Ken Heebner's CGM Mutual Fund Semi-Annual Letter
CGM Mutual Fund returned -1.5% during the second quarter of 2013 compared to a return of 2.9% for the unmanaged Standard and Poor's 500 Index and -2.5% for the Bank of America Merrill Lynch U.S. Corporate, Government and Mortgage Bond Index. For the first six months of the year, CGM Mutual Fund returned 8.6%, the unmanaged Standard and Poor's 500 Index, 13.8% and the Bank of America Merrill Lynch U.S. Corporate, Government and Mortgage Bond Index, -2.6%.
Much like the first three months of the year, the second quarter served up a mixture of good and bad economic news. On April 3, the Institute of Supply Management (ISM) announced its nonmanufacturing index fell to 54.4, a seven month low. Higher taxes and federal budget cuts were purported to blame for the slowdown. Two days later on the first Friday of the month, the Labor Department released disappointing March employment numbers: Employers added only 88,000 new jobs, fewer than any month in the past year (though the number was later revised up to 142,000). The unemployment rate dropped to 7.6%, but only because an estimated almost half million people left the workforce in March. On a more encouraging note, housing starts in March rose 7.0% to an annual rate of 1,036,000 (later revised to 1,005,000) and new home sales climbed 1.5% (revised to 1.3%) to 417,000 annualized (revised to 451,000), the second highest jump in three years. Despite the mixed signals, the U.S. equity market, as measured by the S&P 500 Index, rose a modest 1.9% in April.
In May, news on the economy was decidedly better though not across the board. The Conference Board's Consumer Confidence Index jumped from 68.1 in April (later revised to 69) to 74.3 in May, a five year high. Employment numbers for April were better than expected with 165,000 new jobs added (later revised to 199,000), driving the unemployment rate down to 7.5%, a four year low. Additionally, February and March employment numbers were revised upwards by 150,000 combined.
June headlines included new car sales, which soared to 1.4 million in May (15.3 million annualized), up 8% from May 2012 according to Autodata Corp. The June "first Friday" employment numbers (for May) were higher than expected, coming in at 175,000 positions added (revised up to 195,000), but not so high as to convince the Federal Reserve Board to discontinue its policy of "quantitative easing." The Standard and Poor's Case-Shiller Index released in June revealed that existing home prices skyrocketed by 12.1% from April 2012 to April 2013. Important to note was the fact that home prices increased in every one of the twenty metropolitan areas surveyed. The bad news came again from the ISM, which reported a drop in its manufacturing index from 50.7 in April to 49 in May (a reading below 50 indicates contraction in the manufacturing sector). Culprits most likely were cuts in government spending, a downturn in Europe and some slowing in the Chinese economy, but the U.S. equity market was largely unfazed. The Consumer Confidence Index jumped nearly ten points to 84.1 in June.
Longer term interest rates began to move in May with the ten-year Treasury bond trading to yield 1.63% on May 3 and rising to 2.13% on May 31. The Fed met in mid-June and voted to continue its bond buying program, but suggested it might decrease the volume of monthly purchases later in the year as the recovery grows stronger. The bond market reacted quickly with the ten-year Treasury yield jumping to 2.61% on June 25, up almost a full percent since early May. Adding to the jitters were credit problems in China, which sent the short-term interest rate for overnight funds in Shanghai from 6% to 13% in June. The U.S. equity market reacted quickly, and the S&P 500 Index fell from 1,652 on June 18 to 1,573 on June 24 before recovering somewhat to 1,606 at the end of the quarter. In our view, the new Fed policy is constructive and we believe a stronger economy will help drive corporate profits higher, which should support a stronger equity market later in the year.
CGM Mutual Fund was 26.5% invested in short-term government securities at quarter end. The three major industries in the equity portion of the portfolio were money center banks, housing and building materials and vehicle assembly. The three largest equity positions were Morgan Stanley (MS), Citigroup Inc. (C) and Ford Motor Company (F).
Robert L. Kemp
July 1, 2013