The United States economy is on solid footing, though growing at a modestly slower pace than over the past few years. We think a 2.0% rate of growth is consistent with the recent slowing business investment activity caused in large part by uncertainties related to trade negotiations. We expect those negotiations to be practically resolved in early to mid-2020 as the US election cycle approaches. Below is a graph of the past four years of US economic growth as measured by Gross Domestic Product (GDP):
US Personal Income is another indicator of the wellness of the economy as measured through individual earnings. Personal income has increased consistently since the end of the 2008-2009 downturn. In addition, as noted below in the row entitled Personal Savings, Americans are saving roughly 8% of compensation – consistent with the current near full rate of employment.
Inflation at both the producer and consumer level remains in check with annual rates hovering consistently around a 2% level.
In a recent speech at the annual meeting of the National Association for Business Economics, Ms. Esther George, President of the Federal Reserve Bank of Kansas City, stated, “the US economy is currently in a good place with low inflation, low unemployment, and an outlook for continued moderate growth.”
An accommodative Fed has been a primary driver of market gains this year. The central bank lowered rates in July for the first time since the financial crisis and followed up with another cut in September.
We believe there will be continued political and economic unrest around the globe as most major central banks provide ongoing policy accommodation in the form of lower interest rates, the UK and European Union work through details of a potential Brexit agreement, social unrest and demonstrations continue in Hong Kong, tensions increase across the Middle East with repeated hostilities and the threat of oil supply disruptions, and political jockeying accelerates in Washington, DC. Situations like these invariably create uncertainty and investment price variability.
The accelerated level of economic and political uncertainty has created a more attractive investment environment. Over the past few weeks the Dow Jones Industrial Index has had numerous days in which it swung from negative to positive and back again, moving several hundred points or more. We appreciate price variability and the irrational behavior it begets as this leads to the short-term mispricing of stocks and bonds. We remain confident in the securities we hold, our investment strategy, and our rigorous analytical process. Although the prices of many of the companies we hold remain depressed, we see through the short-term price volatility to discern the long-term value of the underlying businesses. This is where our analytical process focus is – not the last quoted stock price.
An extreme example of a mispriced stock is Gulf Island Fabrications (Nasdaq: GIFI). Although the company holds cash of nearly $5.00 per share and has no debt, shares recently traded at $4.85. In other words, the stock trades for less than net cash-on-hand. In addition to cash, the business has over $7.00 per share of tangible assets on its balance sheet. This is a prime example of short-term irrational pricing of a business that we expect to work out very well for shareholders over time.
We seek to invest in stocks when they can be purchased at irrational price levels. This applies to bonds as well. We recently invested in the bonds of Signet Jewelers Limited, purchasing $1,000 bonds at a depressed price of $870. Within weeks of our purchase, the company offered to buy the bonds from current holders for $950. We apply the same principals of mispriced stock analysis to our bond analysis.
To be sure, there are situations in which our analysis falters. For instance, we bought shares of Bristow Group, Inc. in 2018 for $8.00. After a series of poorly executed decisions by the executive team and board of directors, the company sought protection through bankruptcy court. Given these types of exceptional situations, we manage portfolio risk by committing just a small percentage of any portfolio to a single position; that way, if a business fails to meet our expectations, we limit any loss to one that is small and manageable. We never plan to make unprofitable investments, but recognize that factors beyond our control can lead to unplanned outcomes. As such, we manage capital with a defensive bias.
We believe that business managers are important to a successful investment outcome. Consequently, we speak with management before making an investment and frequently throughout the life of our holding. When appropriate, we visit with management in person. Over the past quarter we had onsite meetings with Flexsteel Industries, Inc. (Nasdaq: FLXS) in Dubuque, IA, Gulf Island Fabrication, Inc. (Nasdaq: GIFI) in Houston, TX, and LSB Industries, Inc. (Nasdaq: LXU) in Oklahoma City, OK.
We frequently attend investment conferences where we listen to multiple companies speaking with institutional investors about their businesses, often followed by one-on-one meetings. We review dozens of companies in order to identify a single suitable new investment. Research conferences are a terrific place to gain an initial exposure to a company and its executive management team.
While we can’t visit every company or meet them at conferences, we do speak quarterly with the management teams of nearly every company in which we invest. As companies report earnings and provide financial updates, we supplement our research file with a telephone conversation to discuss details that may not be obvious from published information. It is because of our frequent and in-depth engagement with executive management that we are able to influence company boards and other institutional investors through our operational activist initiatives. As in the case of Wayside Technology Group, Inc. (Nasdaq: WSTG), a company where our CEO sits on the board, we share our strategic perspectives in order to impact financial results for all shareholders.
We are uncovering more interesting investment opportunities now than at any time over the past few years. We are increasingly optimistic given the recent price variability and broad market slump. We are seeing wide discrepancy between prices and valuations, which is very encouraging. Many of the large, popular stocks that have dominated headlines recently are dramatically overvalued. Just as trees don’t grow to the sky, these elevated valuations are bound to fall – this correction process is a positive for markets in general. As new investment opportunities arrive, we will deploy cash reserves in accretive endeavors.
Portfolio (Treasury Bill Investments):
As noted above, we continue to hold an above-average amount of cash reserves in portfolios. We have done so for the past few years as we’ve patiently waited for better valuations.
To improve returns on cash holdings, we’ve been investing in 90-day Treasury Bills. Every 30 days we roll over a new T-Bill so that over a three-month period we end up holding a 30, 60 and 90-day T-Bill, creating a ladder of liquidity.
T-Bills are direct obligations of the US Government and arguably the safest, most liquid asset in the world. We invest in T-Bills due to their safety and return characteristics – our last three T-Bill investments earned annualized returns of 1.87%, 1.97% and 2.12%. Compared to an average yield of 0.09% on FDIC-insured bank account, we are earning a sizable return on cash.
From Our Library:
Nearly every week GVIC associates read a chapter from a selected book with industry relevance. We recently completed Flash Boys by Michael Lewis. The book is a critique of high-frequency trading, the much-maligned investment strategy that presupposes one can gain an edge through very fast and frequent trading in and out of securities.
As a group we were fascinated with the algorithmic trading strategies and Lewis’ captivating writing style, as he described back room deals and ‘dark pools’ where off-exchange trades are becoming more and more common. This all seemed inconsistent with our day-to-day experiences in the capital marketplace, so we picked up a second book on the subject, Flash Boys – Not So Fast by Peter Kovac, an experienced Wall Street trader and compliance officer. Mr. Kovac was quick to shine a light on many of the exaggerations and overstatements purported by Lewis.
Our takeaway: continue with our long-term, fundamental approach to investing and ignore those investors with time horizons often spanning less than a second. Also, a good dose of skepticism with a critical thinking overlay remains useful with our investment strategy.
After more than twelve years in our current location, we are moving to the city. On December 1st we will move to a new downtown Milwaukee office located at 1433 N. Water St. This move is in response to the changing needs of our dedicated associates as well as evolving workspace requirements. A reminder letter with our new address will be sent in November. Our phone numbers and e-mail addresses will remain the same. We welcome your visit if you should be in the area.
Of greater interest and importance, JP and his wife, Erin, are expecting their first child in late November. Please be sure to congratulate him when you next speak.
We wish to thank Prakash Goath of our India office for his nearly four years of service to the firm. He has decided to relocate to his hometown in northern India to be closer to his family. His positive attitude and insatiable curiosity will be missed.
Each day brings new challenges and continued learning for all of our associates. Our internal processes continue to improve as the firm matures and new associates are hired. I am grateful to all of our clients, both new and old, for your trust and confidence.
If you would like to update your investment objectives or portfolio restrictions, please let us know so we can make appropriate adjustments.
We remain committed to achieving long-term investment excellence by investing intelligently and opportunistically. Our capital is invested in the same companies we recommend. Please call anytime for a more detailed discussion of our strategy and market outlook. We are always happy to share our views and outlook.
Your Investment Research & Advisory Team
Global Value Investment Corp.
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The opinions expressed herein are solely those of Global Value Investment Corp. (GVIC), its divisions and its subsidiary business. The data is furnished for informational purposes only and should not be relied upon as the basis for an investment decision or recommendation. Although it is derived from sources believed to be accurate, GVIC cannot guarantee the accuracy of any statistical information.