Ken Heebner's CGM Mutual Fund Down 5.2%, 2Q Investor Letter
The second quarter of 2011 unfolded much like the first quarter when the Gross Domestic Product increased only 1.9%. Though the sluggish housing sector and relatively high unemployment numbers have hindered the economic recovery since it began, just one year earlier, first quarter GDP growth was a much higher 3.1%. The Conference Board’s Consumer Confidence Index dipped to 58.5 in June from a revised 61.7 in May, making June’s the lowest level thus far this year. Also, the current 9.1% unemployment rate is unusually high given the economic recovery has been underway for two years.
Still, there were a few bits of good news scattered within the gloomier broader indicators. April employment numbers surprised to the upside coming in at 232,000 versus an estimate of 185,000 (though they were subsequently revised downward by 15,000). April non-farm payrolls were first reported to be up by 268,000 which, if true, would have been the largest increase since February 2006. The markets reacted enthusiastically, but the euphoria was somewhat misplaced and short-lived. May’s new jobs numbers logged in at a truly dismal 83,000 (and, as it turned out, even April’s number was revised down twice to a non-record-setting 241,000). Many economists point to May as a “soft patch,” citing falling commodity prices in the first week of the month, including a decline of 15% in crude oil and 27% in silver futures.
On roughly the same schedule, the yield on the 10-year US Treasury bond fell from 3.58% on April 7 to 3.17% on May 9 and eventually to a low of 2.87% on June 24, 2011. This decrease may be attributable to the slowdown or perhaps a “flight to safety” given the resurfacing financial difficulties of Greece and Europe. In fact, the second quarter of 2011 bore a striking resemblance to the second quarter of 2010 when headlines struck fear with talk of a relapse to recession, the economic turmoil in Greece and, instead of oil gushing into the Gulf of Mexico last year, business supply chain disruptions as a result of the Japanese earthquake and tsunami were making the news for most of the second quarter of this year. This week, however, more encouraging reports on the refinancing of Greek debt have emerged and today (July 1), the Institute of Supply Management announced an increase in manufacturing activity from 53.5 in May to 55.3 for June reducing fears of further economic slowdown and providing investors with a welcome shot of optimism which drove the S&P 500 Index up 5.6% for the week.
The Federal Reserve Board has vowed to keep monetary policy loose until the economy seems to be on a stronger footing, and on Wednesday, June 22, the Fed announced it will keep interest rates low “for an extended period.” The quantitative easing program commenced last November ended June 30 on schedule and without mention of a new initiative. While the so-called QE2 may have kept a lid on interest rates, there is little economic recovery to show for the $600 billion bond buying program.
In the meantime, corporate profits continue to increase at a good clip with estimates of $94 per share of the S&P 500 Index on June 30, positioning the market at an earnings yield of 7.1%. We believe it is a rare opportunity when the market capitalizes earnings at this level with 10-year Treasury bonds yielding roughly 3%.
On June 30, 2011, CGM Mutual Fund was approximately 26% invested in government securities and corporate bonds. The three largest positions in the equity portion of the portfolio were in the oil service, retail and vehicle assembly industries. The Fund’s three largest equity holdings were National Oilwell Varco, Inc. (NOV), Halliburton Company (HAL) and Bed Bath & Beyond Inc. (BBBY).