CGM Mutual Fund increased 1.1% during the fourth quarter of 2015, compared to the Standard and Poor’s 500 Index (S&P 500 Index) which increased 7.0% and the BofA Merrill Lynch U.S. Corporate, Government and Mortgage Bond Index which returned -0.6% over the same period. For the twelve months ended December 31, 2015, CGM Mutual Fund decreased -3.1%, the S&P 500 Index increased 1.4% and the BofA Merrill Lynch U.S. Corporate, Government and Mortgage Bond Index returned 0.6%.
The Year in Review and Economic Outlook
2015 began with mixed signals on the direction of the U.S. economy. February reports of prior month U.S. auto sales showed a 14% overall increase from December 2014 and a 19.3% increase for higher priced light trucks and SUVs for the same period. The pace of new home sales continued to expand and the Commerce Department reported that January and February sales remained near the six year high, despite the severe winter weather in much of the U.S., tight credit for borrowers and rising home prices. In March, the Federal Reserve ("Fed") reported U.S. industrial production increased 3.5% and capacity utilization increased 3.1% over the year before, suggesting a long term outlook of moderate economic growth. Despite these positive indicators, the stock market continued to react to the timing uncertainty of an interest rate increase by the Fed, which moved bond yields higher and contributed to the rising value of the dollar. Ultimately, the harsh winter, strong dollar, falling oil prices and a labor dispute that shut down U.S. West Coast ports led to a 0.2% decrease in the gross domestic product for the first quarter, according to the Commerce Department.
In April, the Fed referred to the economic difficulties in the first quarter along with cautious spending by U.S. consumers and businesses as evidence of some restraint in the growth of the U.S. economy. Still, the Fed indicated that it anticipated U.S. economic growth to again pick up to a moderate pace. Growth continued to be found in the housing market. An April report from the Commerce Department showed that first quarter 2015 sales of new homes increased by 21.7% over the first quarter of 2014. The increase was likely attributable to low mortgage rates, job growth and improving wages. In April, the Labor Department’s Employment-Cost Index, a wide-ranging measure of compensation expenses, reported a seasonally adjusted increase of 0.7% for the first quarter, indicating a tightening job market and an upward trend in wages. In May, the strengthening manufacturing sector, coupled with a Commerce Department report that U.S. housing starts rose 20.2% from March to April, led to a sell-off in U.S. Treasuries. However, by the end of the quarter, the 10 year Treasury yield stood at 2.3% as investments moved to safety in response to Greece’s default on its debt to the International Monetary Fund and European creditors.
In July, the Commerce Department provided some positive news of growth, reporting that orders for durable goods in June increased by 3.4%, a sign that businesses started to increase spending. The Commerce Department also reported that the monthly growth in starts for single family housing units, which account for approximately two-thirds of the housing market, increased by 12.3% and again by 12.8% in June and July respectively. However, U.S. stock market performance was negatively impacted by reaction to slowing Chinese economic growth. Large sell-offs in the Shanghai Composite Index, the impact on commodities prices of weakening demand from China for raw materials and China’s devaluation of the yuan in early August contributed to the first U.S. stock market correction in four years.
The sluggish Chinese manufacturing sector, coupled with OPEC’s decision to maintain its high level of oil production into a near-capacity world market, pushed oil prices below $40 a barrel in the fourth quarter. While subdued oil prices have had a negative impact on the energy sector, the Fed saw enough strength in the overall U.S. economy to raise interest rates for the first time in seven years. Addressing the Fed’s decision, Chair Janet Yellen acknowledged the unevenness across different industrial sectors but pointed to improved labor market conditions and predicted sustainable continued improvement in the economy. Labor Department reports through the year showed increasing average hourly earnings and the unemployment rate dropped to 5% by October. While mixed economic signals are expected to continue, Congress acted in December to extend tax breaks to businesses and low income families and to fund the government through September 2016. This bi-partisan action demonstrated that Congress can work together and avoids the threat that a government shut-down will drag on the U.S. economy into 2016.
Portfolio Strategy
CGM Mutual Fund was fully invested throughout 2015 in anticipation of stronger expansion in the U.S. economy. The fund's portfolio was focused on companies that we believed would benefit from more rapid growth and rising U.S. interest rates. Consumer spending was stimulated by sharply lower gasoline and fuel prices and rising employment, but growth was less than we anticipated. The strong dollar negatively impacted exports and reduced pricing flexibility for some companies.
The portfolio benefited most from appreciation in our investments in homebuilding, automobile and lighting products companies, and realized its largest losses from investments in retailers and appliance manufacturers.
The fixed income section of the fund fluctuated between 26% and 30% of the portfolio during the year. The fixed income portfolio was invested in U.S. Treasury notes with less than a two year maturity in anticipation of higher interest rates.
On December 31, 2015, CGM Mutual Fund was 27.2% invested in U.S. Treasury securities. The three largest industry positions in the equity portion of the portfolio were in housing and building materials, the retail industry and commercial banks. The Fund’s three largest equity holdings were D.R. Horton, Inc. (DHI, Financial) (housing and building materials), the Lennar Corporation (LEN, Financial) (housing and building materials) and Citigroup Inc. (C, Financial) (commercial bank).
David C. Fietze
President
G. Kenneth Heebner
Portfolio Manager
