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Kenneth Heebner's Annual Investor Letter - Positioned for More Economic Growth
Posted by: Holly LaFon (IP Logged)
Date: March 1, 2012 10:49AM

Ken Heebner positioned his portfolio for global growth, which did not happen as quickly as he expected in 2011. He still believes the U.S. equity market is undervalued going into 2012 and has positioned his portfolio again for more growth:

CGM Mutual Fund increased 5.4% during the fourth quarter of 2011 compared to the Standard and Poor’s 500 Index which rose 11.8% and the Merrill Lynch U.S. Corporate, Government and Mortgage Bond Index which returned 1.1% over the same period. For the twelve months just ended, CGM Mutual Fund declined –16.9%, the S&P 500 Index returned 2.1% and the Merrill Lynch U.S. Corporate, Government and Mortgage Bond Index increased 7.9%.

The Year in Review and Economic Outlook

Last year began with some optimism sparked by a rise of 1.3% in Industrial Production in December 2010, an increase of 6.7% on a year-over-year basis. Unemployment peaked at 9.9% in 2010 and declined to 9.0% in January 2011 and fell again to 8.8% in March. However, in March, global events began to overshadow financial markets as political upheaval rocked North Africa and the Middle East. Additionally, consumer spending was threatened by crude oil prices which shot up to $105 per barrel at the end of the first week of March from $91 at the beginning of the year. Then on March 11, more uncertainty was unleashed when a 9.0 magnitude earthquake drove a devastating tsunami onto the Japanese coast, wrecking a major nuclear power plant as well as damaging many factories and disrupting the manufacture of many goods intended for export to the U.S.

The second quarter of 2011 saw little in the way of encouraging economic news: Greece’s financial troubles—and to a degree also those of Italy and Spain—spurred a “flight to safety” into U.S. Treasury securities which drove the yield on the 10-year Treasury bond down from 3.6% on April 7 to 2.9% on June 24. Yet, despite the disquieting influx of capital into government bonds and ongoing business disruptions caused by the Japanese disaster, the S&P 500 Index was up 6.0% for the year on June 30.

The second half of the year began with a mixed bag of economic signals. June retail sales were reported to be 8.2% higher than one year earlier. The Conference Board’s Consumer Confidence Index increased to 59.2 in July (up from 57.6 in June). But a Congressional standoff over raising the debt ceiling and Standard and Poor’s subsequent cut in the United States’ debt rating from AAA to AA+ on August 5 took their toll. The S&P 500 Index struggled in anticipation of the downgrade and plummeted on the first trading day after the announcement, eroding 10% of the market’s value since the beginning of the year. The Consumer Confidence Index collapsed to 45.2 in August and the remainder of the third quarter was marked by days of extreme volatility in the markets. The S&P 500 Index closed on September 30 down 8.7% since December 31, 2010.

Europe was particularly noisy at the start of the fourth quarter with squabbling over austerity programs and resistance to budget discipline roiling European economies and shaking the U.S. equity market as well. Nonetheless, other vital economic signs began to improve domestically. Third quarter GDP was initially reported up 2.5% (later revised to 1.8%) over the previous quarter and retail sales for September were encouraging. The unemployment rate which had popped back to 9.0% dropped to 8.6% in November and new jobless claims fell for three straight weeks in December to the lowest level since April 2008. Consumer Confidence recovered from its August depths and rose from 55.2 in November to 64.5 in December. At its final meeting of the year, the Federal Reserve Board reiterated its view of an economy that is slowly improving, though possibly also held back by the slowdown in the rest of the world.

Against a backdrop of the lowest interest rates in more than fifty years (10-year Treasury yields of 1.88%), a slowly improving economy and attractive valuations on many securities, we believe the U.S. equity market continues to be undervalued as we enter 2012.

Portfolio Strategy In 2011, CGM Mutual Fund was invested in industries that would benefit from significant global growth. Global business did improve during the year, but not as fast as we had hoped and the Fund suffered substantial losses in oil service, mining, and financial investments. Fears of a European financial crisis and the attendant possibility of global economic destabilization magnified these losses in the second half of the year. The Fund was not significantly invested in economically defensive industries which did appreciate during 2011.

The fixed income portion of the CGM Mutual Fund portfolio ranged between 26% and 28% of the Fund’s net assets during the year. The lion’s share of the Fund’s fixed income investments was in short-term U.S. Treasury notes though the Fund did hold one long-term corporate bond.

We believe the U.S. economy will continue to grow in 2012 despite European challenges. We believe we have structured the Fund’s portfolio to benefit from further U.S. business expansion.

On December 31, 2011, CGM Mutual Fund was approximately 27% invested in fixed income securities, primarily U.S. Treasury securities with a modest position in a corporate bond. The three largest positions in the equity portion of the portfolio were in money center banks and the airline and vehicle assembly industries. The Fund’s three largest equity holdings were Delta Air Lines, Inc. (DAL), Citigroup Inc. (C) (banking) and Herbalife Ltd. (HLF) (health care services).

Robert L. Kemp

G. Kenneth Heebner
Portfolio Manager

Guru Discussed: Kenneth Heebner: Current Portfolio, Stock Picks
Stocks Discussed: DAL, C, HBL,
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