Muhlenkamp All-Cap Value conference call audio and transcript for the month of February, 2016.
Muhlenkamp All-Cap Value February 2016 Conference Call – Audio
Muhlenkamp All-Cap Value February 2016 Conference Call – Transcript
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.
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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 All-Cap Value February 25, 2016 Amended Transcript
Tony Muhlenkamp, President
Ron Muhlenkamp, Portfolio Manager
Jeff Muhlenkamp, Portfolio Manager
Tony Muhlenkamp: Good afternoon, everybody, thank you for joining us. There are a few new listeners, so I’d like to make some quick, introductory comments. It’s been our habit to host these calls as a way of letting our clients and shareholders know what we’re seeing, what we’re doing, and give them a chance to ask some questions. If we raise more questions than we answer, or if you don’t get a chance to ask a question, please give us a call, or email us. We’re happy to talk with you.
On the call today, we have myself, serving as your host, and our portfolio managers, Ron and Jeff Muhlenkamp, who will take turns answering questions and bringing us up to date.
Ron, you’ve been saying that what we’re seeing today is a continuation of a number of things that we’ve been talking about for the last couple of years. Starting on the global, big-picture end, where are we today and how did it get started?
Ron Muhlenkamp: We have said for the last several years that what was happening, for instance, in the banking industry, was being heavily influenced by what was happening in Europe and Japan, and that cyclical stocks were being heavily influenced by what’s happening in China.
I’m going to turn it over to Jeff to fill you in on what we’re seeing in those areas. When we’re done with that, we’ll bring it home to the U.S. and cover what’s happening domestically in an economic sense, and how that gets reflected in the marketplace. Jeff, go ahead.
Jeff Muhlenkamp: Thanks, Ron. Reflecting on what markets around the globe have done this year, the U.S. has actually been one of the better-performing markets for stocks. [As of February 23, 2016], the S&P 500 Index and the DOW (DJIA) have been down about 6% year-to-date. The Russell 2000 Index, which includes smaller-cap stocks, is down about 11% year-to-date. You compare that with the German index [DAX], which is down about 12%, and the broader European Index, which is down about 11%; India’s down about 10%. China is down about 18%, but that was before it dropped 6% yesterday. So, China’s probably the worst off among the ones I just listed, down almost 25% year-to-date.
We saw Japan, in the middle of January, adopt negative interest rates that Europe had adopted last year. [In response], they got about two days of weakness in their currency, and two days with an up-move in their stock market, which is, I think, what they expected. After two days, however, it reversed rather dramatically. [As of February 23, 2016], the Nikkei is actually down 15% year-to-date. Japan had a pretty dramatic sell-off in their stock market two days after that move [i.e. adopting negative interest rates], and their currency has actually appreciated. I’m not sure that’s what they were looking for.
This is interesting to us because it might signal that the investing public now views actions by the central banks, or at least negative rates adopted by Japan, in a negative light, as opposed to a positive light, which, we think, the investing public had probably viewed before.
You’ve seen European banks sell off quite dramatically this year. I think a lot of that has to do with their exposure to emerging markets and their exposure to energy loans across the globe. They’re down about 24% this year.
Banks are also the worst performing sector in the U.S. so far this year; last year, that would have been energy and materials. This year, banks have sold off quite significantly in the US.
Ron Muhlenkamp: Jeff, have you not also said that about 20% of the banks in Italy appear to have problems? Whereas, two years ago, the headline in Europe was Greece. Now the headline has shifted to Italy, which incidentally is much larger than Greece. Greece is a very small part of the European economy [number 18 in nominal GDP]. Italy is, number four [in nominal GDP].
Jeff Muhlenkamp: I think all the banks in Italy have problems, and approximately 18% of the loans in Italy are now classified as nonperforming loans. So, there’s a banking problem—there’s a debt problem— in Italy that will have to be resolved, which is presently on the back burner. But, that accounts for what’s happening, in my opinion, in the Italian and, probably, some of the other banks that lend cross-border.
There have also been big moves down in some of the British banks that are known to be heavily exposed to the emerging markets and in the oil and gas industries globally. HSBC had a quarterly loss of $858 million, its first loss since at least 2009; and Standard Chartered Bank, just reported its first loss in 27 years in this quarter. So, a number of loans across the globe—oil and gas, emerging markets, Italian banks—are coming up bad right now.
Ron Muhlenkamp: Talk a little bit about the feedback loop that we’re seeing among banks (including Japan, Europe and China), China’s slowdown and its impact on the cyclical parts of the economy (which has hit commodities), and the headline, oil, and how that affects the emerging markets. There’s a huge feedback loop going on among these various things.
Jeff Muhlenkamp: We’ve been saying for a number of years that we think China drove demand for commodities, driving up their prices as demand from China increased. But, China didn’t just consume the commodities; they would also shape them, form them, assemble them, and sell them. China would import the commodity and export the finished good.
Ron Muhlenkamp: In addition to oil, we’re talking steel, aluminum, copper…all of these basic commodities.
Jeff Muhlenkamp: Correct.
Ron Muhlenkamp: …Much of which was supplied by likes of Australia, the South Americas, Canada–the emerging economies of the world.
Jeff Muhlenkamp: Correct; Brazil being the poster child for that, as was Australia.
In order to meet demand from China—and I’m going to specifically talk about the harder metals, because crude oil gets into Saudi Arabia and there are different dynamics—everybody that was producing those products (coal, iron ore), ramped up their capacity: they dug an additional mine, they put extra money to work in the ground. Prices have been coming off in those commodities for three or four years now, and all of that extra capacity, which had been built in anticipation of China’s demand, is now excess. That’s, of course, what’s driving commodity prices down.
Regarding the impact of that domestically… First, it impacts prices, right? You’ve got excess capacity, which means inventory is built, which means prices go down very quickly. The impact directly to the United States has been that the coal miners are decimated. It is truly a depression in the U.S. coal industry; a large number of coal companies have gone bankrupt or are on the verge of bankruptcy. It’s the same with iron ore. One of the largest U.S. producers of iron ore is Cliffs Natural Resources. They’ve been struggling now for about two years to wrestle with their debt.
Remember, China is a processor of raw materials; so you take coal, you take iron ore…you make steel. China had built a lot of capacity to make steel, which is now excess [supply]—and that has depressed steel markets across the globe. Everybody, from Nucor Corporation [Nucor pioneered electric arc furnaces and mini-mills] to especially the blast furnaces of U.S. Steel Corporation, is really seeing a lot of pain right now.
That’s true not just in the U.S., it also hit Australia, and Brazil, which has been in a recession now for about three years; it has hit a number of the exporting countries. Because these countries had revenues in dollars, they had borrowed money in dollars. As they see their dollar revenues declining, they’ve got a problem paying off those dollar loans. The supply of dollars internationally, both because of what’s happening in hard metals, and also because of what’s happening in crude oil… As the price of crude oil comes down—even if you’re selling a million barrels a day–if the price of oil drops in half, your dollar revenue dropped in half, but the payments you have to make on your loan didn’t go away.
There’s now a shortage of dollars internationally to pay off loans that were incurred during the commodity boom (both in oil and in the harder metals), which feeds back into the banks. As a result, banks start contracting credit, creating a negative credit cycle on a global basis…coming out of commodities…coming out of less demand from China than people had expected. Is that the feedback loop you wanted me to address?
Ron Muhlenkamp: Yes.
What we saw coming out of the sizable recession we had in this country in 2009, is that our central bank [Federal Reserve] did quantitative easing (QE), lowering interest rates, and putting money into the banks, which continued through October 2014. The Bank of Japan (BoJ) initiated its second round of QE in 2013-14. The European Central Bank (ECB) started its version of QE in January 2015.
Japan had had 0% interest rates for most of 20 years. You commented a couple minutes ago, Jeff, that Japan took another step recently [adopting negative interest rates], and that it appears to have backfired. So, the questions on all of this remain: How far can the central banks print money? How far can they do QE before the markets no longer accept it? It may be that we saw that occur in Japan a couple weeks ago.
See full transcript below.