CGM Mutual Fund decreased -1.8% during the second quarter of 2016 compared to a return of 2.5% for the Standard and Poor’s 500 Index (S&P 500 Index) and 2.3% for the BofA Merrill Lynch U.S. Corporate, Government and Mortgage Index. For the first six months of the year, CGM Mutual Fund returned -6.7%, the S&P 500 Index, 3.8% and the BofA Merrill Lynch U.S. Corporate, Government and Mortgage Bond Index, 5.5%.
The second quarter began with the U.S. economy continuing to demonstrate relative strength compared to elsewhere around the globe. On April 1, the Labor Department reported that U.S. employers added an additional 215,000 non-farm payroll jobs in March and wages increased 2.3% from a year earlier. However, signs of a slowdown in U.S. economic expansion also began to emerge. On April 13, the Commerce Department reported that retail sales for March decreased by 0.3% as U.S. consumers pulled back on spending. Likewise, U.S. businesses also reduced spending. On April 26, the Commerce Department reported that orders for non-defense capital goods excluding aircraft, a proxy for U.S. business investment, decreased 2.4% in the first quarter of 2016. Declining business investment together with weak global demand ultimately resulted in the Commerce Department reporting a lackluster GDP of 0.5% (later revised to 1.1%) for the first quarter of 2016. Citing a combination of diminished growth, a mixed U.S. economic outlook and persistently low inflation, the Federal Reserve announced at its meeting on April 27 that it would leave interest rates unchanged.
The Fed’s decision to hold off on a rate increase was positive news for the market but contributed to a weakening dollar and a continued rise in oil prices. By the end of May, the price of U.S. crude had recovered to almost $50 per barrel, which was enough to reduce pressure on oil producers while not significantly impacting consumers. On May 17, a report from the Federal Reserve showed industrial production jumped 0.7% in April, the largest expansion since November, 2014. Increased production coincided with increasing prices as the
Labor Department reported, also on May 17, seasonally adjusted growth in the Consumer Price Index for April of 0.4%. This was the largest one month increase since February 2013 and it followed a 0.1% increase for March. Low unemployment, increasing wages and low interest rates provided further strength to the continued housing recovery. In mid-May, the Commerce Department reported that housing starts jumped 6.6% and building permits increased 3.6% from March to April. On May 24, the Commerce Department announced that purchases of new single-family homes expanded 16.6% for the month of April to a seasonally adjusted rate of 619,000, which was the largest one-month increase since January 2008. Median prices for new homes also increased 9.4% in April from a year earlier, indicating a strained supply of new housing coupled with significant consumer demand.
June began with surprisingly poor employment numbers from the Labor Department, with a report that U.S. employers added a mere 38,000 jobs in May (later revised down to 11,000), the weakest performance since September 2010. The news dampened expectations of a Fed rate increase, pushed Treasury yields lower and negatively impacted financial stocks. On the other hand there were also positive developments during the month. On June 1, the Institute of Supply Management reported its index of manufacturing activity for May climbed to 51.3 from 50.8 in April, demonstrating a recovery from the first quarter of 2016. A reading above 50 indicates expansion. U.S. consumer spending rebounded, driven by low interest rates, low oil prices and low unemployment. The Commerce Department reported on June 14 that retail sales increased a seasonally adjusted 0.5% in May, following an April increase of 1.3%. Citing slow economic growth and low inflation, the Federal Reserve held interest rates unchanged and lowered projections for near-term rate increases. Meanwhile, through much of early and mid-June, the markets reacted strongly to speculation on Brexit, i.e. whether Great Britain would vote to leave the European Union. On June 24, Great Britain voted to leave the European Union which sent investors to the relative safety of government bonds, currencies and gold. The S&P 500 Index dropped 3.6% in response and bank stocks, in particular, were hit hard. After two days of declines, the market had three of its best days of 2016, with the S&P 500 Index climbing 4.9% to finish out the quarter.
The yield on the 10 year U.S. Treasury began the quarter at 1.78%. Historically low global government bond yields driven largely by central bank bond buying programs, including negative yields in Japan and Germany, have kept U.S. bond yields low. Additionally, the Brexit vote drove further investment to government bonds with the yield on the 10 year U.S. Treasury finishing the quarter at 1.49%. On June 30, the S&P 500 Index was priced at 23.7 times the trailing twelve month earnings. While this remains above the historical average, we believe this valuation is appropriate given the low inflation rate and historically low interest rates.
On June 30, 2016, CGM Mutual Fund was 25.7% invested in short-term U.S Treasury Notes. The three largest industry positions in the equity portion of the portfolio were in housing and building materials, commercial banks and basic materials. The Fund’s three largest equity holdings were D.R. Horton, Inc. (DHI), the Lennar Corporation (LEN, Financial) (both housing and building materials) and Citigroup Inc. (C, Financial) (commercial banks).
David C. Fietze
President
July 1, 2016
