CGM Mutual Fund increased 5.9% during the fourth quarter of 2017, compared to the Standard and Poor’s 500 Index (S&P 500 Index) which increased 6.6% and the ICE BofAML US Corporate Government & Mortgage Index which returned 0.4% over the same period. For the twelve months ended December 31, 2017, CGM Mutual Fund returned 17.1%, the S&P 500 Index returned 21.8% and the ICE BofAML US Corporate Government & Mortgage Index returned 3.6%.
The Year in Review and Economic Outlook
The stock market started the year strong, continuing a rally that began with the presidential election at the end of 2016. Bank stocks were a significant driver of market performance early in the year based on the prospects of a more favorable regulatory environment and the possibility of upward inflation pressures. U.S. and foreign stocks advanced in response to rising commodity prices and improved global economic conditions. The prospects of continuing U.S. and global economic growth led the Federal Reserve to raise interest rates in mid-March with plans for two further rate increases during the year. Stocks reacted favorably to the news but pulled back as the quarter came to a close. The decline at the end of the quarter may have been in reaction to the inability of the Trump administration and congressional Republicans to pass a replacement for the Affordable Care Act and concern that this failure was an indication that the administration would have trouble implementing its agenda of infrastructure spending, tax cuts and reduced regulation. Despite the market weakness, consumer confidence continued to grow through the end of the quarter and the Conference Board’s Consumer Confidence Index reached its highest level in seventeen years. In another healthy sign for the economy, the Commerce Department’s Personal Consumption Expenditure Index (the index the Fed consults when planning interest rate adjustments) for February surpassed the Fed’s target of a 2% annual gain for the first time in five years.
Stocks climbed through the second quarter despite mixed economic news. The Institute for Supply Management (ISM) reported accelerating growth in the non-manufacturing sector and also indicated that the manufacturing sector continued to expand, though at a slightly slower pace than earlier in the year. Lackluster U.S. business investment since the end of the recession resulted in tempered growth in the manufacturing sector. Labor Department reports in April provided signs of upward inflation pressure. The Producer Price Index for Final Demand, which measures the prices U.S. companies receive for their goods and services, grew to its highest level in five years. Import prices also increased by 4.1% from a year earlier. However, this news was offset by oil prices that dropped into bear market territory in June and countered rising inflation pressures. Despite the conflicting news, the equity markets continued to climb through the end of the quarter, led by technology stocks which outperformed the broader market, and bank stocks which benefited from the news that all of the 34 largest U.S. banks passed the Fed’s capital requirements test mandated by the Dodd-Frank Act.
U.S. economic growth picked up in the third quarter despite low inflation. Strong employment and wage data along with resurgent consumer spending contributed to the steady expansion. Wage increases have been subdued throughout the recovery from the recession but the Labor Department’s June employment report indicated that workers at the bottom of the pay scale were now seeing their earnings increase at a faster rate than the median for all workers. The Commerce Department reported that retail sales for the first half of the year surpassed the first half of 2016 and grew at an even quicker pace in July. In early September, the impact of hurricanes Harvey and Irma along with rising tensions between the U.S. and North Korea temporarily weighed on stock prices and, along with weak inflation numbers, contributed to low bond yields. But the Fed expressed its confidence in continued economic growth by announcing that it would begin to reduce its portfolio of bonds and other assets purchased to stimulate the economy in the wake of the recession. By the end of the quarter, stocks were back in record territory.
The fourth quarter saw continued growth with the ISM reporting that manufacturing activity in September reached a thirteen year high despite the impact of the recent hurricanes. In October, the Labor Department reported that the unemployment rate dropped to a 17 year low of 4.1%, where it remained through the end of the year. As the market anticipated passage of the Republican’s tax plan, stocks continued to hit new records, led by banks and small cap stocks which are expected to benefit the most from the new corporate tax cuts. Bond yields rebounded after passage of the tax plan in anticipation of upward inflationary pressures and the yield on the 10 year U.S. Treasury bond ended the year at 2.4%. Expanding corporate earnings and a growing global economy drove the S&P 500 Index and the Dow Jones Industrial Average to their best returns since 2013.
Portfolio Strategy
CGM Mutual Fund was fully invested throughout 2017 in anticipation of strengthening economic growth around the globe. The Fund’s largest industry positions over the course of the year were in the financial sector, including commercial banks, money center banks and broker/dealers. Other significant holdings during that period were in semiconductor production and semiconductor capital equipment companies and mining companies.
CGM Mutual Fund’s largest portfolio gains were in commercial banks and broker/dealers with smaller contributions from semiconductor production and semiconductor capital equipment companies and mining companies.
The fixed income section of the portfolio was invested in short term U.S. Treasury securities as we expected interest rates to rise.
On December 31, 2017, CGM Mutual Fund was 26.6% invested in short term U.S. Treasury securities. The equity portion of the portfolio was 15.0% invested in metals and mining companies, 13.4% in commercial banks and 10.8% invested in money center banks. The Fund’s three largest equity holdings were Citigroup Inc. (commercial banks), Vale S.A. ADR (metals and mining) and Bank of America Corporation (commercial banks).
David C. Fietze
President
G. Kenneth Heebner
Portfolio Manager
January 2, 2018
Portfolio Manager
G. Kenneth Heebner has managed CGM Mutual Fund since 1981. In 1990, Mr. Heebner founded Capital Growth Management Limited Partnership ("CGM") with Robert L. Kemp. Prior to establishing CGM, Mr. Heebner was at Loomis, Sayles & Company where he managed the Fund, then known as Loomis Sayles Mutual Fund. In addition to CGM Mutual Fund, he currently manages CGM Realty Fund and CGM Focus Fund as well as one pooled investment vehicle.
