Buy! Sell! Faster, Faster

McClure Investment Management, LLC

2014 1Q Market Commentary

For a market that hasn’t gone much of anywhere (+1.30% for the first quarter of 2014) there sure has been lots of yelling and screaming going on.  Let’s look at where the noise has been coming from:

High Frequency Traders

Author Michael Lewis’ appearance on 60 Minutes has kicked up a firestorm of controversy regarding High Frequency Trading (HFT) which he describes in his new book, Flash Boys.  His assertion is that high frequency traders are able to insert themselves between us and our stock trades acting as a sort of unwanted middleman.  I believe Lewis’ assertion is essentially true, these traders make our buy prices minutely higher and our sell prices minutely lower.  (As my investing style has very low turnover this is a very small issue for us.)  However, the public outcry has been significant and is still ongoing.  To date, the best public shouting match came on Tuesday, April 1st on CNBC as Brad Katsuyama, the good guy from Flash Boys, got into it with bad guy William O’Brien.  It’s worth seeing.  Lewis has since also been interviewed on numerous programs including Charlie Rose and The Daily Show.  While Lewis’ claims have some merit, I believe his calling the market “rigged” is an exaggeration.  The playing field may not be 100% fair, but it is far from rigged.

Scott Patterson’s Dark Pools, written in 2012 addresses the issue of HFT in a slightly less accessible but, ultimately more comprehensive manner.  If you follow this link to Dark Pools on Amazon, you’ll see that Michael Lewis himself called it “an excellent history of the early electronic traders.”

Don’t get me wrong, Michael Lewis is a great writer.  He’s written some great books, i.e. The Big Short and Liar’s Poker, that I’ve used as required reading in courses I’ve taught.   But Flash Boys isn’t going to be one of them.

Aging Bull Market

The financial press is inundating us with warnings that our bull market may well be on its last legs.  A few observations:

  • The bull market in U.S. equities turned five years-old on March 9th.  Since World War II there have been 11 bull markets and their average lifespan has been 4.5 years.  Only 3 of those 11 bull markets have made it to their 6th birthday.  (Of course, the bear market from October 2007 to March of 2009 was one of the worst in history, setting the stage for a strong turnaround.)
  • Morningstar analysts had literally hundreds of 5 star (their highest rating) stocks in late 2008 and early 2009.  Three weeks ago that number was down to thirteen.  Today there are 8.
  • Many of Wall Street’s darlings of the past year (Tesla, Facebook, Netflix, etc.) have been absolutely hammered since late March.  When Wall Street’s favorites start getting beat up, the broader market often follows suit.

While these facts are a bit unsettling, keep in mind we don’t own the whole market.  Our focus remains centered on the earnings, revenues, cash flow and, ultimately, the valuations of the 20 stocks we own and those on our watch list.

  • While generally pleased with the operating results of our companies, there are a few things I’m watching closely.  I have a 10% trailing sell stop on NYT.  We’ve had a solid return with NYT rising nicely over the past year but it may have gotten a bit ahead of itself.  Its P/E is now 40 (compared to 17.1 for the broader market) and, unless they can bring earnings up a faster rate, may be getting a bit expensive.  While they have migrated subscribers to their digital content fairly successfully, they need earnings and revenue growth in order to justify the current price.
  • Last quarter I wrote of concerns with MeadWestvaco and their problems with profit margins being squeezed.  In the last few months they’ve launched a substantial cost cutting campaign and, while the stock moved up nicely in the 1st quarter (+7.9%) it’s trading at a P/E of only 8.6 times next year’s earnings.  I’m still concerned as MWV is essentially a commodity business, lacking much of the “moat” Warren Buffett likes his businesses to have.  However, at a cheap valuation well continue to be an owner as long as financial results don’t disappoint.
  • Monsanto is in the crosshairs of more than a few groups.  Here are a couple Monsanto related articles, one from Scientific American I’ve posted before regarding GMOs, and a recent posting from Snopes.com explaining Monsanto developed corn does not harm rats or women.  Monsanto has diversified into agricultural analytics and has raised its profile in traditional crossbreeding of vegetables with its Seminis brand.  Even if the public outcry against Monsanto’s GMO operations causes more Monsanto boycotts (see General Mills going GMO free with Cheerios), the company seems well prepared to weather the storm and continue to show positive financial results.  As long as they continue to deliver earnings, revenue and cash flow and we intend to hold on.
  • While we’ve heard quite a bit about Apple’s cash hoard of $150 billion, virtually no one seems to care about the $79 billion Microsoft has on its books. Trading at just 11 times earnings it looks very attractive. The stock price has recently surpassed $40/share for the first time since July of 2000.  Of course then the stock earned $1.04 per share, adjusted for stock buybacks.  Today that number is $2.70 per share.  With their strong balance sheet and the possibility of bigger dividends or stock buybacks in the future, we’ll be holding on to this one as well.

 

Muni Bond Market

During the first two months of 2014, $33.1 billion in municipal bonds were issued, a drop of 29% from the same period last year.  This decline in supply has worked in favor or two large but troubled muni issuers: Puerto Rico and the city of Chicago.

Puerto Rico planned on issuing $3.0 billion in new debt but raised that to $3.5 billion after receiving orders worth $16 billion.  That Puerto Rico’s credit rating has been cut to junk status, (BB+) with further cuts likely, doesn’t seem to have mattered a bit.  My guess is the pricing of these bonds to yield 8.7% (state and federal tax free, mind you) blinded many otherwise sane investors to jump on this bandwagon.  This reminds me of the great saying, “More money has been lost reaching for yield than at the point of a gun. “We’ll pass on this one.

In a similar vein, Chicago raised their debt issuance last month from $400 million to $884 million after investors orders rose to $3.6 billion.  Moody’s downgraded Chicago’s credit rating three levels (from Aa3 to A3) last August and one more level (A3 to Baa1) last month as well as placing the city on credit watch indicating another possible downgrade.  With a massively underfunded pension, this is another high yielding issue I’m glad to avoid.  Clearly this is no time to be buying muni bonds

By the way, I’ve found some surprisingly attractive muni bonds lately.  (ha!)  I have no idea why in this low supply, high demand market I’m finding municipal paper with decent characteristics (+/-4% yield, 5-6 years to maturity, investment grade).  Hopefully we’ll be able to find enough to fill some of those bond allocations that have been sitting in cash the last couple years.

As always, I thank you for your business, your patience, your referrals, and, most of all, your trust in me to manage you’re your hard earned wealth.

Bob

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