Muhlenkamp and Company hosted an investment seminar on Dec. 3, providing keen insights on where founder Ronald Muhlenkamp sees the economy, and by extension the stock markets, going next. Muhlenkamp, the portfolio manager for its namesake Muhlenkamp Fund, spoke for the first half of the seminar. His son and co-manager Jeff Muhlenkamp took over for the last half.
The Muhlenkamp philosophy
Muhlenkamp is a value investor concentrated on corporate equities with a long-term outlook. The investments in the fund’s portfolio are held for an average of 10 years. Muhlenkamp’s philosophy is that stocks will represent the true value of a company given enough time, so he looks for companies with strong balance sheets that may be undervalued. The two big indicators Muhlenkamp looks for is an ROE that is on the high side (>15%) and a lower PE ratio than its peers.
Insights for your portfolio
Whatever your investment philosophy, listening to value investors is a good way to get a handle on what is happening in the economy and stock market perceptions. After all, the markets are largely irrational. There are ways to exploit those inefficiencies, be it through a day trade, an option or a long-term position, but understanding the circumstances surrounding the market, company performance and consumer behavior is never a bad thing.
Seminar topics
On Dec. 3, Muhlenkamp and Company took the time to explain quite a bit that could benefit your portfolio. Muhlenkamp and his son explored some of the different issues affecting the economy and discussed how some things changed over time, offering quite a few economic insights. Here are some of the most actionable takeaways.
Consumer spending
Ron Muhlenkamp began the investment seminar by discussing consumer spending. He noted that while the expectation for GDP and economy growth often used in forecasts is 4%, recovery has been closer to 2% – but even at 2%, that leaves people today roughly three times better off than their grandparents’ generation.
He went on to explain that personal consumption percentages have remained largely the same, and the quality of life has gone up. For instance, the average home size went from 800 square feet to 2400 square feet. Only four things have increased: social security taxes, fees for financial services (because there is more excess money), the cost of leisure time (because there are more free time and excess money) and healthcare.
Healthcare
Concerning healthcare, Muhlenkamp explained the increased costs as being part of higher co-pays, larger deductibles, and bigger premiums, but he also noted that healthcare costs are up because of the way we use healthcare. It doesn’t just prolong life; it improves the quality of life for its duration. Muhlenkamp noted how many innovations that have since come along and how people use them to live better lives, be it a knee replacement or a cure for Hepatitis C.
He is bullish over healthcare as an investment over the next few years, noting innovations, growth trends, and the quality of the science as reasons for the enthusiasm, but he was careful to discuss the effect politics can have on medical access and pricing. If a government limits how much a pharmaceutical company can charge for prescriptions, it could deter large companies from putting their resources towards finding those groundbreaking cures. Investors should keep an eye on the economic climate.
PE and ROE
As mentioned before, Muhlenkamp looks to company PE ratios and ROE for its strategy. Muhlenkamp discussed how ROE can drop in a recession and that PE ratios look lowest when earnings are high, but that it is necessary to look deeper to understand certain companies. Businesses that are cyclical or subject to seasonality may have a higher PE, and that can be better when business is predictably variable.
Business reinvestment
While some say companies should take advantage of low interest rates to finance expansion and equipment upgrades, Muhlenkamp explained that companies won’t (and really shouldn’t) look to make those sorts of investments until their capacity is around 80%, and that has not been the case:
Muhlenkamp also talked about how many companies are not expanding because of regulations like Dodd-Frank and the stress that is placed on an organization. He cited how the number of publicly traded organizations has fallen by roughly 50% over the past 15 years:
Interest rates
Jeff Muhlenkamp took over the presentation and discussed Europe and Japan. He explained that the U.S. dollar is strong against the euro right now because they started printing money and focusing on quantitative easing, while the U.S. has moved away from those measures. Now many of the banks in Europe are offering negative interest rates, and a similar series of events is happening in Japan.
In response, many companies and institutional investors are leaving Europe and Japan and coming to the U.S. They are selling their euros and yen to buy U.S. dollars and taking on domestic equities. Muhlenkamp explained that some of this is strategic. A smaller country like Switzerland wouldn’t want a large number of people to flood the banks there and impact the local currency, so they keep interest rates low as a discouragement.
Muhlenkamp believes the U.S. dollar is strong and does not see anything changing that in the near future, but, of course, it is the unexpected things that have the greatest impact.
China
Muhlenkamp said China is trying to encourage growth through consumerism, a change from growing through infrastructure. Consumer spending has not increased much yet, and that is why GDP is lower, but that is a good thing for now – at least for China. The companies who were hired to help the country build that infrastructure have been impacted by the decline in demand, like many commodity companies.
Commodities and credit default
There is nothing on the horizon to suggest oil prices will rise. At the same time, growth in China is slowing, the Japanese and European banks are printing money and countries like Saudi Arabia and Russia are keeping oil production high. In turn, many commodity prices are dropping, and the U.S. dollar is strong. Commodity producers like Brazil, Australia, Russia and Canada are feeling the effects. This gives rise to a real risk that these impacted companies will not be able to support their debt. If the energy industry shrinks, it could pull the U.S. into a recession.
The trend is apparent when looking at credit default swaps:
Muhlenkamp explained that the market is beginning to expect a default from Brazil and possibly Russia.
Construction companies
Muhlenkamp said construction companies like Caterpillar (CAT, Financial) may take a hit as these countries experience a pull back.
Going forward
Muhlenkamp currently does not see many opportunities, and many of its positions have matured, so the fund is holding 25% to 30% cash. In turn, the Fund expects to pay capital gains tax on 11% to 12% of its portfolio, but it would rather pay the tax than put money in a wrong position. Muhlenkamp has looked for new investments and found many good companies, but not at the right prices. Instead, it will hold on to its cash until equities get cheaper.
