CGM Mutual Fund decreased -9.8% during the second quarter of 2018 compared to a return of 3.4% for the Standard and Poor’s 500 Index (S&P 500 Index) and -0.2% for the ICE BofAML U.S. Corporate, Government & Mortgage Index*. For the first six months of the year, CGM Mutual Fund returned -9.1%, the S&P 500 Index returned 2.6% and the ICE BofAML U.S. Corporate, Government & Mortgage Index returned -1.6%.
Trade tensions between the U.S. and China dominated market news in the second quarter. On April 1, China retaliated against U.S. tariffs on steel and aluminum with its own tariffs on a range of U.S. goods including, most notably, agricultural products. Throughout the quarter, the market reacted to escalating rhetoric and threats from both countries and the potential impact on U.S. industries targeted by possible Chinese sanctions. Rising interest rates and upward inflationary pressures also influenced stock prices. One marker of mounting inflation appeared in early April when the Labor Department reported the Producer Price Index increased more than expected in March, climbing 0.3% for the month. Our current historically long stretch of low unemployment is beginning to meaningfully impact labor costs, intensifying inflation in the service sector. The Labor Department’s March employment cost index, released on April 27, indicated wages and benefits rose 2.7% for the trailing twelve months. This marks the largest annual increase in almost a decade. Also at the end of April, the Commerce Department released its Personal Consumption Expenditure Index, which increased at an annual rate of 2% in March. The Personal Consumption Expenditure Index is the Federal Reserve’s preferred inflation gauge and this was the first time in over a year that the index met the Fed’s 2% target, providing sound evidence that inflation is impacting consumer prices.
U.S. employment numbers continued to improve in the second quarter and the unemployment rate dropped in April to 3.9%. Remarkably, the U.S. economy has added jobs every single month since October 2010. On May 8 the Labor Department also reported a record 6.6 million job openings at the end of March, which meant that for the first time ever, there were enough openings to provide every unemployed person in the U.S. with a job. The stock market was underwhelmed by the positive employment news and instead reacted to political risks and economic issues from abroad. Stocks moved up when the U.S. announced its withdrawal from the Iran nuclear deal as oil prices shot higher on the theory that renewed sanctions could reduce the supply of an already tight oil market. Late in May, short lived political turmoil in Italy resulted in a rapid selloff of European debt, dragging down U.S. stocks especially in the banking sector. U.S. tariffs on European Union, Canadian and Mexican steel and aluminum went into effect on May 31 and U.S. stocks dropped in anticipation of retaliatory sanctions.
The market rallied in early June as the U.S. and China attempted to defuse trade tensions. On June 13 the Federal Reserve raised interest rates by 0.25% and also indicated the pace of rate increases in 2018 and 2019 could accelerate to prevent the economy from expanding too rapidly. Despite new and threatened tariffs, political turmoil in Europe and slower economic growth abroad, Federal Reserve Chairman Jerome Powell cited solid U.S. growth, strong labor markets and rising inflation to support the Fed’s decision. By mid-June, the U.S. and China were once again exchanging trade threats and vowing to impose billions of dollars in tariffs on each other. While stocks dropped in response to increased trade friction, U.S. government data released for the month of May continued to provide evidence of a stronger economy. The Labor Department reported the unemployment rate fell further to 3.8% and the Consumer Price Index increased 2.8% from the prior year to its strongest reading in over six years. Retail sales bounced back from a slow start in the first quarter and, according to the Commerce Department, rose 0.8% for the month. The market remained in positive territory at quarter-end as the U.S. economy continued its second longest expansion in history.
The yield on the 10-year U.S. Treasury bond was 2.7% at the start of the second quarter. The yield climbed to a high of 3.1% on May 17 largely in response to inflationary indicators including rising prices for oil and other commodities. Rising trade tensions in June pushed the yield down slightly to 2.9% to end the quarter. The S&P 500 Index was priced at 22.9 times the trailing twelve month earnings at the end of the second quarter. While stock valuations remain high, we believe that the expanding U.S. economy and strong corporate earnings will continue to provide ample investment opportunities.
On June 30, 2018, CGM Mutual Fund was 26.8% invested in short-term U.S Treasury Notes. The three largest industry positions in the equity portion of the portfolio were in leisure, metals and mining and commercial banks. The Fund’s three largest equity holdings were Turquoise Hill Resources Ltd., Vale S.A. ADR (metals and mining) and JP Morgan Chase & Co. (commercial bank).
David C. Fietze
President
July 2, 2018
