The Golub Group
October 13, 2012
Quarterly Commentary – October 1, 2012
Global stock markets continued their advance this quarter as investors cheered the announcement of additional stimulus spending by both the European Central Bank and the U.S. Federal Reserve. Globally, central bankers are resolute in their efforts to bolster sluggish economic growth. In the U.S., the Fed has made it clear that they will keep interest rates low (through 2015) in order to stimulate economic activity and attempt to lower the unemployment rate. The old adage of “Don’t fight the Fed” has proven apt, as the S&P 500 delivered a total return (dividends included) of 6.4% in the quarter just ended and is now up 16.4% for the year. Even more impressive, stocks have returned over 30% during the past 12 months and are up nearly 130% from the lows hit in March of 2009.
Despite the advances in equity prices there is no shortage of concerns for investors to fret over. The European debt crisis, U.S. fiscal cliff, slowing growth in Asia, and tension in the Middle East to name a few, continue to cycle through as reasons for investors to be cautious.
We remain more optimistic than most, due largely to the fact that the U.S. economy appears to have entered a sustainable recovery on the backs of a strengthening housing market and a renaissance in U.S. manufacturing. Residential construction of new homes has shown a 30.5% increase (year-to-date) in permits issued and a 25.7% increase in new construction starts (U.S. Census Bureau data). Home prices, while still well below peak levels, have shown four consecutive months of price improvement. The latest ISM (Institute for Supply Management) data show expansion in both the manufacturing and non-manufacturing services sectors of the economy. Both housing and manufacturing are key drivers of employment which bodes well for further reductions in the unemployment rate. With Europe in or on the verge of recession and initial signs of a slow down in China, the United States, by comparison appears to be the safest and most durable economy in the world to invest in.
Bolstered by the recovering economy, U.S. corporations and consumers are in the strongest financial shape they have been in years. Corporate America is flush with cash as businesses have deleveraged their balance sheets and are generating record high profits and cash flow. The consumer has also reduced their debt burden, either by paying down or refinancing their liabilities and are “wealthier” due to higher stock portfolios and stabilization (if not appreciation) in home values.
Another reason for optimism is the fact that the resulting uncertainty has caused many investors to avoid equities altogether for the perceived safety of cash and fixed income. We find it difficult to believe that this apathy towards stocks can continue much longer. With interest rates at historic low levels, investors need to earn more than the current 0%-2% rates offered by cash and bonds. High-quality businesses that have the ability to pay and increase their dividends are even more attractive in this low yield environment and the valuations of these businesses are cheap on an historic basis and relative basis to the alternatives.
Q3 Portfolio Changes
During the third quarter, we increased our position in Intel Corporation (“Intel”). Please keep in mind, these commentaries should not be construed as a recommendation to buy or sell the securities discussed. Such decisions are made only within the context of the market environment as we perceive it at the time of the decisions and the structure of the diversified portfolio of which the securities are a component.
Intel is the world’s largest semiconductor company and dominates the microprocessor industry due to its global scale, massive research and development budget, and cutting-edge manufacturing capabilities. We have been long-time owners of this business due to its unassailable competitive positioning, financial strength, and attractive growth opportunities. Over the past five years, Intel has grown revenues 54% (from $35B to $54B), net income 160% (from $5B to $13B), and free cash flow 117% (from $4.7B to 10.2B).
During the quarter, Intel shares sold off significantly due to their lowered growth forecast for the third quarter. Intel cited weakness in demand from PC manufacturer customers (Dell, HP, etc.) and a slowdown in demand from higher growth emerging markets. For all of its strengths, Intel is still a cyclical business that is not immune to the supply/demand fluctuations of the PC business. We are not believers in “the death of the PC” at the hands of tablets and smartphones, as long as emerging markets and corporations continue to purchase PC/laptops as their primary computing device. Importantly, we believe in the future an increasing percentage of internet connected devices will have “intel inside” as Intel’s competitive advantage in manufacturing allows for their next generation chips to be extremely competitive in both power consumption and price, which are two critical factors necessary for success in this market.
At the recent price of $22.50, shares of Intel were trading at 9.5x trailing earnings with a dividend yield of 4%. We are hard pressed to find equally high-quality business trading so cheaply and thus added to our position on the share price weakness.
As always, we look forward to speaking with you, and if you would like to come in for a visit, please drop us a note or give us a call.
Disclaimer: All opinions presented in this commentary are strictly those of the Golub Group. You should not construe any implied or expressed conclusions presented as a promise of future returns.
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