share-price declines. The Great Bull Market of 2009-2014 started on March 9, 2009 when the S&P 500 Index stood at 667. The S&P 500’s relentless bull market advance over the course of the next 2,000 days would reach a record high index level of 2000 in late August. Relentless indeed, according to Bespoke, the S&P 500 Index has been up seven quarters in a row – the best streak since 1998 and the fourth best since 1950.
Furthermore, the S&P 500 has not corrected by at least -10% in +1,130 days – the fifth longest bull streak since 1926. This one-way stretch is the longest since August 1987 and the fifth-longest stretch since 1928. The only bull markets that have lasted longer were in 1974-1980 (2,248 days), 1949-1956 (2,607 days) and 1987- 2000 (4,494 days). From a historical perspective, the Great Bull Market of 2009-2014 has been only average in length of time, but exceptional in terms of gains. Rare is the bull market that triples in gain in just six years. The S&P 500 Index officially tripled in price when the S&P closed above 2001 on August 29. Not to be out done by such a middling +200% gain, the S&P 500 Equal-Weighted Index is up +280%. Stock market index bragging rights during this bull market go to the Value Line Arithmetic Index, which is up almost five-fold (+365%).
As the stock market continued its relentless bull charge with nary a correction, our current views on the investing environment and individual stock opportunity set are little changed from our views expressed in our first quarter 2014 and second quarter 2014 Client Letters – at least through mid-September. As you could imagine (and we hope, expect) we have been net sellers of stock year-to-date and our cash position has correspondingly risen to high single digits.
While the major market indices remain relatively close to bull market highs, as of the writing of this letter there has been considerably more turbulence under the stock market’s surface. In fact, we may just be entering a period of long awaited bargain hunting. Even though the S&P 500 is still up only +1% year-to-date, the Dow Jones Industrial Average is now -2% on the year, the NYSE Composite has declined -10% from recent highs and the Russell 2000 Index is down -13% from recent highs and is down nearly -10% on the year. Specifically too, higher quality company stocks (our favored fishing pond) which have not participated much at all in the market’s advance over the past few quarters, have corrected as well. Our investment-process pencils are fully sharpened as such emerging opportunities hopefully become fatter pitches.
See full David Rolfe’s Wedgewood Partners Q3 2014 Portfolio Commentary in PDF format here.