Portfolio Review & Analysis
By Julien B. Booth
September 18, 2015
Investors assess price based on value while speculators assess value based on price. -Benjamin Graham
We spend a lot of time in the granularity of understanding credit quality and subsequent equity valuation of over 1,100 companies via our sister firm Sixty Guilders Research. (www.sixtyguildersresearch.com). While incredibly important over the longer term, financial markets are now primarily driven by the economic forces of interest rates, currencies, global growth dynamics, and political/Federal Reserve policy. The interactions and outcomes of these forces are always in motion, pushing and pulling on one another as global players compete for growth.
Growth is an absolute necessity to outrun the volume of debt created over the past 7 years. We remain skeptics that debt-funded growth is the long-term way to prosperity and market cycles are inevitable, regardless of the magic conjured amongst the host of sovereign central banks (IR manipulation). With the elixir of U.S. quantitative easing over – asset prices (stocks) are struggling. Judging by commodity prices, inventories, and industrial output we have a major overhang of capacity. Deflationary forces are generally not good for equity investors.
By definition, Equity (stock), is the residual value of an enterprise after the settlement of all liabilities. Late in bull markets, many have forgotten the subordinate nature of equity and its inherent value (or lack thereof) when earnings growth is slowing. A quick reminder of the capital structure of an enterprise is below. Note: debt is a structural and contractual obligation of a corporate or municipal entity. Debt (bonds and bank) has intrinsic value through its payment structure and senior standing in the capital structure, and generally retains value even in the event of an adverse outcome. Equity (stock) as residual value only, generally suffers a permanent capital impairment in the event of adverse outcome. Bank equity coming out of 2008 is a good proxy. Many are still awaiting its recovery.
NET-NET: will the federal reserve raise rates into a chaotic Europe/middle east/Asia, Chinese devaluation and stock market implosion, plunging commodity prices surging US dollar, and unstable generally global macro marketplace?
Interest rates will be lower for longer. There is compelling opportunity in tax-free bonds, closed end funds, selected REITS, some mortgages, and selected bond-like stocks/MLP (utilities).
As usual, thank you for investing with Forest Capital! For additional information on portfolio positioning, please contact Forest Capital directly at jbooth@forestcapital.net.