To Our Shareholders,
Thank you for your investment in The GAMCO Growth Fund.
For the quarter ended September 30, 2015, the net asset value (“NAV”) per Class AAA Share of The GAMCO Growth Fund decreased 6.2% compared with decreases of 6.4% and 5.3% for the Standard & Poor’s (“S&P”) 500 Index and the Russell 1000 Growth Index, respectively. See page 2 for additional performance information.
The third quarter began with investors digesting the final act (for now) of the Greek drama and a plunging Chinese stock market. Domestic economic growth had been hurt by the strong dollar, a West Coast port strike and job cuts in the broader energy complex. Still, economic data was skewed to the positive side, enough so to perpetuate a healthy debate surrounding the timing of the Fed’s first tightening move. In last quarter’s commentary, we stated a “growing likelihood that the increase that has been expected in September gets postponed until December, if not later.” We stand by those comments.
In mid-August China moved to devalue the yuan. This unexpected move to prop up exports triggered a slide in global commodities and stocks. Clearly, China was not and is not growing anywhere near their official GDP growth rate of about 7%. The yuan’s devaluation was the catalyst for heightened global growth fears which translated into wider corporate and emerging market debt spreads and a ballooning of emerging market credit default swap (CDS) premiums. The S&P fell nearly 12% in the six trading sessions that followed, hitting a low of 1867 on August 25, which was the low for the quarter. It ended the quarter about 3% higher, at 1920. As stated in our last commentary, “we never said it was going to be easy.”
The Economy
In this day and age, it doesn’t take much to stir the stock market. The market reacts instantaneously to substantive economic reports like those for real gross domestic product (GDP). But such lightening quick reactions are dangerous. Most key government reports are revised multiple times and sometimes significantly. The first quarter GDP report showed growth of 0.2%, before being revised to a decline of 0.7%, before being revised again to a decline of 0.2%, before being revised yet again to growth of 0.6%. Second quarter growth was first reported as 2.3%, before being revised to 3.7%, before being revised further to 3.9%. Phew. The unemployment rate was 5.6% last quarter and is now lower at 5.1%. While the domestic economy is in pretty good shape, it is not totally sheltered from a softer picture globally. So the 3.9% advance in the second quarter (annualized rate) is most likely the high point for the year, with growth in the 3.0% neighborhood more realistic for the third and fourth quarters.
Low single digit gains with earnings of approximately $120 remain expected for S&P operating earnings this year. But earnings were up less than 2% in the first quarter and registered a decline in the second quarter. The quarterly gains for the third and fourth quarters are estimated at 4% and 12% respectively. So the quarterly progression appears favorable at this point. The weak link is to be found in the foreign profits of multinational companies. The good news is that domestic profits are two and a half times larger than foreign profits. As we approach the fourth quarter, the market will increasingly discount expectations for 2016 profits. The consensus is looking for about $130 in S&P profits, for a gain of 8% or so. It will be telling to see how expectations for 2016 change following third quarter reports and updated company guidance.
As we look ahead to 2016, every region of the world is expected to show an improvement in growth with the exception of the Middle East, where growth is expected to be flat at 3.3%. This includes the emerging markets as a block, despite all the anxiety about China dragging them down. Of course we have no confidence in estimates for China’s growth, given China’s lack of transparency and adjusting for that might generate a different forecast for the Pacific Rim. Still, North America, Latin America, Western and Eastern Europe, Asia ex-Japan, Japan and Africa are all expected to show improvement. Obviously some countries will be less fortunate. Brazil and Venezuela will be in recession although Russia is expected to move out of recession and show modest growth of 0.3%. The overall picture depicted by data, not headlines, is pretty constructive, but the situation is fluid and the numbers in the forecasts will face adjustments.
The Markets
Interest rates have moved a bit lower in the past three months, with the 10-year Treasury now yielding 2.05% in early October, down from 2.20% when we wrote in July. After hitting 2.48% in June, the 10-year fell to 2.00% in the August sell-off, rebounded to 2.29% in mid-September and then fell to 1.99% on a disappointing September jobs report (to be revised). The equivalent Japanese government bond yield is at 0.31%, down from 0.45% last quarter. The German 10-year is at 0.57%, down from 0.67% last quarter. Clearly, global growth has been tempered by the slowing of China, Russia, Brazil and other emerging markets. Additionally, fixed income investors have expressed a preference for government debt, highlighted by widening spreads for corporate credit.
It had been several years since we had a full blown stock market correction (widely defined as a 10% decline). Last year the worst decline was 9.9% (using S&P closing prices). We were overdue. Now we have had a 12% correction. The catalyst was primarily the slowdown in China and contagion from the related plunge in commodity prices. Investors were also complacent and margin debt has grown to exceed $500 billion for the first time. Last quarter we said “stocks need periodic declines to keep investors honest.” Well, we have had a swift shake out and many individual investors have fled the stock market, pulling many billions out of domestic stock funds. In today’s high frequency trading world, augmented by ETF day traders, corrections may be sudden and sharp.
We do have some confidence in saying we do not see a recession on the immediate horizon. That being the case, we don’t see a long and deep slump in stocks given 2% interest rates, 3% GDP growth and prospects for about 8% profit growth next year—and not with stocks at 15 times forward earnings, which is very average, and a dividend yield of 2.2%, which exceeds the 10-year Treasury yield.
Portfolio Observations
During the third quarter we added new positions in Federal Express (1.2% of net holdings as of September 30, 2015) and Charles Schwab (1.1%). Federal Express is gaining market share from UPS and is a primary beneficiary of the trend toward online commerce. We expect earnings growth in the high teens this fiscal year and next. Schwab is one of the largest asset gatherers with a business model geared to help individual investors and independent Registered Investment Advisors, which is the growth end of the business. Schwab’s earnings will benefit from a Fed rate hike (allowing it to recoup some waived money market fund fees) and steepening of the yield curve (widens the net interest margin), two likely events over the next year. Schwab has one of the fastest growth rates among large cap financial service companies.
We added to a number of holdings, especially Sherwin Williams (2.0%), Adobe Systems (2.7%), Facebook (4.4%), Celgene (1.4%), Walt Disney (2.3%) and Walgreens Boots Alliance (1.4%).
We eliminated 8 positions. We sold Precision Castparts after they received a takeover bid from Berkshire Hathaway. We also sold companies where we were concerned about the strength of their foreign based profits. These were Abbott Labs, Mead Johnson Nutrition, Cummins Inc., DuPont, Eaton Corp., Paccar, and United Technologies.
We also reduced a number of positions, including Liberty Global plc (0.4%), Texas Instruments (1.0%), EOG Resources (1.0%), Apple Inc. (6.1%), CBS Corp. (0.5%) and Oracle(0.8%).
At quarter’s end, we continued to have 25% of the portfolio invested in the Consumer Discretionary sector. During the quarter we increased our exposure in Technology from 23% to 25%. We also gave a boost to Financial Services from 9% to 11%. Healthcare was cut back from 18% to 16%. Producer Durables fell from 11% to 10% and Energy from 2% to 1%. Consumer Staples remains with a 7% weight and Materials is unchanged at 5%. We have no investments in Utilities. There were 77 companies represented in the portfolio, 4 of which are domiciled outside the U.S., representing 4% of assets.
Performance Commentary
Companies that made the most positive contribution to our results for the quarter (based upon price change and position size) were, in order, Amazon.com (3.6% of net assets as of September 30, 3015), Google (4.4%) (note: Google changed its name to Alphabet Inc. in October 2015), Nike (1.3%), Facebook, Home Depot (3.1%), Precision Castparts, Starbucks (1.3%), TJX (1.0%), Priceline.com (1.2%) and Visa (2.2%). Six of the top ten contributors were Consumer Discretionary companies. There were two technology companies and one each from Producer Durables and Financial Services.
Hurting us the most for the quarter were, in order, Apple, PPG Industries (1.2%), Gilead Sciences (1.5%), Biogen (0.8%), McKesson (1.4%), Allergan (2.2%), Goldman Sachs (1.5%), Abbvie (1.0%), Sherwin Williams and CBS. Half of these were Healthcare stocks, which speaks to concern about the spotlight on drug price increases, combined with a multi-year run in the whole Healthcare sector.
In Conclusion
Let us not forget the dollar. The broad trade weighted dollar index is up 9% this year. That has crimped earnings and hurt exports. Some of the dollar’s appreciation was predicated on a Fed tightening cycle beginning this year. That now appears to be less likely. While the jury is still out, the decline in commodity prices and global interest rates is setting the stage for stronger growth. We believe this, along with a delayed Fed rate hike, could take pressure off the dollar. Indeed the dollar typically declines during periods of rising global growth. Ironically, we would be even more positive if commodity prices staged a rebound from this depressed level, which would collapse the emerging market CDS premiums and debunk the notion that the sky is falling. This does not mean we should adopt a bearish stance if and when the Fed tightens. A 25 basis point tightening is not a game changer, not when your starting level is so low. A quick succession of hikes would be another matter but that is not going to happen on Janet Yellen’s watch. In other words, our base case scenario leans to the positive for longer term investors. Stay tuned.
Howard F. Ward CFA
Portfolio Manager
Let’s Talk Stocks
The following are stock specifics on selected holdings of our Fund. Favorable earnings prospects do not necessarily translate into higher stock prices, but they do express a positive trend that we believe will develop over time. Individual securities mentioned are not necessarily representative of the entire portfolio. For the following holdings, the share prices are listed first in United States dollars (USD) and second in the local currency, where applicable, and are presented as of September 30, 2015.
Apple Inc. (AAPL, Financial)(6.1% of net assets as of September 30, 2015) (AAPL – $110.30 – NASDAQ) designs Macs, arguably the best personal computers in the world, along with OS X, iLife, iWork, and professional software. Apple leads the digital music revolution with its iPods and iTunes online store. Apple has reinvented the mobile phone with its revolutionary iPhone and App Store, and is defining the future of mobile media and computing devices with the iPad and Apple Watch.
Facebook Inc.’s (FB, Financial)(4.4%) (FB – $89.90 – NASDAQ) mission is to give people the power to share and make the world more open and connected. People use Facebook to stay connected with friends and family, to discover what's going on in the world, and to share and express what matters to them. As of June 30, 2015, Facebook had 1.49 billion monthly active users (MAUs) worldwide and an average of 968 million daily active users (DAUs), creating a powerful targeted advetising platform.
Microsoft Corp. (4.4%) (MSFT, Financial)(MSFT – $44.26 – NASDAQ), the world’s largest software company, develops, manufacturers, and licenses a range of software products for a variety of computing devices from PC’s to servers to its Xbox game console. While the company’s core desktop operating system and applications software franchise (Windows/MS Office) is maturing, Microsoft is gaining share in the enterprise market and, with its Internet and Xbox efforts, in the consumer markets also. The company’s latest operating system, Windows 10, was released in July, 2015.
Google Inc. (GOOG, Financial)(4.4%) (GOOG – $608.42 – NASDAQ, GOOGL – $638.37 – NASDAQ) is widely recognized as the world’s leading Internet search engine. Google’s stated mission is to organize the world’s information and make it universally accessible and useful. Google generates revenue by providing advertisers with the opportunity to deliver measurable, cost effective online advertising that is relevant to the information displayed on any given webpage. This makes the advertising useful to consumers as well as to the advertiser placing it. We believe this highly innovative and fast growing company is uniquely positioned to create new market opportunities while maintaining its lead in online search. Beginning October, 2015, Google will be known as Alphabet as part of a corporate restructuring.
Amazon.com Inc. (AMZN, Financial)(3.6%) (AMZN – $511.89 – NASDAQ) opened on the World Wide Web in July 1995. The company is guided by four principles: customer obsession rather than competitor focus, passion for invention, commitment to operational excellence, and long-term thinking. Customer reviews, 1-Click shopping, personalized recommendations, Prime, Fulfillment by Amazon, AWS, Kindle Direct Publishing, Kindle, Fire phone, Fire tablets, Fire TV and Amazon Echo are some of the products and services pioneered by Amazon.
Mastercard Inc. (MA, Financial)(3.2%) (MA – $90.12 – NYSE) is a technology company in the global payments industry that operates the world’s fastest payments processing network, connecting consumers, financial institutions, merchants, governments and businesses in more than 210 countries and territories. MasterCard’s products and solutions make everyday commerce activities – such as shopping, traveling, running a business and managing finances – easier, more secure and more efficient for everyone.
Home Depot Inc. (HD, Financial)(3.1%) (HD – $115.49 – NYSE) is the world's largest home improvement specialty retailer, with 2,270 retail stores in all 50 states, the District of Columbia, Puerto Rico, U.S. Virgin Islands, Guam, 10 Canadian provinces and Mexico . In fiscal 2014, The Home Depot had sales of $83.2 billion and earnings of $6.3 billion. The Company employs more than 370,000 associates.
Adobe Systems Inc. (ADBE, Financial)(2.7%) (ADBE – $82.22 – NASDAQ) is the global leader in digital marketing and digital media solutions. Their tools and services allow customers to create groundbreaking digital content, deploy it across media and devices, measure and optimize it over time and achieve greater business success. Adobe’s software and services help customers make, manage, measure and monetize their content across every channel and screen.
Honeywell International Inc. (2.6%) (HON, Financial)(HON – $94.69 – NYSE) is a Fortune 100 diversified technology and manufacturing leader, serving customers worldwide with aerospace products and services; control technologies for buildings, homes, and industry; turbochargers; and performance materials. Based in Morris Township, N.J., the company employs more than 127,000 people worldwide, including more than 22,000 engineers and scientists.
The Walt Disney Co. (2.3%) (DIS, Financial)(DIS – $102.20 – NYSE) together with its subsidiaries and affiliates, is a leading diversified international family entertainment and media enterprise with five business segments: media networks, parks and resorts, studio entertainment, consumer products and interactive media. In addition to its namesake, other brands include the ABC Television Network, ESPN, Pixar Animation, Marvel, and Lucasfilm.
October 6, 2015
Note: The views expressed in this Shareholder Commentary reflect those of the Portfolio Manager only through the end of the period stated in this Shareholder Commentary. The Portfolio Manager’s views are subject to change at any time based on market and other conditions. The information in this Portfolio Manager’s Shareholder Commentary represents the opinions of the individual Portfolio Manager and is not intended to be a forecast of future events, a guarantee of future results, or investment advice. Views expressed are those of the Portfolio Manager and may differ from those of other portfolio managers or of the Firm as a whole. This Shareholder Commentary does not constitute an offer of any transaction in any securities. Any recommendation contained herein may not be suitable for all investors. Information contained in this Shareholder Commentary has been obtained from sources we believe to be reliable, but cannot be guaranteed.
Minimum Initial Investment – $1,000
The Fund’s minimum initial investment for regular accounts is $1,000. There are no subsequent investment minimums. No initial minimum is required for those establishing an Automatic Investment Plan. Additionally, the Fund and other Gabelli/GAMCO Funds are available through the no-transaction fee programs at many major brokerage firms. The Fund imposes a 2% redemption fee on shares sold or exchanged within seven days after the date of purchase. See the prospectuses for more details.
www.gabelli.com
Please visit us on the Internet. Our homepage at www.gabelli.com contains information about GAMCO Investors, Inc., the Gabelli/GAMCO Mutual Funds, IRAs, 401(k)s, current and historical quarterly reports, closing prices, and other current news. We welcome your comments and questions via e-mail at [email protected].
The Fund’s daily net asset value is available in the financial press and each evening after 7:00 PM (Eastern Time) by calling 800-GABELLI (800-422-3554). The Fund’s NASDAQ symbol is GABGX for Class AAA Shares. Please call us during the business day, between 8:00 AM – 7:00 PM (Eastern Time), for further information.
You may sign up for our e-mail alerts at www.gabelli.com and receive early notice of quarterly report availability, news events, media sightings, and mutual fund prices and performance.
